David Feldman's book, Reverse Mergers: Taking a Company
Public Without an IPO, now in its third printing, was published in 2006
by Bloomberg Press (available on http://www.amazon.com).
View David Feldman's reverse merger blog at www.reversemergerblog.com.
Joseph Smith and David Feldman are coauthors of PIPES:
Revised and Updated Edition - A Guide to Private Investments in Public Equity
(Bloomberg Press, 2005) available on http://www.amazon.com.
In the News
David
Feldman quoted in The Reverse Merger
Report, Fourth Quarter 2006 article
about Worm/Wulff letters.
Form
10-SB blank check companies, or so-called
"virgin shells," are becoming an alternative
route to the public markets. But the
companies, like other shells, fall under
the purview of the Worm/Wulff Letters,
which prevent blank check shares from
instantaneously trading once Form 10-SB
shells consummate a reverse merger with
a private firm, regardless of how long
the virgin shells have been reporting
public companies.
Ultimately, that can pose challenges
to investors who, with growing frequency,
are financing blank check companies
through a private placement simultaneously
with a merger's closing: Because no
shares are trading immediately, funds
can't rely on the market to provide
a value for the securities, and they
lack a ready exit strategy. On the other
hand, investors who make private placements
into virgin shell reverse mergers are
familiar with buying restricted securities.
And one measure of value stems form
the $1 million to $1.5 million in equity
Form 10-SB shareholders typically want
today in the surviving operating company,
says David Feldman, a partner with the
law firm of Feldman Weinstein &
Smith in New York.
Concerns over Worm/Wulff have failed
to slow the proliferation of virgin
shells. More than 70 Form 10-SB shells
were filed in the past year and are
awaiting business combinations, compared
with a handful only a few years ago.
Feldman reports that clients have hired
his firm to create almost 100 of the
blank check companies since the spring
of 2005, and that about 65 of those
have launched self-filings and 10 have
completed reverse mergers.
Several virgin shells have completed
mergers with operating companies and
begun trading. One such company is now
known as Global Employment Holdings
(GEYH.OB), a provider of staffing and
professional employment services. The
shell, launched as R&R Acquisition
Corp. I by Rodman & Renshaw, filed
its initial 10-SB in January and then
completed a reverse merger with Global
Employment Holdings in late March. Shares
of the scantily-traded companyvolume
through mid-October totaled 10,500 sharesopened
at $5.30 on Aug. 16 and a few days later
fell slightly to $5.25, which is where
it's remained.
Some skeptics wonder if the proliferation
of Form 10-SB shells is justified. Michael
Williams, principal of the Williams
Law Group in Tampa, Fla., for example,
acknowledges that Form 10-SB shells
generally fulfill a need for hedge funds
that by charter can only invest in publicly
reporting companies. For private companies
simply aiming for the public markets,
however, they don't always make sense.
"There is a legitimate, valid business
purpose for Form 10 shells," says Williams.
"But often times they get used in other
situations because people still believe
you have to have a shell to go public.
For most people, Form 10 shells don't
serve any purpose."
Among other public offering methods,
private firms can file SB-2 registration
statements-known as a direct public
offering as well as "self filing"-which
puts companies roughly through the same
disclosure and registration process
that they would go through anyway in
a reverse merger with a virgin shell.
Yet small private companies shooting
for the public markets often need quick
financing and lack the luxury of waiting
several months for an effective registration
statement to raise money by selling
shares. Pursuing a reverse merger
with a Form 10-SB shell alleviates that
problem, Feldman argues, for the exact
reason Williams cites: After combining
with a 10-SB shell, the private firm
immediately becomes a publicly reporting
company and complies with most investment
manager rules, particularly those in
the PIPEs space.
Plus, he adds, if a company goes the
SB-2 route, it can't raise any money
privately while the registration is
pending. "The major advantage of
creating these shells is that you can
close a merger and a PIPE into the shell
even though they're not trading," says
Feldman. "At least 90% of the PIPE guys-at
least those we've seen-are willing to
invest so long as the shells are reporting
to the SEC and as long as it's all but
certain that their shares will be trading
by the time their tradable." (That
is, by the time the company's registration
statement becomes effective, it will
have a ticket symbol and an OTC Bulletin
Board listing upon a market maker's
successful Form 211 filing with the
NASD.)
