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 was consulted for and quoted
in the article "Capital: Shell
Game", about reverse mergers, in
the May 1, 2002 issue of Inc. Magazine.
Capital:
Shell Game
by
Thea Singer
Decorize
Inc., a home-furnishings importer, went
public with a listing on the over-the
counter bulletin board on July 5, 2001-just
16 months after CEO Jon Baker cofounded
the company in his horse barn in Springfield,
Mo. The whole process cost $100,000.
In December, Baker, 49, applied for
the company to make the leap to the
American Stock Exchange, which-with
its more rigorous listing requirements-would
increase the likelihood that investment
firms like Merrill Lynch and Morgan
Stanley would recommend the company's
stock to their institutional and individual
clients. Three months later, on March
5, Baker walked into his office and
found the Amex approval letter waiting
for him. "Getting on the Amex, that
changes the world for us," says Baker.
The route that Baker took to the public
markets was not new, but it was controversial:
he went public by a reverse merger-that
is, he backed into a nonoperating public
company, or a "shell." The shell he
chose, called Guidelocator.com Inc.,
had been created for the express purpose
of being acquired by a small, fast-growing
private company that wanted to go public
sans the hassles and costs of an initial
public offering.
Entities like Guidelocator are called
"blank-check companies" or "blind pools."
But a shell may also be a public company
that has ceased operations. Because
of the dot-com bust, says Lawrence Kaplan,
CEO of investment-banking firm G-V Capital
Corp., in Melville, N.Y., scores of
companies down to their last $4 million
are languishing on the exchanges. There
are also many that raised $10 million
or $20 million but realize they'd be
better off private, so they want to
sell their public presence.
Mention reverse mergers to investment
professionals, and you'll get one of
two reactions: they're either enthusiastically
for or rabidly against them. Detractors
like Todd McMahon, a managing director
at RCW Mirus, Inc., an investment-banking
firm in Boston, say the process is like
"trying to lose weight without diet
and exercise." Reverse mergers, claim
the naysayers, give you none of the
advantages of an IPO-such as the road-show
exposure, the credibility that comes
from being associated with a leading
underwriter, and the true liquidity-but
entail all the risks. The most typical
problem is negligible share prices.
Indeed, RCW Mirus's research, which
tracked 46 companies that had gone public
by means of reverse mergers, found that
from 1999 to 2001 the stock of those
companies declined by 67%. During the
same time period, the S&P SmallCap
index decreased by some 15%. "An IPO
is a vetting process-institutional investors,
asset managers, and larger retail banks
assess a company's viability as a publicly
traded company," says McMahon. "If a
company isn't suited to going public
by the normal route, there's no reason
to think that capital will be attracted
to that same company if it goes public
through the back door."
There have been horror stories. "In
the 1980s there were lots of bad guys
engaged in blind pools and shells,"
says David Feldman, a partner at the
New York City law firm of Feldman Weinstein.
"For a while the Wall Street cockroaches
resided there."
Some unsuspecting companies simply aren't
ready to be public. "The vast majority
[of reverse mergers] are crash and burns,"
says McMahon, citing as an example a
southern California search-engine developer
called Diamond Hitts Production Inc.
that went public by means of a reverse
merger in 1999 and by February 2001
was trading at 4 cents a share.
But there's another side to the story-one
highlighted by reverse-merger successes
like Turner Broadcasting and Occidental
Petroleum. Advocates like Feldman
see reverse mergers, done properly,
as a "terrific vehicle for companies
that can benefit from being public in
an environment where there are no IPOs."
Like, say, now. Just 10 companies went
public from January 1 to March 1, 2002;
in all of 2001, there were 96 IPOs,
compared with a high of 871 in 1996.
Companies can benefit from the chance
to attract institutional and individual
investors through brokerage houses that
recommend their stock; capital-raising
options such as secondary public offerings;
stock with which to make acquisitions
and attract top management talent; and
liquidity. Reverse mergers are quick,
taking no more than three months to
complete, compare with as much as a
year for a typical IPO. They're cheap,
costing about $150,000 in legal and
accounting fees as opposed to $1 million
or $2 million in expenses for an IPO.
The truth about the strategy, of course,
lies between the two extremes. Even
advocates agree that reverse mergers
are only a stepping stone. "You haven't
pulled a rabbit out of a hat," says
Keating. "Once you become public, you
still have to go through the process
of building investor relations and a
shareholder base."
