Reverse mergers are a bit like the elephant who allows himself to be swallowed by a snake so he may more easily slither to greener pastures. The process is ungainly, and seemingly odd, but it beats the costly and labyrinthian path of the IPO by a country mile.
Being publicly traded is every company’s dream. With a world of investors backing you, expansion opportunities appear limitless. But the traditional IPO’s million dollar-plus price tag makes this dream an expensive and often unobtainable one.
The Venture Association of New Jersey will present “Reverse Mergers and Other Alternatives to Traditional IPOs,” a seminar given by David Feldman, author of the book of the same name, and founder of New York-based law firm Feldman LLP, on Tuesday, March 23, at 11:30 a.m. at the Marriott Hanover in Whippany. Cost: $75. Visit www.VANJ.org.
Feldman is the recognized reverse merger authority. His 14-attorney firm, which he founded in 1996, has engineered more successful ones than nearly anyone else around. His two books “Reverse Mergers — Taking a Company Public Without an IPO” (Bloomberg Press, 2006) and “Reverse Mergers and Other Alternatives to Traditional IPOs” (Bloomberg Press, 2009) have made him a frequent speaker on his profitable niche.
Content with his initial surroundings, Feldman today lives a quarter mile from the Hewlett, Long Island, house where he grew up; his son attends the same nearby Lawrence Woodmere Academy. Though Feldman’s father was an orthopedist, his uncle and many other relatives served as attorney models. Thus, after earning his bachelor’s in 1982 and his law degree, both from Penn, Feldman returned to his uncle’s law firm for his initial practice.
“I then tried seven years in big New York law firms,” says Feldman. “I really got tired of being yelled at every day.” So he founded his own partnership, practicing corporate law, until 14 years ago when he launched his own boutique law firm and brought aboard “big firm refugees, like myself.”
Feldman is among the many who view the giant IPO hurdle into the public exchanges as an overwhelming obstacle, separating solid companies from willing investors. If a company can find a publicly traded “shell” company and buy it up, couldn’t they slip into the public exchanges through the back door and avoid the immense cost, time, and restrictions?
More than 200 companies annually are entering this reverse merger process and answering with a resounding, profitable “Yes, you can.”
The public shell. Not every firm listed on a major exchange is active. Hundreds have ceased to trade or report partially or even completely. But they glitter in investment circles because of one shining asset — their SEC trading registration.
This means they have spent typically $1 million to $2 million in legal, printing, preparation, disclosure, and registration fees to make an initial public offering. They have endured the required yearlong IPO process. They have taken the risk that their underwriting may be canceled in mid course due to market conditions, wasting all their expenses and efforts. And they have operated under the restrictive SEC guidelines for new publicly traded entities.
Such non-active corporations still holding this distinction may quietly promote themselves as a public shell company, available for buy out by bidding firms anxious to break into the public exchanges. It also provides an exit strategy for the shell’s owners.
The shell game. “I recently completed one reverse merger in just one week,” states Feldman. “That’s unusual, though.” Typically,
Feldman LLP shepherds private corporations into public ones over the course of one or two months for the comparatively cheap sticker price of $200,000 to $500,000.
The reverse merging launches when the private firm finds a public shell of the right size with its trading status intact. Buying up the shell’s available shares, the private firm takes position as majority stockholder. Thus gaining some measure of control, the board votes in the merger between the two companies.
The remainder of the merger may be achieved by nonvoting, executive action. The formerly private company now has stock available for public investors. The shell’s existing shareholders retain their shares, though at a greatly diluted rate. This seldom makes the takeover hostile, however.
“Normally the shell’s people are thrilled,” explains Feldman. “Five percent of something is a heck of a lot better than 100 percent of nothing.” The newly merged entity’s name and ticker symbol usually changes to reflect the private firm’s ownership.
It all seems sweet and easy, but there are a distinct disadvantages. Following a standard IPO, a company’s stock invariably shoots upward. This pop-and-drop syndrome allows money to be made by all at that point. With a reverse merger, the stock is not bursting glamorously onto the floor and its growth is more of a slow build. Frequently, the newly merged corporation must take its stock to a financial relations firm in order to get the brokers’ attention.
Also, public-shock soon settles on the formerly private company’s owners. Their percentage of holdings is greatly diminished as hedge funders and individual investors climb aboard. They must maintain totally transparent records and open actions. Being available for such scrutiny involves costly executive time and brings a sluggishness to operations. “Companies can count on a cost of $500,000 to $800,000 a year to keep themselves public,” says Feldman. “A lot of them don’t consider that expense.”
Caveats galore. Reverse mergers have, interestingly, opened the door to a Chinese invasion. Viewing America as the golden fountain of secure and lush investment, one-third of all reverse mergers in the past few years have come from private Chinese companies. Domestic or foreign, companies aspiring for public trade hold between $50 million to $100 million in revenues. This means they have substantial funds to wield, and often little experience in the public arena. Too many enter it ripe for plucking.
A good shell is hard to find. Feldman constantly pushes private firm clients to scrub their prospects and diligently look for skeletons. When you buy a shell, it’s like a house — all its liabilities become yours. The landscape is filled with hired touts, championing failing public companies who see a buyout as the best way out of their hidden debt. “There are a lot of well known people making appearances on mainstream media who frankly are crooks as yet uncaught,” says Feldman.
Training wheels. Investment banks are getting into the merger act by funding private firms in their initial share purchasing. Within their own holders, the banks can often bring in the necessary financing. This semiprivate offering can boost the aspiring firm up toward a public position.
Custom shells may also be specially designed for private companies, but this remains a tricky playing field. Many such shells are legitimate, but when, for example, a company forms a gold mining corporation that has no intention of mining minerals, but only to share buyers, it’s time to be cautious.
Throwing one’s hard-won, home-built company out into the public arena and putting its ownership up for grabs is a daunting move. On the other hand, it truly is the only way to expand fully and play in the big leagues. The reverse merger offers, for many, the step to make it all possible.
But as with any other major venture, it pays to search out the best professionals in the field who know all the players and have done this operation hundreds of times before. With a little luck, and a lot of good advice, you may just be swallowed up into those greener, more profitable pastures.