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 an article in Inc.
magazine in February 2007 over-viewing
developments in shell.
A
New Shell a Shady Strategy Gets a Makeover
by
Max Chafkin
Shell
Companies, along with junk bonds, penny
stocks, and shoulder pads, are usually
dismissed as an unfortunate trend of
the 1980's. Back then, shells-that is,
companies with ticker symbols but no
operations became synonymous with so-called
pump-and-dump schemes in which stockbrokers
artificially inflated share prices after
a shell merged with a private company,
without making financial statements
on the acquisition available to investors.
Now shells are making a come back in
the form of specified purpose acquisition
companies, or SPAC's. Unlike the 1980's
vintage, these shells are created by
experienced management teams that hope
to acquire a private company and take
it public using a process called a reverse
merger. The strategy, which gives shells
two years from formation to sign a merger
agreement, has become increasingly popular
thanks to the tepid IPO market, which
is prompting companies to look for creative
financing alternatives. Meanwhile, investors,
including many hedge funds, see a potential
for big returns. In the first half of
2006, 23 SPAC's raised money in public
markets, compared with 27 in all in
2005 and none in 2002, according to
The Reverse Merger Report. There's
been a sea change in the perception
of SPAC's, says David Feldman, a New
York City attorney who specializes in
small business finance.
For private companies, SPAC's offer
a key advantage over IPO's: more certainty.
Companies have no way of knowing exactly
how much cash they will raise in an
initial public offering. By merging
with a SPAC, on the other hand, businesses
are guaranteed a specific sum from the
SPAC's investors.
The appealed to John Cline, founder
of the eTrials Worldwide, a company
in Morrisville, North Carolina, that
sells software used by pharmaceutical
companies to mange clinical trials.
Founded in 1999, the business grew quickly,
landing a spot on the 2005 Inc. 500
list with $12.7 million in sales. But
eTrials had only $1 million in the bank,
which made it difficult to convince
customers such as Pfizer and Merck that
it could handle more work. What eTrials
als need, Cline decided was the credibility-and
cash-that come along with a public listing.
Several investment bankers informed
Cline that eTrials was far too small
for an IPO. Then one of the Cline's
board members-a venture capitalist who
also ran a SPAC-told him about CEA Acquisition,
a public shell company based in Tampa
that was trading on the OTC Bulletin
Board. CEA had no operations and no
full-time and no full time employees.
But it did have $21 million to invest.
In July 2005, after a reassuring meeting
with CEA's four person management team,
including chairman and CEO J. Patrick
Michaels, Cline began negotiating a
deal. To determine an asking price,
he looked at revenue multiples of other
companies in the medical services industry
and researched the terms of similar
SPAC deals in Securities and Exchange
Commission filings. Cline spent the
next couple of weeks in heated negotiations
with CEA, a process he compares to an
arm wrestling match. The two parties
came to a compromise that August. If
the deal were approved by CEA's shareholders,
mostly hedge funds and institutional
investors, Cline and Etrials other original
shareholders would receive a 56 percent
stake in a new public company valued
at approximately $76 million. CEA's
shareholders would receive 44 percent
of the company, with about 9 percent
going to the firm's management team.
Merger agreement in hand (and the money
in escrow), Cline spent the next five
months on the road trying to win over
CEAs investors, who were looking for
a growth company that was well- positioned
to go public, preferably with a strong
management team and a few years of audited
financials. Unless 80 percent of the
shareholders gave a thumbs up to eTrials,
the deal would be called off and the
SPAC would be liquidated. I was going
from train to plane to automobile nonstop
to get these yes votes, he recalls.
It was nerve-racking. He also racked
up hundreds of thousands of dollars
in accounting and legal fees related
to the deal, including submissions to
the SEC.
The deal was approved last February
and eTrials began trading on the Nasdaq
exchange under the ticker symbol ETWC.
The company now has close to $20 million
in cash and could reap another $61 million
if outstanding warrants are exercised
by shareholders. Cline expects the improved
balance sheet to help eTrials land new
contracts and generate $20 million in
revenue in 2007. That, he hopes, will
help lift the company's stock, which
traded recently at $3.70 per share.
Over the next few years, Cline plans
to use some of the cash and stock to
acquire software companies that will
allow eTrials to oversee the entire
clinical trial process. Merging with
a SPAC, he says, was a hand-in-glove
fit.
Despite the new image, shells still
draw criticism from some financial advisers
who argue that the deals are overly
generous to investment banks and SPAC
management teams, which typically walk
away with a 10 percent stake in the
newly merged company, along with bonuses
and board seats. In 2005, the SEC adopted
new rules designed to prevent pump-and-dump
schemes by requiring shells to release
financial records of acquired companies
immediately after a merger. Before,
shells had 75 days to provide records
to investors. Meanwhile, the NASD, which
regulates brokers, has begun investigating
the marketing practices of a number
of underwriters.
What's more, there are signs
that the SPAC market could be slowing.
The heated activity over the past two
years has created a glut of shells searching
for acquisitions. A number of them are
beginning to run out of time, Feldman
says. This has caused some share
prices to drop amid fears that some
SPAC's may not reach a merger agreement
before their two-year deadlines. In
addition, several SPAC deals have been
voted down recently by shareholders.
Deborah Quazzo, president of Think Equity
Partners, a New York City investment
bank that underwrites SPAC's, chalks
up the pullback to normal supply-and-demand
cycles.
That notion offers little solace to
Mike Traina, founder of ClearPoint Business
Resources, an HR outsourcing company
in Chalfront, Pennsylvania, that posted
$84 million in sales in 2005. Last summer,
Traina signed a merger agreement with
Terra Nova Acquisition, a Canadial SPAC.
He saw the deal as a relatively painless
way to raise money for acquisitions
and offer stock options to his employees.
It has been anything but easy. The SPAC
was trading slightly below its offering
price when Traina signed the merger
agreement, which has made it difficult
for him to round up enough yes votes
from Terra Nova shareholders, who may
be better off voting down the deal and
getting back their original investments
in the SPAC.
Despite the hassles, Traina says that
he will still be happy with his decision
to pursue a SPAC, as long as the merger
wins approval during a proxy vote slated
to take place early this year. There
are no pure solutions, he says. If the
deal goes through, we'll still be a
profitable company, except with $40
million in the bank. I try to keep that
in context.
