Reverse Merger Suicide
By
William Cate
Published December 2004
[http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
Chief Financial Officers (CFOs) are between a rock and a hard place. To attract risk capital investors, the CFO's company must be public. But the average cost of taking a company public in the United States is over $1,500,000. If the CFO decides to raise money as a private company from venture capitalists, the odds of success are less than one-in-ten thousand.
For too many CFOs, the solution is to find a Corporate Dr. Kevorkian and take their private company public via a reverse merger. While the immediate costs of doing a reverse merger are anywhere from a few thousand dollars to a few hundred thousand dollars, the long-term costs are measured in tens of millions of dollars. A reverse merger is a suicide machine where the costs are almost always certain to kill the patient.
The formula for doing a reverse merger is simple. The publicly trading company issues sufficient shares to acquire a private company. The issued shares give the private company insiders the majority of shares in the public company. As the majority shareholders, the private company insiders appoint their own Board of Directors and officers. The public company's name is usually changed to that of the private company. The result is the private company is now a public company.
A reverse merger example would be a bankrupt company trading on the Over-the-Counter Bulletin Board (OTCBB) with five million shares issued. The company is called a 'shell."
Public investors own 500,000 shares of this shell. This is the shell company's "float." The shell company's insiders own 4.5 million shares. The shell company issues 6 million shares to buy the private company. The reverse merger has 11 million shares issued with 500,000 shares in the float.
The Reverse Merger's CFO knows that the public company has a hundred times better odds of raising risk capital from accredited investors. The CFO can offer potential investors liquidity, after one year, and leverage by discounting the price of the Private Placement shares. What the CFO needs is a public company with strong and sustainable share price to attract investment interest. And therein lies the problem, the "poison pill" ignored by most CFOs.
It costs money to find buyers for any stock. Public companies are responsible for finding the buyers of their stock for as long as the company is public. In our example above, the OTCBB Company with a float of 500,000 will cost the public company about $400,000 to maintain a $3/share price. The poison pill is the fact that the shell company's insiders will sell their shares into the market at $3/share. The shell company insiders make 13.5 million dollars from the sale of their shell.
This will create a float of 5 million shares and the Reverse Merger Company must pay an annual four million-dollar investor relation's bill that they rarely can generate from corporate income. The result is the death of another fledgling company. There's a loss of investment capital. And, the community loses jobs. The only winners are the shell company insiders and the Dr. Kevorkians from Texas to New York, who supply the reverse merger suicide service.
CFOs have more than two ways to take their private company public. They should look at the possibility of a corporate death pill in any alternative they consider. A little research is the ounce of prevention that avoids a meeting with Dr. Death.
To contact the author: Visit the Beowulf Investments website: [http://home.earthlink.net/~beowulfinvestments/]
Or, visit the Global Village Investment Club Website:
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]