What is a Reverse Merger with a Public Shell?

A Reverse Merger is a transaction where by the private company shareholders may gain control of a public company by merging it in with their private company. The private company shareholders receive a substantial majority of the shares of the public company (normally 85% to 90% or more) and the control of the board of directors. The transaction can be accomplished in as little as two weeks, resulting in the private company becoming a public company. The transaction does not go through a review process with state and federal regulators because the public company has already completed the process. The transaction involves the private and shell company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement.  At the closing the public shell company issues a substantial majority of its shares and the board control to the shareholders of the private company. The private company shareholders pay for the shell and contribute their private company shares to the shell company and the private company is now public.

Upon completion of the reverse merger, the name of the shell company is usually changed to the name of the private company. If the shell company has a trading symbol it is changed to reflect the name change. An information statement, called an 8-K, must be filed within 15 days of the closing. The 8-K describes the newly combined company, stock issued, information of new officers and directors, and financial statements audited to US GAAP, standards. The 8-K must disclose the same type of information that it would be required to provide in registering a class of securities under the Securities Exchange Act of 1934.
(See Sec Final Rule33-8587, pdf file)

If the shell company is listed on the Bulletin board, the registered or “free trade” shares can continue to trade. The company can do a private placement immediately. To trade new shares offered by the public the newly combined public company must first register the shares with the SEC. This process takes three to four months and normally requires filing a Registration statement with the SEC under Reg. SB-2 or SB-1.

If the shell company does not have a symbol, an application for a symbol is usually made to the NASDAQ Bulletin Board. The application for a symbol requires filing a Form C211 by a market maker that is a member of the NASD. The Bulletin Board has no financial requirements. A listing will be granted if the affairs of the company are in order and the company answers the questions posed by NASDAQ.
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Advantages of Going Public Through a
Reverse Merger or a Public Shell Purchase

• Increased Valuation: Typically publicly traded companies enjoy substantially higher valuations than private companies.
• Capital Formation: Raising capital is usually easier because of the added liquidity for the investors, and it often takes less time and expense to complete an offering.
• Acquisitions: Making acquisitions with public stock is often easier and less expensive.
• Incentives: Stock options or stock incentives can be useful in attracting management and retaining valuable employees.
• Financial Planning: Public company stock is often easier to use in estate planning for the principals.  Public stock can provide a long term exit strategy for the founders.
• Reduced Costs: The costs are significantly less than the costs required for an initial public offering.
• Reduced Time: The time frame requisite to securing public listing is considerably less than that for an IPO.
• Reduced Risk: Additional risk is involved in an IPO in that the IPO may be withdrawn due to an unstable market condition even after most of the up front costs have been expended.
• Reduced Management Time: Traditional IPOs generally require greater attention from senior management. 
• Reduced Business Requirements: While an IPO requires a relatively long and stable earnings history, the lack of an earnings history does not normally keep a privately held company from completing a reverse merger.
• Reduced Dilution: There is less dilution of ownership control, compared to a traditional IPO.
• Reduced Underwriter Requirements:  No underwriter is needed: (a significant factor to consider given the difficulty companies face in attracting an investment banking firm to commit to an offering.)

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Disadvantages of being Public
either via  a Reverse Merger or an IPO

• Less Confidentiality – complete financial disclosure is required to become publicly held.
• More Public Reporting – Reporting expense is greater because of the need for full disclosure.
• Ownership Dilution – Owners give up some equity percent.
• Greater Time Involvement – Management must devote additional time to public company operations.
• Greater Liability – More company visibility brings a higher level of liability exposure.
• Increased Expense – Higher costs of regulatory compliance for audit, legal and investor relations.

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Preparation for a
Reverse Merger or Public Shell Merger

