Going public through a reverse merger (shell), this is an example.
Success, May, 1998 by Elaine Pofeldt
Who needs an IPO when you can buy a corporate shell and take your company public -- instantly?
Imagine how easy your life would be if you could simply flick a switch and raise all the money you needed to create the kind of high-growth business that would leave your competitors in the dust.
That's pretty much What Stephen Dresnick, M.D., did back in 1994. At the time, the Miami physician was running Sterling Healthcare, which staffed 44 hospital emergency rooms. Only seven years old, the company he'd founded was churning out $60 million a year in revenue. It was the perfect moment for him to branch out to more hospitals and begin purchasing some private medical practices. There was one catch: three rivals-had the same basic idea.
Dresnick knew that if he didn't raise big bucks quickly, they'd secure the best doctor's offices and emergency-room contracts before he had a chance. But he'd already exhausted his credit by borrowing to finance the company's growth. Looking for alternatives, he joined Young Presidents' Organization, a networking group for entrepreneurs. He began asking CEOs who'd gone public what advice they'd give someone who was thinking of doing the same.
One of them referred him to a lawyer who suggested a rapid-fire way to go public, called the reverse merger. It is a sort of friendly body-snatching operation wherein you buy the legal framework (known as a shell corporation, or shell) of a publicly traded corporation and have your attorney do all the paperwork necessary to merge your company into it, a process that takes you public. (It's called a reverse merger because you're backing your company into the other firm.)
Where do these shell companies come from? Sometimes people in the securities industry create them to sell to entrepreneurs for exactly this purpose. At other times an entrepreneur takes his company public, but the offering fails and he goes out of business; to recoup some of the money it cost him to go public, he'll sell the shell that remains.
Dresnick found that a reverse merger would have two major advantages for a company like his. To begin with, it was usually faster than the two more traditional ways in which entrepreneurial companies go public: the initial public offering (wherein a broker sells your stock to investors) and the direct public offering (wherein you sell shares directly to your customers). The second benefit was that because the shell corporation was already registered with the Securities and Exchange Commission, he could leapfrog most of the application process that slows down IPOs and DPOs. The beauty part was that when it was all done he'd gain the same advantages any other public corporation had, namely, the ability to use shares of his company as currency to buy other businesses.
On his lawyer's advice, Dresnick began shopping for a "clean shell" -- one that didn't come with baggage like lawsuits left over from the previous owner or shares that were sold to people who couldn't be accounted for and who could, conceivably, sell their stock without warning and drive down the price. Asking around in the business community, he found a shell corporation where someone he knew sat on the board of directors.
After his lawyer checked out all the paperwork on the shell, Dresnick took Sterling Healthcare public on the OTC bulletin board in a reverse merger in 1994, later moving up to the more stringent and prestigious American Stock Exchange. Over the next two years, the company signed contracts with 160 other emergency rooms and bought up 10 medical practices. By 1996 it had $136 million in revenue. Ultimately Dresnick's company was itself gobbled up by another competitor, FPA Medical Management in San Diego. Sterling received $220 million for its share. "I never thought it would be quite as big as it became," Dresnick says today
Doing a reverse merger can be the perfect strategy for a company, like Dresnick's, that needs to go public rapidly and is looking for some currency other than cash, usually to enable it to buy up other businesses, says Nancy Cass, an attorney specializing in securities law and a partner in Cass & Graham in Tampa, Fla. But -- and it's a big but -- they're not for everyone.
Although they're less costly than an IPO, which can run you $1 million, they're still costly. You'll need to allot between $75,000 and $250,000 in fees to the person who sells you a shell and puts your deal together, plus 5 to 30 percent of the value of the public company that the shell corporation holds, say securities-industry sources. And the price may go even higher if the shell comes with money in it, has kept its SEC paperwork up to date, or has a large percentage of shares available for you to control (ones not already owned by existing stockholders). That's not even counting what you'll pay your lawyer, accountant, and printer. According to Cass, the total tab puts the reverse merger outside the scope of companies with profits of less than $250 million, since such businesses usually can't cover the costs of being a public company
But there's another, more serious consideration -- a dark side to the shell game. If you should be so unfortunate as to buy your shell from the wrong people or simply buy the wrong kind of shell, the results could be disastrous -- to wit, your formerly prosperous company could be reduced to a pile of smoking rubble. And there's no end to unscrupulous characters, ranging from investment bankers to consultants, business brokers, and lawyers, who would like nothing better than to help you destroy yourself.
***** Unlike all other exchanges, stocks trading on the OTC Bulletin Board cannot be shorted.
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