Gaining Market Access Through a Publicly Listed Shell

The allure of a public company listing is undeniable. Access to capital, increased brand recognition, more acquisition options, and the ability to attract top talent are just a few of the coveted benefits enjoyed by publicly traded companies. For many ambitious entrepreneurs, the traditional Initial Public Offering (IPO) has long been the gold standard for achieving this goal. However, the IPO process can be notoriously lengthy, expensive, and fraught with uncertainty.

Enter the use of a reverse merger (RM), a strategic alternative that offers a potentially faster and more streamlined path to the public markets. In a reverse merger, a private company merges with a publicly traded shell company. This results in the target company effectively "going public" by acquiring control of the existing public listing.

While not without its own set of challenges, the reverse merger has emerged as a viable option for companies looking to capitalize on the advantages of being publicly traded. This comprehensive guide delves deep into the world of reverse mergers, exploring their key advantages, the mechanics of the process, considerations for both the target and the shell company, and crucial due diligence steps to navigate the path to a successful public listing.

The Advantages of a Reverse Merger

There are many reasons why a private company may choose to go public via an RM with a publicly traded shell company. It’s faster, cheaper, and can be easier than a traditional IPO. More recently, many biotech and cannabis companies have chosen to go this route to get access to the benefits of the capital markets while avoiding some of the scrutiny that an IPO process would entail. In addition to the reasons listed above, going public for these types of companies is equivalent to a crossover round, meaning that, at some point in the future, the company intends to list on a major stock exchange. An RM provides liquidity for existing shareholders in the interim and a chance to “try out” the public markets via the OTCBB market or pink sheets.    

RMs differ from traditional IPOs in their approach and execution. They lack the extensive marketing and price discovery processes typical of IPOs, such as testing-the-waters and roadshows. However, the resulting SEC registration and public listing position the company advantageously for a future IPO on a major exchange when market conditions are favorable.

The effectiveness of reverse mergers can be enhanced when the existing publicly traded shell company can contribute significant cash, complementing available private financing, but this is not always the case. When that is not an option, the RM may be executed concurrently with a Private Investment in Public Equity (PIPE) transaction. Moreover, the guaranteed public listing outcome can make reverse mergers more attractive to certain investors compared to traditional crossover rounds.

How Do I Find a Publicly Traded Shell Company to RM Into?

You can use a stock screening tool, such as  Yahoo’s stock screener, to see the current publicly listed shell companies listed on US exchanges. This list includes many Special Purpose Acquisition Companies (SPACs) that became popular a few years ago and remain on the market in search of private company targets to buy. Most publicly traded shells that can be purchased are not on an established exchange but traded in the Over-The-Counter market that Yahoo ignores. There are also many shell companies that are available outside of the US that can be purchased as well.  

You can find publicly traded shell companies in many ways:

• Online databases such as Dealstream (which has one of the largest inventories of shell companies for sale on the internet). A simple Google search will yield a long list of websites to explore. 
• Research using stock screeners filtering for the industry “shell company” and then look for companies with minimal operations or assets. 
• Network with lawyers, investment bankers, accountants, and consultants who specialize in reverse mergers.

When you find a potential publicly traded shell company partner to make your dream a reality, you need to perform extensive due diligence. Due diligence will help validate the value of the publicly traded shell and determine the deal’s exchange ratio. Key areas to consider include:

• How was the publicly traded shell company created? For example, is it a fresh, newly minted publicly traded shell with few, if any, legacy liabilities? Most SPACs would fit this description and have the benefit of previously raised capital that can be immediately deployed in the deal, but they are not the only option — frequently failed pharmaceutical companies whose drugs may not have passed an FDA trial, are coming available with assets to invest in a new venture and few, if any, liabilities. 
• Does the publicly traded shell company have any pending lawsuits? A clean shell has no one filing suit against the company, no issues with any past filings or SEC reporting, and perfect standing with the regulators and the stock exchanges. Unclean is the exact opposite of that.
• Does the publicly traded shell company have existing assets or liabilities? This can be both a positive and a negative and may include A/P, royalties or even environmental liabilities. If the assets are liquid, they can be used to invest in the target; if not, they must be sold, liabilities settled, and any risk of recourse mitigated. This will require the expertise of securities lawyers which will take time and money.  
• Is the shell company trading or non-trading? A trading shell company is better as it has more liquidity. If it is not, it will require more lawyers and experts to become trading and is therefore worth less.  
• Is the publicly traded shell company a reporting or non-reporting entity? Non-reporting entities will be on the Pink Sheets or grey market, while the reporting entities who are up to date on their fees will be on the OTCBB markets. 
• What is the publicly traded shell company’s shareholder base?  The more shareholders, the better it is to increase liquidity. 

