Put It In Reverse

The Scoop

Reverse merger defined: A privately held company acquires a publicly traded, but usually dormant, company. By doing so, the private company becomes public.

Appropriate for: Companies that don't need capital quickly and will experience enough growth to reach a size and scale at which they can succeed as a public entity. Minimum sales and earnings to reach this plateau are $20 million and $2 mil-lion, respectively.

Supply: There are thousands of dormant public companies, sometimes called shells, that might be viable merger candidates. By becoming public, a company becomes a more attractive investment to a wider range of investors. The supply of equity capital is more abundant for public companies than for private ones.

Best use: Reverse mergers can be used to finance anything from product development to working capital needs. However, they work best for com-panies that don't need capital quickly. Not that reverse mergers take long to consummate, but the initial transaction is usually just the halfway point. Once public, a company generally must still find capital. Also, this financing technique works better for companies that will experience substantial enough growth to develop into a "real" public company.

Cost: Expensive, but compared with a conventional initial public offering, fees and expenses are not that high for a reverse merger. Deals can be completed for $50,000 to $100,000, which might be 25 percent of the out-of-pocket costs that would come with a full-blown IPO. In the process of making the deal, however, the acquiring company might give up 10 percent to 20 percent of its equity. This is very expensive. After all, it means a company is surrendering ownership just for the privilege of being public. More equity will probably disappear when the company actually raises money.

Ease of acquisition: Difficult, but not as difficult as a conventional IPO. Perhaps the most challenging aspect of a reverse merger is trying to create a real trading market for the company's shares once the deal is done.

Range of funds typically available: $500,000 and greater.

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This article was originally published in the June 1999 print edition of Entrepreneur with the headline: Put It In Reverse.

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