Plus, Feldman adds, the SB-2
self directed offering works the best
when at least three significant conditions
exist: The Company has the patience
and wherewithal to wait up to potentially
several months for effectiveness a base
of some 40 shareholders with at least
100 tradable shares each; and a strong
Wall Street-savvy CEO or advisor to
help build a public company.
Still, neither the SB-2 self-filing
nor merging into a virgin shell is an
anathema to Feldman or Williams.
Each attorney says they've helped
create both types of structures for
a number of clients, and one or the
other may work better depending one
the needs of the companies. The
bottom line is that both require issuers
to file a registration statement for
the resale of shares. One big difference,
however, separates the two: Non-affiliate
shareholders of operating companies
who elect to go to the direct public
offering route generally can avail themselves
of Rule 144 to sell their shares without
registration under certain circumstancesif
they've held the shares for more than
two years, for example.
In terms of shell companies, including
Form 10-SB virgin shells, Worm/Wulff
scuttles all hope that any shareholders
may receive freely-trading shares upon
the closing of a reverse merger. All
shares must be registered, so even non-affiliated
shareholders who happen to have owned
stock in a blank check company for two
years can't avail themselves of Rule
144.
The rule stems from letters exchanged
by SEC and NASD officials six years
ago to clarify the legality of transfers
of shares of a blank check company in
several different scenarios. The SEC
took the position that private placement
shell securities owned by insiders,
affiliates and non-affiliates, regardless
of how they were acquired, could not
be resold as free-trading securities
without registration either before or
after a merger.
But Worm/Wulff stops being an
issue once a company's registration
statement becomes effect, Feldman says.
Although clearing shares for resale
may require companies to respond to
the SEC in a handful of comment rounds,
he adds, the commission thus far hasn't
displayed any more scrutiny toward the
registration statements filed by post-merger
virgin shells than those filed in other
types of reverse mergers.
Global Employment Holdings filed four
amended registration statements, for
example, and was declared effective
four months after completing the merger.
Another non-trading company that merged
into a virgin shell, Cougar Biotechnology,
filed its second amended registration
statement in early October, about five
months after its initial registration
filing. The company merged with WestPark
Capital's 10-SB shell SRKP 4 in early
April.
Whether the SEC starts resisting post-merger
10-SB shell registration statements
remains to be seenthe concept and process
are both still very young. On the other
hand, the SEC to date hasn't impeded
a company's initial 10-SB filing or
the blank check structure in general,
which are crafter under the Securities
and Exchange Act of 1934.
In fact, the only ways to create free-trading
blank check shares instantly is through
a public offering by launching a specified
purpose acquisition company (SPAC) or
a blank check company under the Securities
Act of 1933. The former method, though
highly popular, can force the company
too file several amended registration
statements before the SEC approves the
IPO. It can also cost promoters more
money, particularly as SPAC investors
are increasingly demanding that SPAC
management put more skin in the game.
Still, shares in a SPAC trade even as
the company searches for a merger candidate.
Filing under the Securities Act of 1933,
on the other hand, is more onerous:
It mandates adherence to Rule 419, a
series of strict regulations that among
other stipulations, require blank check
companies to keep their proceeds from
the sale of the securities as well as
the securities themselves in escrow
until a merger is consummated. The shares
don't become freely trading until after
a merger closes. "Rule 419 is a real
mess," William says. "The commission
doesn't care for 419 offerings."
Given the limited opportunities to find
freely trading shares in blank checks
before the companies close a reverse
merger, investors are readily adapting
to the Form 10-SB structure despite
the Worm/Wulff restrictions. Investment
banks also have displayed a greater
appetite for the structure, and issuers
in need of quick financing will no doubt
keep their way to the shells, too.
"I'm not seeing any negative
fallout in either the SEC reviews or
the overall satisfaction with this virgin
shell concept," Feldman say. "I'm seeing
nothing but a desire to make more of
them."
