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10 Sep Reverse Merger Due Diligence

As I’ve said before, I think a shell is a great adjective for a previously publicly traded company as it indicates something died inside. Proper due diligence of a public shell is an absolute necessity for private companies looking to take their business to the public markets. What follows is a good starting list of due diligence items (although not complete exhaustive) when investigating a public shell corporation.

 

  • Check required SEC filings including those required by directors, officers and shareholders with greater than 5% equity in the business. It’s good to ensure all filings are current and such reports should provide good insight into such persons, even if they have not been with the company for a long time.
  • Review a list of current and previous shareholders of the company. If you can, get in touch with them and see if they have any legal ties and what their interest in the company will be during and post-merger. It will provide helpful insight.
  • Go back through previously released press and investor relations material from the shell. Doing so will help in gauging and finding a bit more about the company history which could also help in uncovering some unsavory data–or even helpful data.
  • Check all corporate history documentation which could include, but is not limited to, stock issuance certificates, stock records, corporate bylaws, and incorporation docs & agreements.
  • Review everything having to do with the current and previous management, their consultants and the backgrounds of those involved in the merger deal. It is also wise to check the backgrounds of such persons to determine their interest in the shell and in previous deals that could be less than savory. Start from the present and work back to the beginning.
  • Take a thorough view of all SEC filings of the shell. Are the filings current? Complete? Were they done according to SEC regulations and rules? If the shell is reporting (or at least claiming to be) you’ll want to check on any previous SEC investigations. It is also helpful to see how the shell began and what has happened since then.
  • Review the history of all the shell’s activity. That could include the business that has been in the shell, liabilities and litigation and any issues that could still haunt the shell.
  • Has a reverse merger been completed in the past? Has a RTO been attempted in the past, but not completed? If so, what occured?
  • Is there any litigation or suit threats against the shell?
  • Review all Intellectual Property (IP) the shell claims to own. Check and see what IP may provide benefit and what liability relating to such IP could come back to haunt the shell. This could include trademarks, patents or copyrights.
  • Are there any previously-executed contracts the company may have entered into that could still be in force?
  • Follow the trail of the auditors. Has the company always received regular audits? Has the audit management ever changed? If so, why?
  • Seek out questionable payments. Are payments given to shell managers that are above normal or which may seem odd?
  • If the stock is trading are there recent trading aberrations or patterns that may cause red flags to arise?

 

Other issues not listed here could become readily apparent as you simply ask the questions above. These should be a good starting point. Due diligence’s importance in these transactions should not be downplayed. Expert counsel, audit and financial “diggers” should be employed. When you don’t perform the right amount of due diligence in a reverse merger, you’re smoking dope. Like the development of a fetus, there are almost always more ways to have a failure than a success. I’m always amazed when deals with issues make their way through successfully. Where there’s a will, there’s a way.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.