November 13, 2009
David Feldman will be a panelist at the Financial Executive Institute seminar entitled, "Where’s the Money? Finding Public vs. Private Capital Today."
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.
David Feldman is a contributor to PIPES: Revised and Updated Edition - A Guide to Private Investments in Public Equity (Bloomberg Press, 2005) available on
http://www.amazon.com.
Dov Scherzer is the U.S. contributor to the British
treatise, Internet Law and Regulation (Sweet & Maxwell, 2d Ed. 1997;
3d Ed. 2002; 4th ed. 2007),
Available Here.
Dov Scherzer is the U.S. contributor to the British
treatise, Electronic Signatures Law and Regulation (Sweet & Maxwell,
1st Ed. 2004),
Available Here.
In the News
David
Feldman quoted in Financial Week about
reverse mergers on July, 14, 2008.
Reverse
Mergers Are Hotter Than Szechuan
By:
Tim Catts
Financial Week (July 14, 2008)
Backing
into a shell is a faster, cheaper way
to go public in the U.S. than a traditional
IPO. Chinese companies especially love
it.
Joseph Meuse, the managing member of
Belmont Partners in Washington, Va.,
describes his firm as “the CarMax
of shell corporations.” In other
words, he runs a giant depot of what
are essentially the ghost ships of business:
public companies that no longer have
any operations of their own, or maybe
never did, but remained current in their
Securities and Exchange Commission filings
and now sit idle, ready to provide a
relatively quick and inexpensive route
to U.S. capital markets for privately
held enterprises that don't want to,
or can't, carry out a traditional initial
public offering.
Mr. Meuse and his company are part of
a small but thriving ecosystem of investment
bankers, attorneys and shell corporation
brokers who see great opportunity in
transactions called reverse mergers,
reverse takeovers or “alternative
public offerings.” In these deals,
a private company merges with a public
one solely to take advantage of the
public entity's listing on a U.S. exchange.
From Chinese medical equipment manufacturers
to fledgling U.S. biotech firms, companies
looking to raise relatively small amounts
of capital have turned away from traditional
IPOs to this alternative path to the
market. They are going public in reverse
mergers and often raising capital from
institutional investors when the deal
closes. In many ways, the deals are
mirror images of those involving special
purpose acquisition companies, or SPACs,
in which a publicly traded shell corporation
is set up by investors to acquire privately
held companies and bring them to market.
According to data compiled by the Reverse
Merger Report, a trade publication that
covers the field, 94 companies went
public in these deals in the first half
of this year, compared with 100 over
the same period last year and 99 in
the first six months of 2006. But the
share of these deals involving obscure
Chinese companies has exploded, from
19% two years ago to 32% so far this
year.
“The rate of growth in these transactions
is really high,” said Maj Soueidan,
president of Market's Edge, an investment
firm that tracks the deals and invests
in Chinese companies that have participated
in them.
And with only 22 companies floating
IPOs in the first quarter of 2008, compared
with 53 in the same period last year,
this could be the rare year that reverse
mergers are the more popular route to
going public, said David Feldman, a
founding partner of Feldman Weinstein
& Smith, a New York law firm specializing
in the deals. “Even if you're
looking for $200 million or $300 million,
there are no IPOs for anyone right now.”
Meanwhile, companies pursuing reverse
mergers are typically looking for less
money. Indeed, all companies raising
capital via private placement concurrent
with a reverse merger attracted a total
of $187 million so far this year, according
to figures from the Reverse Merger Report. “Many people are referring
to this as the heyday of reverse merger
transactions,” Mr. Feldman said.
Reverse mergers have taken off, while
traditional IPOs have slowed significantly
due to the turmoil in the credit markets.
Much more stringent SEC disclosure requirements
and an influx of Chinese companies looking
to reverse mergers as a faster route
to U.S. capital markets have also contributed
to the surge in the number and value
of deals. Recently, bigger and more
profitable Chinese companies have undertaken
reverse mergers, further helping the
deals shake off an unsavory past as
the province of boiler-room scams and
pump-and-dump artists.
“It's the quality and the size
of the companies going public through
the reverse takeover method that's helped
legitimize it,” said Matthew Hayden
of HC International, a San Diego company
that handles investor relations for
some 30 Chinese companies that have
gone public here via reverse merger.
The basic reverse merger works like
this: A privately held company will
spend anywhere from a few hundred thousand
dollars to a few million dollars to
buy the lion's share of stock in a publicly
traded “shell” company,
so called because it no longer has any
real business of its own but has stayed
current with its SEC filings in order
to keep its shares listed. Shell companies
typically trade over the counter via
the OTC Bulletin Board quotation system.
Some boutique investment companies and
advisory firms specializing in reverse
mergers keep a stable of shells available
for sale and try to clean up some of
their problems, which can include liens,
court judgments and disgruntled shareholders.
Others take steps to create “virgin”
shells that offer a blank slate.
This process alone does not introduce
any new capital into the company. To
address that situation, many companies
bring in institutional investors through
private placements as soon as the reverse
merger closes. The average value of
an IPO last year was $229 million, according
to data compiled by Renaissance Capital.
In contrast, it isn't uncommon for companies
going public in a reverse merger to
raise $10 million or less.
Chinese companies are increasingly taking
advantage of reverse mergers because
they're relatively quick and inexpensive.
“It's not that they're enthralled
with the U.S. markets,” Mr. Hayden
said. “They want access to growth
capital, and this is the avenue that
works.” Recent typical examples
of Chinese companies using a backdoor
into the U.S. capital markets include
Shanghai Medical Technology, which merged
into Aamaxan Transport Group in May
and raised $12.5 million in a concurrent
PIPE, and Yongye Biotechnology International,
which raised $10 million through a PIPE
concurrent with its merger with Golden
Tan in April.
