With the IPO window only beginning to open, entrepreneurs could
be forgiven for giving reverse mergers more than fleeting
consideration. This "back door" to the public
market— reviled in the '70s and '80s for the shady
deals it spawned— private companies to become public by
acquiring or merging with a public "shell" company. The
shell is listed on an exchange, usually the OTC Bulletin Board, but
has no assets, typically following a sale or bankruptcy. A slew of
regulations from the SEC in the early '90s made reverse mergers
safer, both for entrepreneurs and for investors, but many experts
remain skeptical.
For business owners desperate to take their companies public,
reverse mergers are in fact a cheaper, quicker alternative to an
IPO. They're also more certain, says David Feldman, managing
partner of law firm Feldman Weinstein LLP in New York City, who
believes they no longer warrant their bad rap. "You can work
on an IPO for 12 months, and then market conditions say
'We're not doing it,'" he says. Unlike a
traditional IPO, a reverse merger doesn't depend on market
conditions, so it happens on schedule, come bull or bear.
But on the downside, because the company isn't escorted onto
the trading floor on the arm of a powerful brokerage company or
investment bank, market support and analyst coverage are basically
nil. "Pretty much nobody cares," concedes Feldman.
"Support develops over time." The reverse merger, he
adds, is not about raising tons of capital, although it does offer
more liquidity for investors. Rather, it's best for those
companies for which being public would be a significant asset, a
strategic advantage.
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That was so for Immediatek Inc., a Richardson, Texas-based technology
solutions provider that makes burn and copyright protection
software. CEO Zach Bair says the technology is in high demand,
given the music industry's piracy headaches. But as a private
company, Bair couldn't get the time of day from either
potential customers or investors. "Without being public, I
wouldn't have been able to make the contacts I have with Sony,
Warner and other record labels," says Bair, 40. He adds that
the potential for liquidity made Immediatek more attractive to
investors.
But critics say that in a down market, liquidity is still just a
wish for OTC stocks. "Without the affiliation or certification
of a traditional investment banking firm, it's hard to convince
legitimate investors there's not something to be wary
about," says Jay Ritter, Cordell professor of finance at the
University of Florida in Gainesville. Without Wall Street support,
the company's stock can languish in obscurity, no better off
than when it was private.
Bair is counting on a few deals with big labels to give the
company, with $1.5 million projected 2003 sales, the boost it needs
to move from OTC to one of the bigger exchanges. "We have the
technology and the road map that will make us a major player in
this industry," he says.
According to Elizabeth Saunders, chair and co-founder of
investor relations advisory firm Ashton Partners
in Chicago, too many entrepreneurs hope OTC will be a springboard
to Nasdaq, but very few actually make it. "Most end up as OTC
Bulletin Board stocks-a really tough place to be," she says.
"It's not as if financing comes easier than if you're
private. And you have a slew of reporting requirements."
The onerous requirements that come along with the Sarbanes-Oxley
Act have placed a heavy burden on smaller companies and may make
going public less attractive than it once was, even via the
relatively inexpensive reverse merger. Bair says he doesn't
regret doing it, but adds that he learned a lot of lessons the hard
way. "It's not about making a quick buck. But if you stay
focused on your business, and the product is compelling, and you
have an excellent management team, you have the chance to make it
work."
C.J. Prince is executive editor of CEO Magazine. She
can be reached at cjprince@chiefexecutive.net.