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   Getting There in Reverse;
   An Alternative to the IPO

   By: David Lubin, Esq.
   Managing Partner
   Zysman, Ahroni, and Gayer

As we have seen in recent months, even after spending valuable time and money preparing your company for an IPO, market conditions ultimately dictate whether you will even make it out of the starting gate. An alternative to the tortuous IPO route is the process of becoming a public company through a reverse merger transaction. Merging an operating company into a public shell company can accomplish most of the objectives driving the decision to go public at a significant lower cost in a more expedient time frame.

The Reverse Merger
In a typical reverse merger transaction, a private company with operations or a significant business plan is merged into a public shell company. The owners of the private company receive a controlling position in the public company and continue their business through the public entity. While the existing stockholders of the public company are diluted as a result of the issuance of a controlling block of stock, their ownership in the shell company has been transformed from a dormant shell company into an operating company with growth potential. As a result of the merger, the private company becomes public without the necessity of filing a registration statement (which is generally meticulously reviewed by the SEC). The reverse merger transaction can be accomplished within as little as 30 days.

Unique Concerns to the Reverse Merger
Although the reverse merger can be accomplished cheaper and quicker than an IPO, extensive due diligence must be conducted on the shell company and its principals. The transaction is structured as a merger so that the public company remains the surviving entity. Accordingly, all obligations of the shell, whether known or unknown, survive the merger; a significant liability (such as environmental or tax liabilities) can adversely impact the operations of the company on a going-forward basis. Personal indemnification agreements from the principals of the shell and hold-back or escrow provisions can minimize this risk.

The status of the company subsequent to the transaction is another area of concern unique to reverse mergers. Prior to the transaction, the shell company may not be listed on an exchange. Since one of the objectives of the transaction is to obtain listing, the qualification requirements of the desired exchange will need to be analyzed to determine if the transaction satisfies the objective.

Reasons to go Public
A public company is able to offer liquidity to its stockholders, employees and consultants, as well as utilize its stock as acquisition currency. A means of motivating management through stock options and other forms of stock performance based compensation, and as consideration for an acquisition in lieu of or in addition to cash makes the stock of a public company more attractive than the illiquid stock of a private one. As a result of both an IPO and reverse merger, liquidity is obtained; however, in both situations, the securities laws impose restrictions on the ability of the insiders to sell their shares.

Another factor in the decision to become a public company is to raise visibility and credibility of the company in the eyes of business partners, suppliers and future financing sources. Although a well-orchestrated IPO can create a certain ‘buzz’ about the company, a carefully planned investor relations program can accomplish the same result. It is the performance of the company shortly thereafter which is necessary in either case to sustain the market value of the company.

Companies typically go public in order to raise capital. If a significant one-time cash infusion is the primary reason of the IPO, then a reverse merger should not be contemplated. The underwritten public offering is designed to raise capital for a company, while the reverse merger is just the initial step. However, it is typical for the public company to undertake an offering after the reverse merger is completed once the company has had an opportunity to position itself.

While a reverse merger does not initially create new capital for the company, it accomplishes many of the other motivating factors of an IPO with a significant reduction in cost and time. Management, especially those of small companies in an accelerated growth mode, should consider the reverse merger transaction as a viable alternative. 

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