One of the many ways for a small or medium size privately held company to go public and raise additional capital or even acquisitions is through a Reverse Merger. A Reverse Merger is a simple and fast method by which a private company can become a public company. To do this transaction, a private company merges with a public listed company that has no business and with no assets or liabilities (meaning it’s not functional).
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By merging in such a company the private company becomes public. This publicly traded corporation is called a “Shell” corporation. This is so because all that will remain of the original company is its structure. The Reverse Merger was established as an alternative to the famous Initial Public Offering (IPO), for companies who want the benefit of becoming public without the complications and expense that the IPO process has. A Reverse Merger is also known as takeovers or RTO’s (Reverse Take Over). It is often suggested that the Reverse Mergers is the best option in providing greater access into capital markets, offering the opportunity to utilize its stocks to make acquisitions and even improve the way the company is seen in the eyes of the investment community. There are two types of shell companies used in reverse mergers. Firstly, a public company that has failed which exists just to be sold in order to recoup some of the costs that causes the business to fail. And secondly, there are companies that are created directly for the purpose of being sold as a shell in a reverse merger process. These are of less risk because of the unknown liabilities. When the Private Company merges into a public company it gains the majority of stocks, which is usually 90%. This company must first get approval from the majority of it’s stockholders for a merger with a public corporation. Then the company will proceed to change the name of the public corporation which is usually a dominant one, sometimes to its own name and restructure its management board of directors. This new public corporation will now need a base of shareholders that is enough to meet the 300 shareholder requirement to be admitted on the NASDAQ Small Cap Market. The SEC also recently stated that if you will want to go public with a shell, you will need financials that are audited and the equivalent of registration statement within 4 days of the merger. Thus there may be no need for public shells, and it will now take longer if you use it. A process of adopting the New Securities Act Rule Reform and trading on the Pink Sheets is suggested for using to go public. It is said to be less expensive. However, I think that this just means that there are other new alternatives of going public in the making. Even though SEC does not account for the statistics of the number of companies that goes public using the reverse merger, the amount is believed to be hundreds per year. (Stated by: RCW Mirus Technology). There are many benefits of going public via reverse mergers in comparison to IPO. The initial costs are much lower and the extra banking fees for investment is escaped. In addition the time it takes to become public is extremely shorter. After the company is publicly traded, there is a possibility for the company to demand a higher price for offering the company’s securities at a later time. There is less stock dilution when you go public via a reverse merger. The process of going public and raising capital at the same time is combined in an IPO whereas these two is disentangled with a reverse merger. A company can go public without raising additional capital! Doing this simplifies going public to a large extent. In addition, where an IPO will require a long and good steady history, a reverse merger earnings history does not hamper the completion of the merger. The ownership control needed is less and greater valuation for the company is achieved. Also the company does not require an underwriter. When a company has gone public through a reverse merger the financial markets starts to make future provisions for that newly public corporation. The market value will be significantly more than a private company that has the same structure, in the same industry. The capital will off course be easier to earn because, the stocks now has market value and can be traded. The public trading price of the public company’s securities is used to determine the offer price of any following public or private securities offering. Since stocks are now publicly traded acquisitions can be made. These stocks are seen as currency for acquisitions and mergers. The new company can also receive proceeds from the active use of warrants, if the warrants are included in the stock dividend distribution. Basically, reverse mergers are more appropriate for companies that don’t need capital soon, and is willing to wait until it reaches its potential growth and level, when it will be successful as a public unit. They will need a minimum of $20 million or $ 2 million of sales and earnings respectively to reach its peak. Reverse mergers can be best used to finance from the development of products to providing capital needed to enhance working needs. Again, comparing reverse mergers to IPO’s, fees and expensed in this regard is not so high, and deals are completed for $50,000 to $100,000, which is probably about 25 percent of the costs that companies who do IPO’s have to take out of their own pockets to add to their exceedingly costly transactions. However the company that’s acquiring the private company may give up 10% to 20% of its equity. This part is remarkably expensive for the private company. Why? This is because the company is really giving up ownership just for the sake of becoming public. Essentially the first steps to take when doing a Reverse Merger are: Find a shell company- can be done by contacting an attorney from a law firm that deals with securities. Another alternative is an accountant. Those controlling the shell companies usually try to keep the financial statements in order, making the account aware of shell company. Also there are financial consultants that can be contacted because they have shells that they will give if requested. However, there is a cost attached. The consultants may want to become minority shareholders in the new company, holding 2 to 5%. Devise a Financial Strategy – A reverse merger is an indirect way of raising capital, therefore, entrepreneurs must think of how more capital must be raise after the merger is completed. The exercise of issuing warrants, where the common shares are not registered, would need a brokerage firm’s help. The merger also must be done where $1 million does not have to be paid as registration requirement. Have a good Image – companies embarking the reverse merger transaction should follow these steps to promote their “new” company; Hire a national accounting firm. They make investors, traders, and regulators feel secure. That’s why they charge so much. Hire a prestigious law firm; if the attorney that originally helped in the reverse merger transaction is a professional in these kinds of deals, he/she should be kept or the law firm for which he/she belongs. This is because when the investors and brokers are deciding if to join your offering or not, they will look at such things, to know if to trust your company or not. Use clean shells; as was mentioned before some shells are created to use in merging private to public company they have no successor entity, leaving more blockage for business failure. Caution – Don’t be greedy – there is no incentive for other investors to get involved, if only internal parties benefits. Therefore, at least 2 percent of the company should be owned by the public leaving 98 percent to be controlled by owners of the private company that has just gone public. It is possible to structure the merger that way.
