NEW YORK-“The business of resurrections is a very holy thing, taking companies that are dead, dead, dead and making them rise, rise, rise,” said Art Beroff, an angel investor and merchant banker, at the recent Internet Breakfast Club seminar, “Saved by the Shell: Reverse Mergers in Silicon Alley.”
“I’ve made lots of money on companies that went out of business, then went on to a different business, often by accident. The only way this doesn’t work is if the company implodes, and even then, there can be a Chapter 11 clean-up.”
Turner Broadcasting Corp., Radio Shack Corp., Occidental Petroleum Corp. and Blockbuster Entertainment each went public through a reverse merger with a publicly traded shell corporation, Beroff said.
“Three cold, hard realities are staring us in the face. The IPO (initial public offering) market has dried up and there is no clear recovery in sight,” said Marat Roisenberg, a managing director and board member of Atlas Capital Services Inc., a New York investment bank.
“Venture capitalists and private equity funds are hoarding their money, shifting their focus to exit strategies or bailouts to salvage prior investments. Existing public entities have experienced the decimation of their share prices, with some trading below their cash positions.”
Public companies with a significant cash position but a stagnating business are the ideal candidates to become shells for promising private companies in need of the cheaper capital and higher enterprise value that publicly traded status confers, Roisenberg said.
“Usually in these transactions, the private company has more profit and value than the public company,” said Paul Goodman, a partner in the New York law firm of Ellenoff, Grossman, Schole & Cyruli L.L.P.
Reverse mergers traditionally have had a somewhat shady reputation, but that has changed because of reporting requirements the National Association of Securities Dealers imposed in 1999, said Peggy Wood, a partner in the New York office of Grant Thornton, an accounting firm. Since then, companies whose stock is traded over the counter must provide quarterly and annual reports and audited financial statements.
Although large investment banks typically have avoided involvement in reverse mergers, also known as reverse takeovers, many are entering this transaction market, Goodman said. Although “they won’t talk about it,” the principals of some “very large financial firms in New York City” are on the boards of reverse-merged companies, Beroff said.
“Reverse mergers are also good for roll-ups, consolidation of mom-and-pop businesses using a public entity. As long as each acquisition is accretive to earnings, you will make tons of money,” he said.
“A lot of large venture-capital firms in New York have done this, but they won’t admit it. I know because I’ve worked with them on the deals.”
Although each reverse merger has its own unique details, a typical transaction of this kind involves takeover of a private company with an enterprise value of at least $10 million, strong growth potential and a sound business plan, Beroff said. Shareholders of the public shell that takes over the private company usually gain a small stake in the combined entity, with stakeholders in the acquired company retaining majority control.
The basic cost of doing these kinds of deals ranges from $200,000 to $400,000, he said. Legal fees can run an additional $50,000 to $75,000, and accounting fees the equivalent of 2 percent to 10 percent of the equity involved.
“Reverse mergers are action contracts, whereas underwriting (of a public offering) is a best efforts transaction that may or may not happen, depending on market conditions,” Beroff said.
Goodman said completing a reverse merger can take from two to three months. However, Wood said the likely scenario is that it will take three to six months to accumulate the necessary documents to execute the deal.
