>THE TRUTH ABOUT REVERSE MERGERS

A reverse merger (“RM”) is a non-traditional method of going public. Instead of hiring an underwriter to market and sell the company’s shares in an initial public offering (“IPO”), a private operating company works with a “shell promoter” to locate a suitable non-operating or shell public company.1 The private operating company then merges with the shell company (or a newly-formed subsidiary of the shell company).2 In the merger, the operating company shareholders are issued a majority stake in the shell company in exchange for their operating company shares.3 Post-merger, the shell company contains the assets and liabilities of the
operating company and is controlled by the former operating company shareholders.4 The shell company’s name is changed to the name of the operating company, its directors and officers are replaced by the directors and officers of the operating company,5 and its shares continue to trade on whichever stock market they were trading prior to the merger.6 Hence, the operating company’s business is still controlled by the same group of shareholders and managed by the same directors and officers, but it is now contained within a public company. In effect, the operating company has succeeded to the shell company’s public status and is therefore now public.

RMs have been around for years but have recently regained popularity. Closed RMs totaled 46 in 2003, 168 in 2004, 179 in 2005,7 and 69 through the first half of 2006.8 Notwithstanding this resurgence, RMs should be viewed critically. Although RMs are often pitched as IPO substitutes, they provide neither a large infusion of equity capital nor share liquidity, the two primary benefits of an IPO.9 This Article proceeds as follows: Part II describes the principal features of an RM, including the origin of shell companies, RM deal structure, and legal compliance. Part III takes a critical look at RMs arguing that comparisons to IPOs are misleading and, for many companies, irrelevant. Part IV discusses why companies nonetheless undertake RMs. Part V briefly discusses RMs involving special purpose acquisition companies (“SPACs”). Part VI states a brief conclusion.

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