The Advantages of doing so would be that less time is taken to complete the deal (3 – 6 months minimum). It saves money. Total costs will be $100,000 to $300, 000, and no underwriter fees or commissions. The legal work is less compared to an IPO and there are no disturbances. Private fund raising can be completed before the registration. Public fund raising can be initiated after the original registration is finished – this can make you receive money at a higher value. Acquisitions can be made for public stock after company starts trading. Debt can be converted to equity using stock. Any type of company can complete a merger – does not have to be a male/female dominated industry. Offers the liquidity of investors buying and selling stock – original investors have a way out of the investment. There are incentives that management use to attract and motivate employees, such as bonuses via stock/options. The existing private company and its shareholders would have control and own the majority of the public company. Growth is achieved by acquisitions using stocks instead of cash or using it together with cash. There is estimate planning that helps established stock values and monitor it easily. In relation to foreign companies reverse mergers are a simple way to get control of US publicly traded company, without getting US tax. The Disadvantages surround confidentially, public reporting, dilution, time involvement, liability and expense. For instance, to become publicly held total financial disclosure is required. Reporting expense is more due to need for disclosure. A percentage of equity is let go by the owners. Managers must now dedicate more time to public company operations. More visibility for the company carries with it greater level of liability exposure. The cost for legal and investor relations and regulatory audit becomes high. Other needs that are required will be a comprehensive business plan to show would-be investors. A strong management team which public investors demand, a market plan that proves good sales growth and the product or service should show some potential for growth. In addition a financial statement that is qualified by SEC for the past fiscal year and a legal advocate that can handle regulatory compliance. Caribbean countries can enter the public market in a variety of ways, which include trading stocks, bonds and other securities. These being, the Caribbean Stock Exchange, Eastern Caribbean Securities Exchange (ECSE), The Trinidad and Tobago Stock Exchange Limited (TTSE), Bahamas International Securities Exchange (BISX), Securities Exchange of Barbados (SEB), Bermuda Stock Exchange (BSX), and Jamaica Stock Exchange (JCSD). The Eastern Caribbean Securities Exchange is a regional securities market established by the Eastern Caribbean Central Bank and licensed under the Securities Act of 2001, which is a standardized regional body of legislation governing securities market activities. It’s the first regional securities market in the western hemisphere. The ECSE is design to facilitate the buying and selling of financial products, including corporate stocks and bonds and government securities, for Caribbean countries such as, Grenada, St.Kitts and Nevis, Montserrat, St. Lucia, Anguilla, Dominica, St.Vincent and the Grenadines and Antigua and Barbuda (source:www.esceonline.com). There is also the regional Stock Exchange. Involved countries are Barbados, Jamaica, and Trinidad and Tobago. In the regional stock exchange, any transaction of the exchange that is done locally is settled in their currency and those internationally in US$. Trinidad and Jamaica are the only ones with tickers locally. No system is placed for out of the region trading. However, stocks can be bought from Jamaica licenses to take part in the exchange. Local regional companies are the only ones listed, but other companies who qualify can join. Private companies transfer to publics ones by offering a percentage of their securities to the general public, and at the same time enlisting on a securities stock exchange such as ECSE or NASDAQ.
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