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The Reverse Merger: The Small Business Version Of The IPO

Why is our nation so focused on everything large when it comes to business? Multibillion dollar financings, acquisitions and meltdowns have us transfixed like rubber neckers on a highway. Is it possible that we need to revisit the thought that bigger isn't necessarily better?

The most recent poster child for large corporate blunders is Bear Stearns. How could people that were smart enough to create a company that as of November 30, 2006 had total assets of $350.4 billion. (Institutional Investor) allow their shareholders and 14,000 employees to lose almost everything?

And yet, according to the US Dept of Commerce, 60-80% of all new jobs are created by companies with less than 500 employees.

One group that knows this well met last week in Los Angeles. They are the entrepreneurs, investors and professionals that participate in the Reverse Merger industry. This group hailed from the US, China, India, Korea, Vietnam and more. The industries represented there were wide ranging including technology and health care companies from the US and infrastructure companies from emerging nations. Some were startups but most were established businesses in need of growth capital. What they all had in common was an interest in becoming publicly traded in the US.

In the past, these companies may have looked forward to funding and liquidity for their shareholders by going public via a traditional Initial Public Offering (IPO). Today this dream has all but evaporated with the average current IPO in the US raising over $250 million.

In addition, according to Ian Mount writing for Fortune Small Business, �A combination of Sarbanes-Oxley's steep compliance costs, Wall Street's neglect of small caps regardless of their performance, and heightened investor distrust has turned running a public company into a far less appealing proposition�.

Even with these issues to overcome reasons still exist to be publicly traded in the US including:

* Utilizing public stock to acquire other companies without using cash. * Attracting and retaining professional management through stock options and other stock based compensation. * The potential to raise capital through public equity markets at higher valuations than private companies.

One alternative to the IPO for going public is known as a Reverse Merger. This is when a private company merges into a publicly traded company with little or no operations and is issued a majority of the shares. The management of the old public company resigns and the private company's Board of Directors replaces the old Board. One of the biggest advantages of going public this way is that it typically takes much less time ( 4-8 weeks) and the risk of an IPO being canceled is avoided.

No industry is left out of this process. According to the Washington Post, a defense contractor, Argon ST, went public through a reverse merger and is in one of the hottest sectors of the defense industry. Other notable former reverse mergers include Turner Broadcasting and Acclaim Entertainment.

A significant drawback of the reverse merger is that unless a private financing is completed simultaneously with the merger, the formerly private company is now public and has taken on the significant costs of being public without having raised any capital.

The comparison between the health of IPO's and Reverse Mergers for small and mid size companies speak for themselves.

According to Tim Keating of Keating Investments there were only 9 IPO's on average per year over the last 10 years that raised under $25 million.

In 2007 alone there were 220 Reverse Mergers. 100 of these transactions included simultaneous private placements.

In the first half of 2008 only 23 IPO�s were completed including deals of all sizes. (SPAC�s and REITs omitted)

It is not only homegrown companies that are attracted to this method of becoming publicly traded in US markets. According to Robert Comment of Johns Hopkins Univ. The % of co�s going public in the US via Reverse Merger that are non US has gone from approximately 14% to 37% over the last 10 years.

Companies receiving financing using this method create primary US jobs for printing companies, mailing services, transfer agents, lawyers and accountants and their staffs, employees of our stock exchanges and the government employees that regulate them.

This does not include the employees of these now funded companies and their suppliers as they use the new capital to buy equipment, develop new products, open new markets and more.

In the past this method was largely unregulated and often abused. Thanks to thoughtful regulations developed by the SEC and the NASD in conjunction with input from industry members, the quality of the companies accessing capital through Reverse Mergers has improved steadily. Revenues for these companies went from approximately $5 million in 1997 to $16 million in 2007 according to Mr. Comment.

With the IPO market minimums continuing to grow, we are sure to see more Reverse Mergers filling the gap in the coming years.


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Allen R. Goldstone is President of Creative Business Strategies. Inc, a corporate development and turnaround consulting firm based in Boulder Colorado. [email protected]



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