Reverse Merger FAQs

What is a reverse merger?
A reverse merger is an alternative to a traditional initial public offering (IPO) for a company desiring to have its stock become publicly traded. In a reverse merger, the owners of a private company acquire control of a dormant public one, called a “shell,” and complete a business combination with it. When the merger is complete, the private company becomes public and its stock can be publicly traded in its own right. Reverse mergers are also used when a larger private company wishes to combine with a smaller publicly held operating business.

What is a “public shell”?
A “public shell” or “shell company” is a public company that has no or nominal assets (other than cash) and minimal, if any, day-to-day business operations. It may be the remnant of a bankrupt or sold organization or specially formed for the purpose of combining with a private company.

Why should I use a reverse merger rather than an IPO (Initial Public Offering)?
Reverse mergers have a number of benefits over IPO’s. For example, they tend to have lower costs, less required management attention, much shorter process times, and less dilution, which allows a private company’s management, founders, and prior investors to retain a greater percentage ownership of their company after going public. In addition, reverse mergers are not market-sensitive. Therefore, they are not dependent on the unpredictable IPO window “openings” or on underwriters and initial market prices on the particular day of trading.

What kind of companies are the reverse merger appropriate for?
Any company at any stage of development that can benefit from being publicly held and bear the costs of doing so should consider all methods of going public, including a reverse merger. In 2006, the average market capitalization of companies completing reverse mergers was a little over $50 million. Industries vary and tend to match whatever sectors are popular on Wall Street at the time.

What are the general steps to complete a reverse merger?

1. Find a shell company. There are hundreds of dormant public companies available. You can also ask corporate law firms, accountants, or financial consultants.
2. Develop a financial strategy for raising additional capital contemporaneous with or after the deal.
3. Hire a law firm and accounting firm. There are a myriad of SEC rules, forms to fill out, legal documents, confusing numbers, and steps you will need help with.
4. Complete the transaction and trade shares. Shares of the private company are traded for shares of the public company and typically the private company continues its existence as a wholly owned subsidiary of the former shell.

What are the financial requirements before getting into a reverse merger?
At least two years of audited financial information (three years for larger companies) must be filed a few days after a merger with a shell that is fully SEC reporting. Thus, hopefully the company has been run in that two-year period with the expectation of going public, minimizing related party transactions, resolving litigation, etc. In addition, you also should make sure you have a strong marketing and financial strategy for raising capital after the reverse merger is completed.

Which shell should I choose?
A “clean” shell, or a company with well-kept, organized records and no history of unsavory activity. Shells are valued on this, as well as whether or not its stock is trading, whether or not it is fully SEC reporting, and the size of its shareholder base.

What problems should I be wary of in a reverse merger?
First, make sure that going public is right for your company, and that your financial plan is well designed in raising capital and market support after the deal is done. Be wary of “messy” or “dirty” shells that may have shady activity and disorganized record keeping. Make sure you conduct thorough due diligence in reviewing all financial documents, old contracts, SEC filings, and stock issuances.

What is Sarbanes-Oxley?
This is an Act of Congress passed in 2002 as a response to the alleged malfeasance at Enron, WorldCom, and the many other companies caught up in accounting and related scandals. The Sarbanes-Oxley Act (or SOX) requires CEO’s to personally certify to the best of their knowledge that the financial statements in their company’s public filings are materially correct. SOX also established a very short reporting time for insiders. In addition, companies are now required to establish and maintain internal financial controls not therefore required.

What is Rule 144?
Rule 144 allows public resale of restricted and control securities purchased privately, if not registered with the SEC, on a number of conditions, including the following in a reverse merger with a shell:

The securities are held for the longer of (a) 6 months and (b) the date which is one year following the date the shell ceases to be a shell and full disclosure is made (the “One Year Anniversary”).

There is adequate current information about the issuer of the securities for the public until the One Year Anniversary, but the issuer also must have been current in its SEC filings for the 12 months leading up to the sale under Rule 144.

If the seller is an affiliate of the company, the number of shares sold during any three-month period does not exceed the greater of 1% of the outstanding shares of the same class being sold, or if the class is listed on a stock exchange or quoted on NASDAQ, the greater of 1% or the average reported weekly trading volume during the four weeks preceding the sale.

A notice with the SEC on Form 144 is filed by affiliates, unless the amounts are small.

What is SEC Form 10?
This form is for registration of a class of securities with the SEC. It requires certain business and financial information about the issuer. Some shell companies, often called “virgin shells,” go public through filing of Form 10. Form 10 is also used by public companies seeking to become subject to the SEC reporting requirements with out a traditional IPO or a merger with a shell company.

What is Rule 419?
This SEC rule was created in 1992 in order to prevent fraud and severely restrict “blank check” companies (those with no business plan or whose business plan is to aquire another business) seeking to conduct an IPO raising less than $5 million dollars. These restrictions include the following:

All capital raised in separate escrow accounts
An 18 month time limit to find a deal and close it
All of stock of shell in escrow not tradable beforehand
Formal shareholder and investor approval beforehand
How long does a reverse merger take?

Depending on the financing involved, a reverse merger can take place in a matter of weeks or up to three or four months. IPO’s typically take six to twelve months.

How much does the reverse merger usually cost?
Most reverse mergers can be completed for under $1 million (this includes the cost of acquiring a public shell). Costs depend on the cost of the shell and whether or not the private company has already completed proper audits of its financial statements.  We can typically take companies public for less than $50,000.

Are there other options to going public?
Yes, these options include IPO’s, self-filings (process of going public by voluntarily following the same rules and filing the same documents that public companies follow), SPAC’s (set up with a clean public shell where the management team looks for a target to acquire), and merging with Form 10 or “virgin shells” (a blank check company is created and voluntarily reports to teh SEC, the shell that is created is a clean non-trading shell).