Costs And Benefits Of Reverse Mergers

FEATURE ARTICLES Costs And Benefits Of Reverse Mergers by Andrew J. Sherman McDermott, Will & Emery In today's current volatile markets, many emerging growth companies are forced to explore more creative and aggressive options for capital formation. Many clients have approached us about the possibility of a reverse merger as a solution to their capital needs - a risky transaction that definitely has its share of costs and benefits. Let's take a look at the basics of this type of transaction in greater detail. What is a Reverse Merger? A "reverse merger" is essentially a method by which a private company goes public. In a reverse merger, a Strategic Partners private company merges with a publicly listed company which may have a broken business model, an obsolete business plan or underperforming assets and liabilities. Or, it may have been formed as a "blind pool" by its founders and be in search of a viable business that it can acquire (the public company may be sometimes referred to as a "shell" corporation). By merging into such an entity, a private company becomes public. The private company merges into a public company and typically obtains a significant portion of its stock. The private company normally will change the name of the public corporation (often to its own name) and will appoint and elect its management and Board of Directors. The new public corporation will usually have a base of shareholders sufficient to meet the 300-shareholder requirement for admission to quotation on the NASDAQ SmallCap Market. Going public through a reverse merger allows a private company to go public typically at a lesser cost and with less stock dilution than through an initial public offering (IPO). While the processes of going public and raising capital is combined in an IPO, in a reverse merger (also know as a "blind pool" merger) these two functions are unbundled. The newly-merged company can then begin planning for a follow-up "PIPE" deal (e.g., a private placement offering by a public company) or begin setting the stage for a "secondary offering" at a presumably higher valuation. ADVANTAGES Benefits of merging into a public shell include: Lower transactional costs as compared to an IPO Increased liquidity of the shares of the company Greater access to the capital markets through the possibilities of a PIPE or a future secondary offering The ability to use shares of the company to make acquisitions of other companies The ability to use stock incentive plans to attract and retain key employees Enhanced planning alternatives when formulating a retirement strategy for its principals Being publicly traded may raise the profile and reputation of the company The timetable required is considerably less than for a traditional IPO and may be less demanding on the schedules of the private company's management and advisory team While an IPO in today's market requires a relatively long and stable earning history, the lack of an earning history does not normally keep a privately-held company without this track record from completing a reverse merger The private company does not typically require an underwriter or network of broker/dealers to accomplish the transactions There may be less dilution of ownership control for the private company's management team DISADVANTAGES Being a publicly traded company is not what it was 18-24 months ago -- the perception of prestige and stability has been diluted in part by technology and dot.com companies which were "high flyers" at $300 per share that now trade for a few dollars per share! One of the key benefits of going public - the initial capital raised through an IPO - does not typically accrue through the reverse merger process The key benefits of being public -- access to the capital markets, using shares for M&A, using shares to recruit key employees - may also have been diluted by the recent developments in the capital markets. There are different types of reverse merger situations. A truly "clean" shell will offer some cash, minimal assets and liabilities and no operating history -- presenting very little risk for the principals of the privately held company, other than negotiating the key terms of the deal. On the other hand, a publicly-traded company with a broken or obsolete business model may have shareholder lawsuits, employee problems, customer and vendor disputes and other liabilities - therefore it is critical to do your due diligence and be careful what you are walking into. While the costs and time commitments may be lower than a traditional IPO, they are not nonexistent. It will still be a time-consuming and expensive transaction when compared to the alternatives, such as a joint venture, a private placement memorandum or raising money from a venture capitalist. Costs of reverse mergers can range from $100,000 to $500,000. Make sure that you have been briefed by a veteran corporate and securities lawyer or an experienced accountant on the ongoing costs of being a public company -- which can be significant. It is critical that you have the right advisory team in place to get the deal done properly and to continue to work with the company on a post-closing and ongoing basis. I know that it is tempting to try almost anything to help your company grow during these challenging times, but proceed carefully, know the risks and have the proper advisors. Other Information on Reverse Mergers A detailed examination of reverse mergers including advantages and disadvantages and a guide to the reverse merger process from Entrepreneur Magazine. http://www.entrepreneur.com/Your_Business/YB_SegArticle/0,4621,230320,00.html The above cited study by RCW Mirus of 46 companies that went public through a reverse merger between 1999 and 2001. In case you're wondering how Mirus feels about the topic, the study's title provides a hint: "The Reverse Merger: Backing into Wall Street's Worst Idea." http://www.merger.com/pdfs/rsch_reverse_merger.pdf More pros and cons as well as case studies of reverse mergers from Computerworld http://www.computerworld.com/cwi/story/0,1199,NAV47-68-85-1950-1974_STO58924,00.html Andrew J. Sherman is a Partner in the Corporate Department in the Washington, D.C. office of McDermott, Will & Emery, an international law firm with nearly one thousand (1,000) attorneys worldwide. Mr. Sherman can be reached at (202) 756-8610 or mailto:ajsherman@mwe.com. The Web M&A Update is produced by Webmergers, Inc., San Francisco, CA. Visit our web site at: www.webmergers.com Reprinted with permission from The Internet M&A Update, Volume III, Issue 71, Aug 29, 2001. Legal Notice: Subscribers may forward all or portions of this newsletter so long as all forwarded items include the Webmergers copyright. Republication, inclusion in a reference database or other commercial reuse of this information are strictly prohibited. Copyright, 2001 Webmergers, Inc. Back to The Venturer Newsletter for November 2001 Join as a Member | Become a Sponsor | Calendar of Events Contact us | Terms of Use | Site Map | Home Northwest Venture Group P.O. Box 40128, Bellevue, WA 98015-4128 Office: (425) 897-7040. Reservations: (425) 746-1973. info@nwvg.org Designed by InfoAdvantage, LLC webmaster@nwvg.org