Dirty Public Shells

If you’ve been around this industry, you’ll recognize an oft-repeated request, “can you provide me with a clean public shell corp?” The problem with most public shell corporations is that they’re often a shell because something died inside. What remains of the carcass almost always needs thorough investigation through due diligence and some good cleaning-up. Knowing where the potential trip-ups can occur is helpful, but nothing replaces thorough due diligence.

Shell Share Ownership Disputes & Difficulty. Shell shares can be very messy. There may be current disputes that haunt the shell and some shareholders may have preferred shares that are different than others.  Advisors or agents may claim shares have been returned, but the paperwork may not substantiate or could conflict with verbal reports. Sometimes minimal or scanty documentation of all current and previous shareholders prevents the painting of the whole story. Worse still is when share ownership is not current with SEC filings, making it even more difficult to track ownership.

Late or Non-Existent SEC Filing. Failing to stay current with the Securities and Exchange Commission can jeopardize the legitimacy of the public company. Other issues involved with SEC filings could include incomplete or inaccurate filings or attempting to play catch-up just prior to the closing of a reverse merger. It is okay to fix a shell by getting current, but make sure all the bugs are ironed-out and the SEC has provided its blessing before any deal is consummated.

Previous or Repeat Reverse Merger Activity. Some shells have been shells more than once. This can pose a number of potential issues, which are pretty much outlined in the rest of the points here. If the shell has been a shell more than once, there can sometimes be several layers of required due diligence to make sure things are clean. If such a shell has been shopped around and not yet found a suitable mate, red flags should be going off, “why was no one else interested?”

Finding Officers, Shareholders & Board Members. Knowing which throat to choke is an important part of public shell due diligence. Understanding who is/was on the board, who are/were shareholders and who is/was an officer of the organization is helpful if any of the other listed items hit the fan: you’ll know who to go to directly to ask questions and get answers. At least that’s what you hope. In many instances, even those involved or once involved don’t have a clue, but they should and the Operating Agreement will at least help to hold some such folks accountable for missing/incorrect information.

Previous, Current or Potential Litigation. Litigation or liens against the shell will need settled prior to closing a reverse takeover deal. Nothing is more frustrating than being a party to a lawsuit that had nothing to do with the normal course of business, but was instead the result of the previous company now defunct. Sometimes litigation can get messy. For instance, it’s important to keep your eye out for third parties who attempt to indemnify against any current or future litigation. Can such a promoter back up a collection on such an indemnity? Be aware of such shallow or empty indemnities. When in doubt, settle and make the bad stuff go away.

Shell Liabilities. Liabilities that still exist within an existing shell may not be limited to some LOC. They could be buried deep within the Shareholder or Corporate Operating Agreement. Boring and laborious due diligence proceedings will only be able to flesh out the issues.

The more of these types of issues haunt an old, dirty shell the more motivated a private company should be to simply find the next opportunity. There are always other fish in the sea. And while practitioners in the industry love to tout the speed and cost savings of getting a reverse takeover vs. traditional IPO, you get what you pay for. The more time spent on due diligence, shell scrubbing or shell manufacturing ensures the best long term solution for nearly any company. In addition, you’ll typically be required to pay for a higher quality shell. The better equipped the shell, the more it will cost.


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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.
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