Danger Zone

Shell Game

Another common scam involves stock manipulation and can wind up causing more headaches than a small-business owner ever imagined. Some brokers merge an entrepreneur's firm into a dormant shell company, one that's already traded on the public market but is firmly under someone else's control. "It's hard to understand how you make money that way," says Mark Griffin, Utah's security administrator.

It works like this: A broker approaches a small business, offering an alternative to going public for capital. In this scheme, the offer entails becoming part of a company that has already gone public but isn't currently active. Sounds appealing, but it's also very dangerous, says Tom Stewart-Gordon, who publishes the newsletter SCOR Report. "The entrepreneur doesn't ask the appropriate questions-'Who's [tracking the performance of] this company?' and 'What is the trade volume on this company?' Basically, the shells are dead, like seashells. They just lie there," says Stewart-Gordon. If you don't investigate before getting involved, your company could end up dead, too.

While some shell mergers are legitimate (see next month's "Raising Money" column for more on the subject), Griffin warns that getting involved with an empty shell company is exceedingly dangerous, and he recommends asking a great many questions before entering into such an arrangement. First and foremost is finding out exactly who controls the company, although this can be difficult. "A certificate of stock has a name on it, but once that name is endorsed on the back of that stock certificate, it can travel from hand to hand," says Griffin. "It can wind up in somebody's safe or shoebox." Take as long as you must to investigate thoroughly before buying into the deal.

If you make the wrong decision about merging with a shell, Griffin says, you may find yourself answering to a host of angry investors. Once your name is on the public record of an empty shell, you're an easy and likely target for shareholder angst. "You wake up in the morning, and you're answering telephone calls from angry investors complaining about the stock price," he says.

Even more heartbreaking, Griffin says, some scam artists manage to find defunct public shell companies that have been dissolved. They resurrect them as private companies but tell the entrepreneur the company is public. The business owner opts to merge, only to discover, tragically, that he or she is no longer in control of his or her company after building it from the ground up.

Griffin's advice boils down to common sense: When it comes to raising money, haste can land you in a lot of hot water. If something seems too good to be true, it probably is. "[Entrepreneurs] don't realize there is a certain maturation process that has to take place," he says. "Growing overnight can lead to significant pain and discomfort."

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This article was originally published in the August 1996 print edition of Entrepreneur with the headline: Danger Zone.

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