• Locate a Suitable Public Shell - Public shells can often be found by consulting with securities law firms or CPA - Audit firms that deal with public companies.  Flex Financial Group also maintains an inventory of public shells available for merger.  Please contact us for more information.
• It is important to start with a clean shell -  Due diligence on the public shell cannot be over emphasized, advice from your securities counsel, auditors, and a financial consultant should be utilized.  As was mentioned, many shells are created for the express purpose of merging with a private company.  These shells have no predecessor entities, and, as a result, little baggage in the way of a business failure or other skeletons in the closets.
• Comprehensive Business Plan – Potential investors, public shareholders, auditors, securities counsel, brokers and market makers will want to see a well documented business plan.
• Strong Management Team – Public investors demand strong management teams.
• Convincing Marketing Plan – Public companies need the ability to show good sales and earning growth.
• Product or Service – Public companies should be able to develop strong or dominant position in their business segment.
• Financial Audits – SEC qualified audited financial statements for your last two fiscal years.
• Experienced Securities Counsel – Your attorney must be qualified to deal with regulatory compliance, and the ongoing reporting requirements of all public companies.
• Have Public Company Experience -  Your company should have at least one person in senior management that has significant public company experience.  Financing consultants such as Flex Financial Group, can often assist management in the complex issues of being a public company and maintaining a good relationship with the financial community.  In fact, many actually have a couple of shell corporations and, upon request, can manufacture a clean public shell.  A made-to-order shell without the baggage of a business failure in its background can sometimes be the way to go, but there's often a cost involved.  You will most likely end up with the financing consultants as minority shareholders in the new company, holding between 2 percent and 5 percent.  However, in almost any reverse merger transaction, the principals of the shell company keep a small equity position in the company going forward.  Therefore, this surrender of equity is simply a cost of doing business.
• Devise your financing strategy -  A reverse merger is an indirect route to raising capital. Entrepreneurs must first consider how additional capital will be raised after the deal is done.  An experienced financial consultant, like Flex Financial Group, can be very beneficial in this area.

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Requirements Necessary to
Close a Reverse Merger or Public Shell Merger

• Business plan of merger partner. Sufficient information to complete and file the required 8-K with the SEC.
• Management information, including completion of the "Officer and Director Questionnaire," for all Officers and Directors designated by the private company merger partner.
• Agreement on structure and terms of merger.
• Letter of intent with escrow payment made to public company or its principal shareholders. (This must happen for the public company to cease negotiations with other merger prospects.)
• Audited Financial Statement, conformed to US, GAAP for the private merger partner.  The audit statements of the private company have to be consolidated with the public company's financial statements.
• Agreed merger fee in escrow with the securities attorney representing the merger partner.
• Consent from the majority, preferably 100%, of existing shareholders of the private company to merge or exchange their shares for shares of the public company.
• Agreement for the Officers and Directors of the public shell to be replaced with the Officers and directors designated by the private company merger partner.
• List of all shareholders in the private company that will make the share exchange.
• Post Merger Structure. Number of shares to be outstanding “post merger”, and a complete breakdown of share ownership post merger.  Note: It is often necessary for the public shell to do a reverse split and/or cancel shares owned by the affiliates of the public share prior to completing the merger.
• Domicile Agreement. Agreement on state the company will be domiciled in post merger.
• Satisfaction of warranties and representations between public shell and merger partner.
• SEC counsel and auditors. Designation of securities attorneys and SEC qualified auditors that will represent the private merger partner.
• Agreement Preparations of the share exchange agreement, stock purchase agreement, definitive merger agreement, and all other documents necessary to complete the merger.
• Final preparation of the 8K that is required to be filed with the SEC within 4 days of closing the merger.  However, this is required by Flex prior to completing the merger. Please note: The 8-K must disclose the same type of information that it would be required to provide in registering a class of securities under the Securities Exchange Act of 1934.
  (See Sec Final Rule33-8587, pdf file)

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Filing a Form 211 to Receive a Trading Symbol

Rule 15c211 was designed to allow non-reporting public company’s securities to be quoted on the National Association of Securities Dealers’ (“NASD”) Over-the-Counter Bulletin Board (“OTCBB”) by filing some simple disclosures.

Now, companies seeking to obtain a quote on the NASD OTC/BB are required to file reports with the Securities and Exchange Commission (“SEC”), under Section 15D of the Securities Exchange Act of 1933 (the “Act”), as amended, or section 12G of the 1934 SEC Act.  A company who has filed a registration statement with the SEC using an SB-1, SB-2, or Form 10, will become a reporting company when the SEC declares the registration statement effective. Once the company is reporting, it is eligible to have a market maker file a Form 211 with the NASD. The 211 must be approved by the NASD, which normally takes 3 to 6 months, before the company can trade its stock on the OTC/BB.  The NASD will require 40 to 50 shareholders and sufficient public float to approve the 211 application.

If you need assistance in having a Form 211 filed with the NASD so that your company can trade on the OTC/BB, we can help prepare that paperwork and introduce you to a market maker.  Contact us for more information.
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