Public Shells: The Good, The Bad & The Ugly

The market for public shells is often aptly referred to as a “game.” Finding something clean that fits within the target parameters of an intending APO is extremely difficult, especially on shoestring budget. Overcoming this hurdle requires understanding what a particular company may need/desire when it’s time to go public as well as what might be available on the market. While some have unfortunately referred to the entire reverse merger industry as “ugly,” there are still legitimate reverse merger transactions occurring regularly. Because of the nature of this business, we steer clear of the bad and the ugly. Here I’ll outline some of the areas where clients can find and create their own opportunity and avoid the downsides of a bad deal before it even begins.

The Good

Finding the appropriate shell corporation is the single most important option for a private company looking to go public. Something clean, within budget with the right existing structure is likely the best bet.

Manufacturing a Shell from Scratch

We’ve discussed previously some of the benefits of creating your own public shell from scratch, including the timing and cost of doing so. We’ve discussed this more extensively in the past and it’s likely best to simply follow the aforementioned links and do some reading. It should prove helpful for understanding the process and costs.

Shell Creation from a Chapter 11 Bankruptcy

Another method similar to the manufactured shell process we’ve spoken so much about is the ability to take another company out of bankruptcy, perform a spin-out and convert debt holders in the parent into equity shareholders in the new entity. A completely new shell is created, all while circumventing the SEC and going straight through to FINRA. Secured debt holders often become preferred shareholders while the unsecured become series B preferred. This is the most ideal scenario if a company has >35 debt holders. If this is the case, often multiple shells can be created from a single bankruptcy proceeding. Such deals are often very compelling as a somewhat liquid market likely exists for the company’s stock–depending on how the debt was structured. In addition, the company avoids the hassle of a hefty clean-up process and simply is created from scratch.

Direct Public Offerings

Some argue the very best method for avoiding the shell game is to simply go public through a direct public offering. It’s certainly the best likely scenario if a good, inexpensive shell is nowhere to be found. And, while doing so has its own downsides, a Direct Public Offering is actually one of the best ways to avoid some of the pitfalls of a RM. However, if you can swing a good cheap shell, there are some helpful upsides.

The Bad

Bad shells are all over. Some are simple blank checks that took no more than a couple thousand bucks to create while others are fully defunct and once reporting companies whose reporting, debt structure and litigation record would make any logical person steer clear of doing business with such an entity. Others still may be roped in with a group that says they have complete understanding of what it takes to get up and trading, but the total cost might be north of $300K. Knowing what you need before you go out asking for help is going to be your ultimate salvation in working through the “game.”

Hollow or defunct shells often require extensive cleaning and updating for things like corporate bylaws, etc. And, if due diligence isn’t extensive enough, there may be missed items that could be ever-so-beneficial for the previous company shareholders, but which could be used to hold the new company to a barrel at precisely the wrong time post-close.

Perhaps the most egregious deals out there involve the shady promoters selling a bill of goods. If you’re offered a shell from a deal-maker, it’s best to take a look at the trading symbol, get a third party’s opinion and always ensure you’re using a legit attorney escrow agent when submitting payment for any shell purchase.

The Ugly

Many legit operators in the reverse merger market exist–some of whom we know of that use some of the tactics below. But, do your homework and due diligence on individuals and companies as the manipulators often reside among the legitimate players in a modern-day wheat among the tares scenarios.

1. Beware of promoters. Investor relations firms exist for a reason, but many are nothing more than pump-and-dump experts looking to sell their own block of stock on the upside pump, only to leave the company gutted and penniless when the dust finally settles.

2. Beware of offshore groups. If the promoters mentioned in #1 above say they have outsourced folks doing IR overseas, then the second red flag should fly. While there are legit promotion groups that will pump the value of your stock who are located overseas, the percentages are low.

3. Tainted Records. Many have been contacted by the SEC and have been listed, but pay attention to those who may have been blacklisted or who have a tainted past.

Not everyone is a crook, but some think it’s best to presume ill intent and then be happily surprised when none actually exists. That may seem like a pessimistic way to view people, but in this business it’s often required to ensure you’re covering your backside.

Finding the Right Fit 

Finding the right shell for your RM, can be as difficult as a picky dater finding “Mr. Right.” All too often, practitioners find square pegs for round-hole deals, but in the end are not left with something that works well for what they’re attempting to do. In many cases, potential shell buyers have been marketed (via MergerNetwork and elsewhere) that all shells should include 99% deliverability of the company’s public stock. While that sounds nice, many times some public float above 1% can help create a market for the stock before the business is even merged in. In others, the excess public float can simply be diluted.

If your intentions on being publicly-traded are pure and you’re confident a good shell could produce a stellar deal, then you’re 90% of the way there. Avoiding the thorny path is easy though when you already know some of the ropes.

Nate Nead on LinkedinNate Nead on Twitter
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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