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 is quoted in an April 29, 2004
New York Times article on reverse mergers.
An
Often Risky Route for Going Public
by
Ellen L. Rosen
For
companies trying to grow, the lure of
going public can be irresistible. But
with the market for initial public offerings
only beginning to rebound after several
years of drought, small businesses seeking
cash have sought alternative routes
to issuing stock. And some of them have
turned to an established, if often maligned,
technique: merging into the shell of
a public company that has ceased operations
but still exists as a legal entity.
Known as reverse mergers, these deals
are a route to the stock market for
entrepreneurs in a hurry, but they are
fraught with pitfalls.
According to Gerald Laporte, the chief
of the Security and Exchange Commission's
Office of Small Business Policy, reverse
mergers "have been used in ways that
cause investors to lose money and used
in the past with fraudulent and abusive
conduct." As a result, analysts generally
advise start-ups to avoid them, and
investors tend to steer clear of the
stocks that result from them. This month,
the S.E.C. proposed regulations to curb
abuses in the way they are carried out.
If done properly, and in limited instances,
experts say, reverse mergers can work
out just fine. For example, companies
can use them as a vehicle to grow through
acquisitions, they say.
But more often, cash-hungry start-ups
are drawn to them by the hope of raising
easy money and are advised by dubious
concerns that fail to explain that the
stock cannot be sold for a period after
the merger. Moreover, without the support
of market makers and investor relations
experts to manage their stock's prospects,
these companies sometimes wind up paying
just as much as they would have for
floating an initial public offering
- even with all the extra costs required
by the Sarbanes-Oxley Act in 2002 -
while depriving themselves of the financial
benefits.
Worse, some businesses find themselves
facing classes of undisclosed shareholders
who emerge once the deal is closed and
who can dilute the value of the stock.
And, sometimes, companies that do reverse
mergers become unwitting partners in
scams, like "pump and dump" schemes
in which the owners of the shells promote
the stock to drive the price up and
then sell their holdings at the stock's
highest price.
David Feldman, a partner in
the New York law firm of Feldman Weinstein,
had a client who planned to merge with
a shell company whose owner hired family
members and friends to perform various
services. "Three days before he was
ready to announce the deal, there was
a spike in trading," Mr. Feldman said.
"I told my client, who was merging into
the shell, that this was bad and that
he could inherit problems, but my client
chose to go ahead with the deal." Mr.
Feldman refused to represent the company,
which he declined to identify, once
it went public. One week after the deal
closed last December, Mr. Feldman says,
NASD, the securities industry's self-regulatory
body, began an inquiry into trading
in the company's stock.
Other times, problems arise because
the private company does not understand
what it means to be public. The lawyers
and promoters who guided a telecommunications
company through a reverse merger neglected
to tell the owners that they had to
file quarterly and annual statements
with the S.E.C. after going public.
After two years, the company's executives
wondered why the stock price had plummeted
to pennies. An investor relations firm
retained by the company discovered that
the company had made no additional securities
filings since the reverse merger.
The failure not only violated federal
securities laws, but it also left the
company invisible to investors, says
Robert Brown, a partner at the Reitler
Brown law firm in New York, who was
asked to represent the company. He declined
to identify it. To curtail such problems,
the S.E.C. proposed a set of rules this
month that would, among other things,
require companies involved in reverse
mergers to make filings that are tantamount
to those required for initial public
offerings. While the current rules allow
a private company to go public through
a reverse merger with very little disclosure,
Mr. Laporte of the S.E.C. said the proposed
regulations would require "audited financial
statements and disclosure that presents
the new company to the investing public."
(Small-business owners trying to navigate
securities issues can call the S.E.C.
at 202-942-2950.)
