Venture Capital vs. Reverse Mergers: A Few Pointed Questions

Financing is always a double-edged sword. When it comes to looking for money, there are always positives and negatives included in a decision. The question is, what is the lesser of the evils for your particular situation? The answer is not the same for everyone or every business. We always acknowledge the downside risks of doing a reverse merger. Venture capital has its own weighty matters that ought to be considered in detail before signing your life away for a fist-full of cash.

Venture capital money is some of the most expensive financing available. While reverse mergers typically take some money up front and on-going for compliance, there are typically a host of reasons founders choose a Direct Public Offering (or something similar) over venture capital. When making the assessment of whether to pursue private equity, venture capital or going public with a reverse merger, here are some key questions you should ask:

  • What is the cost? This doesn’t just include the up-front cost, but the long term cost of the capital as well. You’re assessment should include all your growth assumptions for the business with revenue and cost analysis over time. Discount it back to today. What do you get. The answer might surprise you. Either way, the process of making such as assessment–while likely wholly inaccurate and very presumptuous–should at least provide you with a good idea of the eventual ROI portion of your business financing assessment. Also, please consider the cost differences in both time, talent and other resources required by both financing methods.
  • How will the stock price differ? In making the assumption in the point above, you’ll likely want to assess how the stock price will differ in both scenarios. In the venture capital scenario, you’ll likely be going public much later so the valuation accretion from being public won’t occur until much later. Unless you experience another M&A event prior, your valuation will most likely remain in the private realm. You’ll need to make some assumptions as to when the public offering event will take place and what your supposed market cap will be, comparing the timing of the event and what you’re assumptions on various capital raising scenarios would be. Inaccurate? Totally, but like I said, the exercise is helpful in understanding the process.
  • How much money do you need? How often will you need it? Initial and follow-on venture capital money can often be larger and more consistent than that obtained through PIPE financing and reverse merger deals, unless you have connections with some big financiers or private money. For those that reach profitability quickly and can be sustained from company profits for growth, VC money shouldn’t be an option. Unfortunately, that’s less likely to be the case in most deals.
  • How quickly do you need money? If you need money yesterday, then a venture capital firm is your partner. Other methods of financing may be less interested in opening their pocket-books that as quickly as you need.
  • How much do you have to spend? If you have no money up-front, then you’ll likely not be privy to a reverse mergers as reverse mergers require 1) the purchase or manufacturing of a shell corporation 2) accounting and legal help for auditing and securities registration. Reverse mergers are a better option for those with some resources up-front to assist in the deal. If you plan on financing numbers one and two above, be prepared to give up some stock as consideration.
  • How fast will you want to sell-out? Rule 144 in a reverse merger allows for the sale of your stock within six months of a consummated deal, in some cases faster. Venture capital deals will keep your stock as an non-liquid asset, typically until an IPO or other sellout event, which could take years. An alternative offering isn’t so cut and dry either as stock sales from insiders is restricted and can be sold on a specific schedule in accordance with the direction of your broker-dealer.

Ultimately, venture capitalists will require more dilution on the part of the founders and more control of the board and business. How quickly and how often you need the money coupled with what you have in the bank right now will likely play the biggest role in deciding on the type of financing you will need to get a deal done.

In most cases, weighing the options carefully can be helpful, but the best alternative for your particular situation is typically pretty obvious.



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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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