Reverse Merger FAQ

It is important to note the history of going public techniques. First, we had the initial public offering or IPO. A company, let’s call it a venture company, seeking to raise money finds an underwriter for their stock offering.

Then came the reverse merger or merger with an OTC shell. The company seeking money, the venture company, found a (hopefully) clean shell trading over the counter. The shell usually had no assets but had trading public stock. The venture company merged with the OTC shell, giving up 5-20% of its value to the public shell shareholders and paying $50-$750,000 to the principals of the public shell. The result was a publicly trading company – fast.

Several problems developed in this reverse merger approach. First, the stock of the new company was trading usually without full disclosure. Second, the people who controlled the shell often dumped their stock on the market without mercy, leading to a disastrous decline in the stock price of the new company and unjustified shareholder anger at the new management for letting the stock price slip when the new management were simply victims as well.

In fact, there were so many abuses in the reverse merger game, that the SEC in 2005 and passed a rule saying that the venture company had to file a Form 8-K within four days after the merger. This Form 8-K had to contain essentially all the information you would need to file in a public offering. Now there would be full disclosure to investors– essentially the same disclosure you would need to file if you were registering the stock for sale. So we now call it a Super 8-K.

However, if you are essentially filing the same information as when you register the stock for sale in an IPO, why not just register the stock for sale and forget about buying the OTC shell? The answer is that there are usually no good reasons to buy the shell. You might as well do what is sometimes called a self-filing or direct registration.

Moreover, when you do a reverse merger, there are many drawbacks to buying the shell over registering the stock in a self-registration. The cost of the cash payment to the principals of the shell and the percentage of your company you give up to the shareholders are very expensive. Shells can have undisclosed problems and liabilities. Instead of having to prepare a filing on one company, in effect you must prepare the documents for two companies that are now in the new company: your company and the shell. Also, a shell deal may carry some negative stigma with some in the financial community.

Having the shareholders in the public shell dumping stock in the market is not a good thing for your stock price. You want loyal shareholders. As a former market maker as well as an attorney and investment banker, I can tell you that a strong operating company can attract more and better market makers than those that usually trade OTC shells. The market makers who trade public shells themselves position blocks of the stock when it is a shell and dirt cheap, buying the stock for a few cents and dumping it in the market when it is a few dollars after the merger. The volume of trading in a shell company is usually thin. While some may think they are paying for a trading market by buying a shell, they are really buying a market that has nothing of much value.

Thus, the more you look at the alternatives, the more you can start to see the advantages of a self-registration. Now you want to contact a good advisor on these transactions. I believe that the more you look at it, the more it usually makes sense to do the self-filing.

The author, John Lux, has been an OTC market maker in new issues, shells and other companies, a security analyst, an investment banker, and attorney. He is a principal in several venture companies and private equity funds.

How can you learn more? Contact John Lux: mailto:lux.investor@gmail.com

Contact John to have all your questions answered about reverse mergers without obligation in a friendly, relaxed manner.

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