public with a reverse merger has all the disadvantages of going
public any other way: the cost of annual audits, SEC filings and
disclosure, investor relations expenses. These costs weigh heavily
on any new venture that is short of capital and income.
reverse mergers in particular, as opposed to an initial
public offering or self-registration
IPO, the following discusses the disadvantages.
when you buy
a shell company, you have the expense of paying for the shell,
which I includes the cash you pay and the amount of the company
you have to give up to the shell shareholders.
Second, you have the
risk of merging into a shell with a hidden defect. These defects
could undisclosed legal judgments against the company, other
liabilities, undisclosed shares of stock that will be dumped on
the market, undisclosed warrants to buy cheap stock, contracts
that create liabilities, lawsuits that will show up only after the
company has assets, etc.
Third, the shell
company may have bad or missing records that prevent the company
from being audited. This limits the options and growth of the
in decades past there was a stigma associated with reverse
mergers, the idea that if you were a real company you would do an
IPO. That stigma dissipated with the use of public shells for PIPE
(private investment in public equity) financings. However, the
reverse merger stigma has returned from the recent discover of a
number of Chinese reverse merger frauds, most certainly after the
SEC warning to investors about any kind of reverse mergers. This
is important because as raising money is the primary goal of a
reverse merger, the willingness of investors to invest is a
Creating a Market
disadvantages are well known, but the biggest problem with reverse
mergers, as well as self-registrations, is the creation of a
trading market in the stock.
The importance of
creating a trading market in the stock is often ignored by shell
merchants and attorneys attempting to sell their wares.
Kindly be advised
that while your company has substantial value, there is also value
in having an active trading market.
Without an active
investor interest in the stock, you cannot find large investors
who will give you money. These investors want to know that they
have an exit strategy to sell their stock. They will not purchase
stock privately or even publicly without a market for their
investment down the road.
I have seen actively
trading companies command as much as $1 million in market value
beyond the value of the company alone.
Even a large
shareholder list with little volume will have value.
CEOs will spend hundreds of thousands of dollars in stock or cash
relations to create the market because they know that having
that market will create millions in market value for their
a trading market using investor
relations firms is not only a cost in money, it has a cost in
time. When you do a reverse merger with a shell what has few
shareholders and little or no volume, you may spend months to get
the stock widely held and actively traded. These months will be
spent telling the story of the company and getting people to buy
stock. The time will be spent on large campaigns of publicity and
During this period,
your company will have to survive more and more scrutiny from
investors. Not only must the story be good, it must be true.
your stock becomes over-priced, you may find that you are under
attack from short
sellers, another disadvantage of going public that can happen
to all public companies no matter how they went public.
Those companies that
have to continually sell stock to raise money are the favorite
prey of short sellers because by driving the price down, the
shorts can drive the company out of business and profit.
Another favorite of
the short sellers are companies using fraud, whether it is false
claims, undisclosed past bad histories of the promoters, or
whatever. Short sellers will do intense investigations of their
targets and broadcast whatever bad news they find.
was the case with the recent campaign of short
sellers on Chinese reverse mergers. The lack of business
ethics in these Chinese companies opened the door to a huge
campaign by the shorts sellers using planted media articles and
other public relations techniques.
company will be on the short sellers radar if it has a high market
value in relation to the book value and earnings of the company.
of Reverse Merger Companies
As I found out in
researching my book “How
to Pick Hot Reverse Merger Penny Stocks,” most reverse
merger stocks will end up declining after a few years.
However, as I found
out researching stocks to find home
run stocks, most initial public offering stocks will face the
same black future. This includes IPOs from some of the biggest
names in investment banking. Many of these stocks were supported
by their bankers for 3-4 years before being allowed to sink into
In my opinion, the
problem is in the nature of business. New ventures often fail.
As I found out in
years of searching for venture capital money, most venture
capitalists lose money in nearly all of their ventures.
for this apparent waste is naturally that without venture
capital, IPOs and the stock market, there would be no economic
In my opinion, the
reverse merger model is a better model for providing venture
capital in that it gives the investors liquidity and gives the
entrepreneurs control over their destiny. It does rob vulture
capitalists of the chance to squeeze new ventures out of equity,
but that is a good thing. I know of worthy ventures that were
allowed to die because their founders would rather do nothing
than pay extortionate profits to the venture capitalists and hand
over control to people who were not expert in their business.
Cost of Capital
model is used, venture capital, IPO, reverse merger or whatever,
the cost of capital for new ventures will be high, but not as
high as not having funding at all.
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