At least half of Chinese companies going
public through reverse mergers have
at least one manager who speaks English,
and nearly all participate in some kind
of “road show” to familiarize
U.S. PIPE (private investments in public
equity) investors with their businesses,
Mr. Hayden said.
Chinese officials plan to open a Nasdaq-style
exchange for small companies and start-ups
in the near future, but “our belief
is that listing in the U.S. will still
be favored by many companies for at
least the next two years,” Mr.
Hayden wrote in a note to clients in
April.
Chinese firms may be the hottest part
of the reverse-merger market, but that's
not to say U.S. companies aren't using
the deals as well. A number of small
biotech firms have used reverse mergers
paired with private placements to access
the capital they need to fund trials
of experimental drugs instead of partnering
with, or selling themselves to, big
pharmaceutical companies, said attorney
John Paris of Richmond, Va.-based law
firm Williams Mullen.
Nonetheless, many of the boutique investment
banks, investor relations shops and
law firms springing up to help companies
with these transactions focus on far-flung
regions of the world. Certainly, China
is immensely popular. But other firms,
such as Southern Trust Securities, a
Miami-based investment bank, specialize
in areas such as South America and the
Caribbean. Kevin Fitzgerald, the firm's
president, said Southern Trust has helped
companies from Argentina and Mexico
as well as China undertake reverse mergers
in the past 15 months, and has deals
pending with companies from Spain, Iceland
and South Korea.
“You have some really profitable
businesses overseas that really can't
go public without these kinds of transactions,”
Mr. Fitzgerald said, because they're
too small for a traditional IPO in the
U.S. or are blocked from accessing capital
markets in their home countries.
Reverse mergers have begun to shake
off a reputation for being the province
of boiler-room operators in the three
years since the SEC changed the rule
governing financial disclosure for companies
that go public in those deals. Pump-and-dump
scammers long exploited the lack of
transparency in reverse-merger transactions
to bring questionable companies into
the capital markets, inflate their stock
prices through high-pressure sales tactics,
and then sell their stakes, leaving
unsuspecting investors with massive
losses.
In 2005, the SEC amended the laws governing
the sale of shares in companies that
have undergone reverse mergers to require
more disclosure of financial information.
That hasn't stopped reverse-merger scams,
but it has made it easier to identify
legitimate companies. The requirements
are now comparable to those faced by
companies going public through a traditional
IPO, according to Mr. Paris. “You'd
have the obligation that Google had,”
he said. Mr. Feldman agreed:
“It's an industry that's shaken
its semi-shady past very effectively.”
The rising popularity of PIPEs among
institutional investors has also made
reverse mergers a more attractive option
for small companies. In particular,
hedge funds are eagerly providing capital
in private placements with companies
using reverse mergers to go public,
observers said. The SEC requires these
investors to hold their shares for up
to a year before selling them, but that
period can vary.
Most deals also include “make
good” provisions, which require
company managers to place a portion
of their stock in escrow and set net
income targets that, if missed, give
investors the right to claim the shares.
That gives an added element of security
to institutional investors providing
capital to companies going public through
reverse mergers, Mr. Hayden said.
In practice, Mr. Feldman said,
most institutional investors realize
private placements with companies involved
in reverse mergers require some patience.
“Most PIPE investors know they're
looking at one to two years before they
see any liquidity,” he said.
Hedge funds aren't the only big players
investing in reverse-merger companies.
Lawyers and bankers specializing in
the practice say some Wall Street heavy
hitters are happy to fund them as well.
“They're starting to see the upside,”
Mr. Meuse said.
Mr. Meuse has big plans for Belmont
Partners. “Like any new young
market, you have a lot of people in
this space, and no one has a huge share,”
he said. Working with Chinese companies—and
companies in other fast-growing emerging
markets, such as Brazil—is the
way forward, he said. “On a macro
level, we want to be an Asian investment
bank with American owners and an American
presence.”
While some players like Mr. Meuse see
immense opportunity ahead in the reverse-merger
business, others, like Mr. Keating,
believe the market may have already
passed its peak.
In fact, the amount of capital raised
in private placements accompanying reverse
merger transactions through June has
fallen 60%, from $469 million in the
first six months of last year, according
to the Reverse Merger Report. To support
his contention, Mr. Keating cites SEC
rules changes enacted in February that
require investors in companies that
have gone public through reverse mergers
to hold their shares longer than those
who've put their money in companies
that haven't. That puts investors in
reverse-merger PIPEs at an unfair disadvantage,
Mr. Keating said.
Other rule changes may also keep investors
away from the deals, including one that
blocks some investors from selling shares
in a reverse-merger company if it -doesn't
stay current in its SEC filings and
another that loosens the protocols governing
the formation of shell corporations,
opening the door for scammers to market
flawed shells as pristine. That's
not to say all recent regulatory developments
have been negative: The same round of
rule changes created liquidity in other
ways—for example, by eliminating
volume restrictions for investors looking
to sell their shares, Mr. Feldman said.
Ask Mr. Keating if this is the heyday
of reverse mergers, and he says it has
already passed. “I would have
said yes, it was, until very recently,”
he said. He is guiding clients toward
another IPO-less route to public trading
that doesn't involve shell corporations:
“Self-filing” instead requires
the company to file with the SEC to
resell stock held by existing shareholders
and voluntarily assume the responsibilities
of reporting financial results.
Mr. Meuse, meanwhile, is encouraged
by the arrival of bigger institutional
investors—including funds run
by Wall Street heavyweights—seeking
to invest in reverse-merger companies.
“Is it still growing? Absolutely,”
he said. “It has the look and
feel of a market that's going to stay
strong for a while.”
