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The Risks of a Reverse Merger

Members of the ISP-Investor list discuss an unusual deal in which a publicly traded company without any assets merges with a privately held company, and why no small business should attempt this seemingly trouble-free IPO route.

[November 14, 2001]

On the ISP-Investor list in November, CF inquired,

"I'd like to get any input on potential pitfalls of doing a reverse merger. It seems like a complicated process, and the proposal we have gives the investment group 100 percent of my stock with the option for me to get it back based upon performance. Any thoughts?"

A number of respondents warned that this was dangerous territory:

[JN asked] "Why do you want to do a reverse merger? If you are looking for an opportunity to gain a public trading position, then you may want to bear in mind that the IPO is the profitable portion of that game. You say you get no real stock until you meet performance requirements? I would feel rather skittish, personally, about giving up real value for the shell. Nobody gives stuff away for nothing: be careful."

[RY agreed] "There's no small number of shysters out there that would love to swindle unwary ISPs out of their companies. This has happened numerous times in the last 18 months. I have had several securities attorneys give me persuasive arguments for not participating in a reverse merger. We considered it, but we've decided to go to the SEC and file ourselves."

[RB added] "99 percent of reverse mergers fail, with the company going bankrupt. If a company has potential, then it should go the proper venture capital route. In some cases, other sources of funding make more sense. But reverse mergers have such a poor record of success that I urge them as a last resort."

Others advised CF to avoid giving up more than 10 percent of the stock:

[PP noted] "They want too much. I've seen reverse mergers where they get 20 percent of the stock to get you public."

[SF agreed] "I wouldn't give up more than 10 percent unless it comes with cash."

CF was thoroughly persuaded:

"I was already in a position to pass on the offer, and after your responses, I have made up my mind to execute my plan without the reverse merger."

—End