FREE online courses on Mergers & Acquisitions - Chapter 3 - Reverse Mergers

 

Before we leave due diligence and dive into valuations, one area that warrants special attention when it comes to due diligence is the Reverse Merger. Reverse mergers are a very popular way for small start-up companies to "go public" without all the trouble and expense of an Initial Public Offering (IPO). Reverse mergers, as the name implies, work in reverse whereby a small private company acquires a publicly listed company (commonly called the Shell) in order to quickly gain access to equity markets for raising capital. This approach to capitalization (reverse merger) is common practice with internet companies.

 

For example, ichargeit, an e-commerce company did a reverse merger with Para-Link, a publicly listed distributor of diet products. According to Jesse Cohen, CEO of ichargeit, an IPO would have cost us $ 3 - 5 million and taken over one year. Instead, we acquired a public company for $ 300,000 and issued stock to raise capital.

 

The problem with reverse mergers is that the Shell Company sells at a serious discount for a reason; it is riddled with liabilities, lawsuits, and other problems. Consequently, very intense due diligence is required to "clean the shell" before the reverse merger can take place. This may take six months. Another problem with the Shell Company is ownership. Cheap penny stocks are sometimes pushed by promoters who hold the stock in "street name" which mask's the true identity of owners. Once the reverse merger takes place, the promoters dump the stock sending the price into a nose-dive. Therefore, it is absolutely critical to confirm the true owners (shareholders) of shell companies involved in reverse mergers.