SEC Attorneys :: Current Issues

REVERSE MERGERS - OVERVIEW

A "reverse merger" is a method by which a private company goes public. In a reverse merger, a private company merges with a public listed company with no assets or liabilities. (The public company is also called a "shell" corporation). The publicly traded corporation is called a "shell" since all that exists of the original company is its corporate shell structure. By merging into such an entity, a private company becomes public.

The private company merges into a public company and obtains the majority of its stock (usually 90%). The private company normally will change the name of the public corporation (often to its own name) and will appoint and elect its management and Board of Directors. The new public corporation has a base of shareholders sufficient to meet the 300 shareholder requirement for admission to quotation on the NASDAQ SmallCap Market.

The advantages of public trading status, which are outlined in greater detail below, notably include the possibility of commanding a higher price for a later offering of the company's securities. Going public through a reverse merger allows a private company to go public typically at a lesser cost and with less stock dilution than through an initial public offering (IPO). While the process of going public and raising capital is combined in an IPO, in a reverse merger (also know as a "blind pool" merger) these two functions are unbundled; a company can go public without raising additional capital. Through this unbundling operation, the process of going public is simplified greatly.

The private company which has gone public obtains the benefits of public trading of its securities, namely:

	Increased liquidity of the ownership shares of the company
	Higher share price and thus higher company valuation
	Greater access to the capital markets through the possibilities of a future stock offering
	The ability of the company to make acquisitions of other companies using the company's stock
	The ability to use stock incentive plans to attract and retain key employees
	Going public can be part of a retirement strategy for business owners

The benefits of going public through a reverse merger, as opposed to an IPO , are the following:

	The costs are significantly less than the costs required for an initial public offering
	The time required is considerably less than for an IPO
	Additional risk is involved in an IPO in that the IPO may be withdrawn due to an unstable market condition even after most of the up-front costs have been expended
	IPOs generaly require greater attention from top management
	While an IPO requires a relatively long and stable earning history, the lack of an earning history does not normally keep a privately-held company from completing a reverse merger
	The company does not require an underwriter
	There is less dilution of ownership control
	You will receive a higher valuation for your company

Requirements prior to entering into a reverse merger are the following:

A private company will require approval of the majority of its stockholders for a merger with a
public corporation

Once a company is taken public through a reverse merger the financial markets hold the following future prospects in the capital markets for the newly public corporation:

	The market value of a public company is often substantially higher than a private company with the same structure in the same industry
	Capital is easier to raise for public companies because the stock has market value and can be traded
	The public trading price of the public company's securities serves as a benchmark for the offer price of a subsequent public or private securities offering
	Acquisitions can be made with stock since publicly traded stock is viewed as currency for mergers and acquisitions
	Form S-8 stock can be issued for officers, directors and consultants
	If the stock dividend distribution included warrants, the new company can receive proceeds from the exercise of those warrants if the trading price of its common stock exceeds the exercise (strike) price of warrants.

Regulation - SEC Rule 144

The Federal Securities Act of 1933 generally requires that stock and other securities must be registered with the Securities and Exchange Commission (the "S.E.C.") prior to their offer or sale. Registering securities with the S.E.C. can be expensive and time-consuming. This article offers a brief introduction to SEC Rule 144, which allows for the sale of restricted securities in limited quantities without requiring the securities to be registered. First it's probably appropriate to explain the basics of restricted securities. Restricted securities are generally those which are first issued in a private placement exempt from registration and which bear a restrictive legend. The legend commonly states that the securities are not registered and cannot be offered or sold unless they are registered with the S.E.C. or exempt from registration. The restrictive legend serves to ensure that the initial, unregistered sale is not part of a scheme to avoid registration while achieving some broader distribution than the initial sale. Normally, if securities are registered when they are first issued, then they do not bear any restrictive legend and are not deemed restricted securities.

Rule 144 generally applies to corporate insiders and buyers of private placement securities that were not sold under SEC registration statement requirements. Corporate insiders are officers, directors, or anyone else owning more than 10% of the outstanding company securities. Stock either acquired through compensation arrangements or open market purchases is considered restricted for as long as the insider is affiliated with the company. For example, if a corporate officer purchases shares in his or her employer on the open market, then the officer must comply with Rule 144 when those shares are sold, even though the shares when purchased were not considered restricted. If, however, the buyer of restricted securities has no management or major ownership interests in the company, the restricted status of the securities expires over a period of time.

Under Rule 144, restricted securities may be sold to the public without full registration (the restriction lapses upon transfer of ownership) if the following conditions are met.

	The securities have been owned and fully paid for at least one year (there are special exceptions that we'll skip here).
	Current financial information must be made available to the buyer. Companies that file 10K and 10Q reports with the SEC satisfy this requirement.
	The seller must file Form 144, "Notice of Proposed Sale of Securities," with the SEC no later than the first day of the sale. The filing is effective for 90 days. If the seller wishes to extend the selling period or sell additional securities, a new form 144 is required.
	The sale of the securities may not be advertised and no additional commissions can be paid.
	If the securities were owned for between one and two years, the volume of securities sold is limited to the greater of 1% of all outstanding shares, or the average weekly trading volume for the proceeding four weeks. If the shares have been owned for two years or more, no volume restrictions apply to non-insiders. Insiders are always subject to volume restrictions.

The most recent rule change of Feb 1997 reduced the holding periods by one year. For all the details, visit theSEC's page on this rule: http://www.sec.gov/rules/final/33-7390.txt