BAWHAHAHA
Don’t tell me FINRA can’t hold things up…
“Why Reverse Mergers?
Most people think “IPO” when they hear that a company is going public.[1] A cheaper and faster alternative to the traditional IPO, however, is through a reverse merger. In a reverse merger,
“the shareholders of the private company exchange their shares for a large majority of the shares of the public shell company. Although the public shell company survives the merger, the private company’s shareholders gain a controlling interest in the voting power and outstanding shares of stock of the public shell company. Also, the private company’s management typically takes over the board of directors and management of the public shell company. The assets and business operations of the postmerger surviving public company are primarily, if not solely, those of the former private company.”[2]
Reverse mergers are typically consummated in two to three months—a substantially shorter period than the usual six months required for an IPO. [3] As no capital is actually raised as part of a reverse merger, most companies raise capital during or immediately after the merger, in addition to restructuring their capital and changing the company name. [4]
Reasons for entering a reverse merger may vary, but generally its primary purpose is to raise capital.[5] Another reason may be to provide shareholders of the shell company with an exit strategy in the event the company is unlikely to otherwise provide a return on their investment.[6]
Reverse merger transactions are treated as share acquisitions for tax purposes[7] and are typically structured as a reverse triangular merger, as follows:
Public shell company forms a subsidiary;
Private company negotiates with the public company to merge with the subsidiary;
Private company survives the merger with the public subsidiary;
Public shell issues shares to the private company;
Private company is a subsidiary of the public shell, while stockholders of the private company own a majority (usually 90% or more) of the public shell and the private management becomes management of the public shell.[8]
It is important to note that not all public shell companies are created equal and can be one of four varieties of shells: OTCBB traded, SEC reporting but non-trading, non-reporting, or Nasdaq/AMEX. OTCBB traded shells are listed on the OTCBB but were once operating companies. SEC reporting but non-trading shells have the sole purpose, upon formation, of becoming shell and never performed business operations. They are not listed or quoted but do comply with all Exchange Act requirements. Non-reporting shells, or Pink Sheet shells, are not listed or quoted and do not comply with Exchange Act requirements. Finally, Nasdaq/AMEX shells do not technically exist and must requalify at the time of the reverse merger.[9]
There are a number of actions, documents, and filings to take into consideration when planning a reverse merger. These are detailed below and include the internal preparation of the two companies, due diligence of possible shell companies, closing the reverse merger transaction, making all necessary filings with the SEC, and meeting any applicable listing or resale requirements.
Steps to Executing a reverse merger
Internal Preparation of Companies
It is important to ensure that both companies have obtained “SEC qualified audited financial statements . . . for at least the last two fiscal years or the date of organization if less than two years. The financial statements of the private company will need to be consolidated with the public company’s financial statements prior to closing.”[10]
Due Diligence of Shell Company Candidates
Once the private company locates a potential shell company, the parties should create a letter of intent to guide their dealings. It is at this stage that the parties negotiate the main elements of the transaction, such as “percentage ownership, board membership, management of the company, ability to sell stock, representations and warranties, claw backs . . . as well as any simultaneous financing component.”[11] It may also be wise to enter into a confidentiality agreement at this stage so that the private party may conduct due diligence.[12]
Conducting effective due diligence on the shell company is essential, as merging with a “dirty” shell (i.e., a shell whose management failed to follow proper SEC reporting procedures) could prove fatal for the private company.[13] In searching for “clean” shells, private companies should consider the shell’s number of stockholders, reporting record, and how and where it is listed.[14]
All public filings should be read closely, and there should be a focus on any past delistings and trading halts. Diligence should decrease risks relating to the shell, including risks relating to management and controlling stockholders. Background checks on management are also highly advisable, as are litigation searches. Shells that use more well-established auditing firms should be pursued. Most important, a dose of skepticism during the review may serve a company’s interests.[15]
Additionally, the shell company should be able to close the transaction “without undue difficulty or delay,” be eligible to pass DTC scrutiny, and be able to issue the requisite amount of shares.[16]
Closing the Reverse Merger Transaction: The Agreement
The documents used to consummate a reverse merger between the private company and public shell is a share exchange agreement, or stock purchase agreement, which usually takes two to four weeks to draft.[17] Board and shareholder approval must be obtained and a “Super” 8-K form (detailed below) drafted.[18] Financing documents may also be needed.[19] Prior to closing, the shell company must file its proxy statement with the SEC and, as detailed below, a number of other filings.[20]
Additionally, the private company will usually want to mail to the shareholders a 14-C Information Statement in order to “change the name and/or capital structure of the newly acquired public company vehicle.”[21] If the company does not file the 14-C and “if a majority of the Board of Directors is being replaced as a result of the change of control transaction,” the company will later be required to file a Form 14f-1.[22]
SEC and Related Filings
While a traditional IPO would require registration pursuant to the Securities Act of 1933, as amended, no such registration is required of shell companies undergoing a reverse merger. [23] However, shell companies must report the transaction to the SEC by filing “Super” Form 8-K (detailed below).[24] The resulting company will no longer be private, so it will be “subject to Sarbanes-Oxley compliance, corporate governance issues and other public company issues. These obligations will be greater if the company is listed on a national securities exchange.”[25] Once public, it will “be subject to several, and ongoing, time-sensitive filings with the SEC and will thereafter be subject to the disclosure and reporting requirements of the Securities Exchange Act of 1934, as amended.”[26] Finally, officers, directors, and 10% shareholders must make certain filings—“primarily Section 16 filings (Forms 3s)” “primarily Section 16 filings (Forms 3s)”—in conjunction with the transaction.[27]
Registering Shell-to-Private Issued Shares
The issuance of the securities from the shell company to the private company stockholders must “either be registered under Section 5 of the Securities Act or use an available exemption from registration. Generally, shell companies rely on Section 4(a)(2) or Rule 506 of Regulation D under the Securities Act for such exemption.”[28]
Shell to Provide Notice to FINRA under Rule 6490
The Financial Industry Regulatory Authority (“FINRA”) requires many issuers (Form 10 shell issuers in particular), pursuant to Rule 6490, to receive FINRA approval prior to consummation of a reverse merger. [29] The shell company must provide notification to FINRA ten days prior to the anticipated closing date of the reverse merger. [30] FINRA may “request additional documents, conduct detailed and selective reviews of the issuer submissions and cause the issuer to delay the announcement of its corporate action.” [31] The following items must be disclosed to FINRA:
“Share Exchange/Purchase Agreements;
Reverse Merger Transactions;
Holding Corporation Reorganizations;
Dormant Shell Revivals including custodianship and receivership actions;
Changes of Corporate Control; and
Reinstatement of the state of incorporation.”[32]
Additionally, shell companies may need to provide the following:
“Stamped filed certificate of amendment;
Notarized and executed Board of Directors resolution authorizing the corporate action subject to the notice;
Notarized and executed shareholder approval authorizing the corporate action; New CUSIP number or confirmation that CUSIP will not change as a result of the corporate action; and
The appointment(s) of the officer(s) listed on the Issuer Notification Form; along with executed resolutions appointing the current officers or filings previously made to the SEC, such as on Form 8-K.”[33]”
