If a reverse merger still sounds like a good idea to you, here
are the steps you need to take:
1.Find a shell company. As a first stop, ask an
attorney. Every metropolitan area has a law firm with a securities
practice. Often, these firms have a dormant public company sitting
on one of the partners' bookshelves.
Another alternative is an accountant. People who control shell
companies tend to keep the financial statements, such as they are,
up to date. This brings accountants into the loop. Like attorneys,
they know where the bodies are.
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Financing consultants may also be a good source. In fact, many
actually have a couple shell corporations and, upon request, can
manufacture a clean public shell. A made-to-order shell without the
baggage of a business failure in its background can sometimes be
the way to go.
But there's often a cost involved. You'll most likely
end up with the financing consultants as minority shareholders in
the new company, holding between 2 percent and 5 percent. However,
in almost any reverse merger transaction, the principals of the
shell company keep a small equity position in the company going
forward. Therefore, this surrender of equity is simply a cost of
doing business.
2.Devise your financing strategy. As we've
mentioned, a reverse merger is an indirect route to raising
capital. Entrepreneurs must first consider how additional capital
will be raised after the deal is done.
As was mentioned previously, a public company can issue and
exercise warrants. Some public shell companies already have
warrants issued and outstanding and some have previously registered
the underlying common stock shares with the Securities and Exchange
Commission--which is a significant benefit. This is much easier and
much more valuable to a company that wants to raise capital with
warrants. If the newly public company must create and issue
warrants, the road to getting them exercised will be trickier but
still possible. In short, exercising warrants where the underlying
common shares are not registered requires the assistance of a
brokerage firm and must occur in a state where there is no
registration requirement for issuance of shares of up to $1 million
total.
If you're going the private-offering route (i.e., an
offering sold to select individuals rather than through a sale
directly to the public at large), the deal must be carefully
structured. Specifically, the amount of stock owned by investors
that the new owners do not know and cannot influence must be
diminished so that a stable quote can be established. Usually, this
is done by reducing the percentage of the total number of shares
these investors own. By doing so, as an added incentive, the
private investors can be offered stock at a discount to the market
price.
For example, if the stock costs $7, private investors are
offered the opportunity to purchase common stock at $5. This
incentive evaporates when sell orders flood the market and the
market price of the stock drops to $5.
Of course, smart investors know they can't simply load up on
$5 stock in a private placement and turn around and sell it on the
public market at $7. There simply aren't that many buyers to
support that kind of selling. But the point is that it's much
easier to sell common stock to investors at $5 in a private
offering when the market price is $7 than it is to sell common
stock privately at $5 when the market price is $4.
3.Clean up your act. Unfortunately, there's a
stigma attached to reverse mergers. LCA-Vision's Stephen N.
Joffe, who used the technique to brilliant effect (see "A Case
In Point," page 144), says that although reverse mergers
worked for his company, "there's definitely another side
to these deals. If it wasn't for my long-standing reputation in
the medical community, our deal might have been perceived
differently." Largely, the bad rap stems from the fact that
reverse mergers are not understood, Stephens says.
Entrepreneurs contemplating such a transaction can and should
take steps to elevate the profile of their "new" company.
Specifically:
- Hire a national accounting firm. One of the
reasons the Big Five fees are high is because they inspire a lot of
comfort among investors, traders and regulators. If you saved a lot
on fees at the front end, this might be worth investing in on the
back end.
- Hire a prestigious law firm. It's almost a
certainty that the attorney who initially helps you with your
reverse merger transaction, if he or she is an expert in these
kinds of deals, will not be with a prestigious downtown law firm.
However, after the offering is completed, you should consider
retaining one of these firms. Why? When deciding whether to get
involved in your offering, many investors and brokers will judge
your firm by the company it keeps. An unknown law firm makes a
neutral to negative impression. But a well-known and powerful law
firm sends an unmistakable message.
4.Check your greed. The great rallying cry of the
1980s, popularized by the oily Hollywood takeover artist Gordon
Gekko, "Greed is good," doesn't apply with a reverse
merger. It's possible to structure a reverse merger so at the
end of the day, the public owns 2 percent of the company and the
remaining 98 percent is controlled by the owners of the private
company that acquired the shell. Unfortunately, there's almost
no incentive for any other investors to become involved if the only
people who truly benefit are the insiders. The lesson is, if you
plan to involve the public with the intention of engaging in a
truly symbiotic relationship, you simply must leave some value on
the table.
In many ways, the reputation of reverse mergers is similar to
the notoriety junk bonds had during the 1980s. Junk was used by
corporate raiders to buy companies and break them up. But junk
bonds also nurtured an entire generation of exciting growth
companies and had a material and profound impact on the economy in
terms of wealth and employment.
Remember, a reverse merger is simply a technique. The ultimate
quality of the deal depends on how wisely it is deployed.
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