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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.
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 firstname.lastname@example.org.