Executing the Reverse Merger

1. Purchase of shares - The private company buys at least 51% of the public company's shares, often through a shell company. The shell company is a simple entity that can be registered with the Securities and Exchange Commission (SEC) before the deal, making the registration process less expensive and straightforward.
2. Exchange of Shares - The private company trades its shares for the shell company's stock, making the private company a public company. The private company's shareholders usually end up with a majority of the combined company's stock, while the shell company's shareholders become passive investors with a minority stake.
3. Merger - The private and public companies merge into one publicly traded company. The private company's management and employees become the management and employees of the combined company, and the combined company's board is made up of people from the private company. The combined company may also change its name to the private company's name.

Not Just For US-Based Companies

There are several ways in which a non-US-based company can access the US public markets. Two of the most common are American Depository Receipts (ADR) and RMs. While ADRs give a relatively straightforward way for foreign companies to access US investors, reverse mergers offer a potential path to faster, cheaper, and potentially higher valuation, but with increased risks. The best choice depends on the specific circumstances and goals of the company.

The reasons a foreign-listed company may choose an RM over an ADR listing are similar to why a domestic company may choose to list via an RM as well. Here's why a foreign company might opt for a reverse merger instead of issuing ADRs:

• Raising Capital – An RM can raise capital at the time of the merger through a PIPE or from the investment of assets of the shell company. This can be more attractive for companies that may need significant funding. While ADRs primarily facilitate trading of existing shares, with limited capital raising potential.
• Speed and Cost – an RM is often faster and less expensive than a traditional IPO or issuing ADR. Issuing ADRs will involve more complex legal and regulatory processes, potentially leading to higher costs and longer timelines.
• Control and Ownership – RM’s allow the foreign company to keep control over the merged entity while ADR allows the foreign company to retain ownership of its underlying shares, it doesn't directly control the ADR program.
• Market Valuation – RM’s can potentially achieve a higher valuation than through an ADR program, especially if the market perceives the company as having high growth potential. ADRs will typically only reflect the valuation of the underlying shares, which might be discounted due to foreign market risk.
• Regulatory Environment - While RMs are subject to US securities laws, the regulatory burden might be perceived as less stringent than a traditional IPO or ADR program. ADR issuance involves compliance with both US and foreign securities regulations.
• Company Stage – RMs are often suitable for companies in later stages of development with a proven track record, while ADRs can be appropriate for companies at various stages, they are typically more common for established firms.
• Investor Base – RMs can target a broader range of US investors, including retail and institutional investors, while ADRs primarily attract investors who are familiar with foreign securities and willing to accept associated risks.

While both reverse mergers and ADRs offer avenues for foreign companies to access the US capital market, they serve distinct purposes and cater to different company profiles.

Conclusion

The demand for shell companies in which companies can execute an RM varies over time and can often be traced to cross-border or industry-based reasoning. In the period between 2005 and 2010, many foreign-based Chinese companies chose to list in the US via an RM, and unfortunately, many ended with scandals. More recently, biotech companies have been leveraging RMs to realize their business plans, but the Securities and Exchange Commission has started to take a hard look at what constitutes a shell company in these transactions, endangering the benefit and increasing the risks of going public via an RM. 

Choosing the right path for your company to go public requires a mix of factors and tradeoffs. Going public via an RM, including finding and partnering with the right shell company, is not without risk, but effectively balancing risk to achieve one’s goals is the basis for business success.