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 a June 29, 2005
article in the Wall Street Journal concerning
reverse mergers.
Reverse
Mergers Move Into Fashion: Small Companies
Gobble Up Already-Public Concerns As
Cheap Way to Get Listed by
By
Serena Ng
At
a wedding reception in White Plains,
N.Y., last weekend, a fellow guest stepped
up to Tom Tenenbaum and asked the securities
lawyer if he knew anything about "reverse
mergers."
"He had been approached to invest
in one and wanted to know more about
how they worked," says Mr. Tenenbaum,
who runs a practice in Denver. "It reminded
me of tax shelters a few years back,
when they were so popular that people
would talk about them at parties."
Party talk aside, reverse mergers--in
which a private company buys all or
most of the stock of an already publicly
traded firm--are on the scene. Small
firms find them a low-cost, quick and
fuss-free way to instantly become a
public company, often without the paperwork
required for a conventional initial
public offering of shares. Moreover,
the market for traditional IPOs from
such microcap companies has all but
dried up.
NYSE Deal an Exception
The biggest reverse merger deal this
year is probably the New York Stock
Exchange's proposed acquisition of electronic-trading
firm Archipelago Holdings Inc., which
is publicly traded. But the bulk of
reverse mergers, involve much smaller
private businesses acquiring companies
with few or no operation assets, also
known as shell companies, that are quoted
on over-the-counter markets like the
Bulletin Board and the Pink Sheets.
Excluding deals with Pink Sheet companies,
there have been 55 reverse mergers so
far this year compared with 89 for all
of 2004, according to the Reverse Merger
Report, a trade publication. This year's
deals include private China-based businesses,
fledging biotechnology companies and
software companies.
Compare that to the IPO market, which
has seen 83 issues this year -- well
off the 251 of 2004, according to Thomson
Financial.
Fueling the boomlet in reverse mergers
is a growing pool of hedge funds and
other investors keen to buy discounted
stakes in the new public entities.
In the past, such deals occasionally
have had an unsavory air. In some of
the most egregious cases, unscrupulous
promoters would use a shell company
to bring public a company with no real
business, talking up the company's potential
then selling their own stock once the
deal was complete. Once investors realized
they had bought into a business that
essentially didn't exist, it was too
late: They were holding worthless stock.
SEC Cracking Down
But regulators are acting to curb such
"pump and dump" schemes. The Securities
and Exchange Commission is scheduled
to vote today to tighten rules governing
shell companies as part of a final batch
of regulatory measures backed by outgoing
Chairman William Donaldson. The new
rules are expected to compel shell companies
to provide detailed disclosures about
their new businesses shortly after they
merge with private operating companies,
among other structures.
In a conventional IPO, the company must
hire an underwriting bank that examines
the company's business and financial
merits, acting as a gatekeeper between
the company and its potential investors.
In a reverse merger, there's no such
gatekeeper
between the company and its potential
investors. In a reverse merger, there's
no such gatekeeper, although the two
parties generally perform "due diligence"
on each other.
"There are pitfalls with reverse
mergers, but they have become a lot
more legitimate and popular," says David
Feldman, managing partner of New York
law firm Feldman Weinstein LLP. "More
firms are turning to them because they
realize that an IPO is not always the
best way to raise funds."
Microcap companies often find it difficult
to find brokers, who often shun such
deals as unprofitable. In addition,
a conventional IPO can take much longer.
Many companies that aspire to list on
a bigger exchange find a reverse merger
a good "stepping stone" toward that
goal, adds Tim Halter, chairman and
chief executive of the Halter Financial
Group, a Texas-based reverse-merger
consultant. Soon after the reverse merger
is completed, they can raise funds through
a stock sale to fund growth.
Some of the companies executing a reverse
merger do so in conjunction with what's
known by bankers as a PIPE, or private
investment in public equity, transaction.
PIPE investors buy registered or soon-to-be
registered shares in public companies
directly, usually at a discount to the
market price. By tapping the PIPE market
immediately after a reverse merger,
companies get to raise funds as soon
as they go public, just like they would
in an IPO.
"The firms I'm looking at invest
in typically have a rapid growth and
need money quickly to finance that growth,"
says Barry Kitt, manager of the Pinnacle
Fund, a $130 million hedge fund that
invests in microcap companies. "An IPO
can take up to a year to complete, and
with a hot IPO it probably won't be
able to get much of it. But if I'm aligned
with investment bankers of a reverse-merger
deal I can usually buy as many shares
as I want."
