Back in the day, by which I mean the mid-2000s, I worked on a few reverse mergers.  The term is kind of a misnomer, because it sounds like the unwinding of a merger, but it actually refers to an alternative way for private companies to go public by merging with a public “shell” company.  The shell has little or no current operations and files its 10-Ks and 10-Qs, waiting to complete the reverse merger and acquire the private company.  A private company would go this route, rather than doing a traditional IPO, mainly because it is not large enough to attract the interest of first-tier investment banks, and because completing the reverse merger can be done relatively quickly, without the SEC review process associated with a traditional IPO.  However, there are a number of caveats and restrictions that should be considered by any private company before proceeding down this route:

• Several SEC rules limit the activities of issuers and stockholders of former shell companies, including issuers’ ability to conduct certain types of offerings and stockholders’ ability to sell their shares.  Basically, the SEC hates reverse mergers, in part because they historically attracted unsavory promoter-types, and in part because the transaction is viewed as an end run around the SEC’s usual procedures, even if it’s technically permitted.
• The cost of being a public company is significant, especially with Sarbanes-Oxley internal control and other requirements, and such costs may be too much for the former private company to bear.
• The major stock exchanges will no longer list a former shell’s shares immediately after the reverse merger, meaning that at least for some time, the shares will be quoted on the OTC Bulletin Board or Pink Sheets, which are shunned by most institutional investors.
• Perhaps because of these factors, companies that have completed a reverse merger tend not to be successful long-term, though surprisingly, a recent study found that reverse mergers of Chinese companies (which have attracted particularly bad press in recent years) performed fairly well on average.

Reverse mergers are not as common as they were, and they may become less so following the enactment of Regulation A+, which will permit mini-public offerings of up to $50 million, which will presumably be attractive to those companies that currently would consider the reverse merger route.

Generally, the terms “public offering” and “private offering” have the meanings that the words imply: a public offering of securities is made to hundreds or thousands of investors who may have no connection to the company, and a private offering is made to a select group of investors known to the company or its broker. Historically, private offerings made under widely-used SEC Rule 506 (part of Regulation D) were required to be completed without the use of any “general solicitation or general advertising.” However, a provision of the federal JOBS Act, enacted in 2012, blurred the lines between private and public offerings by permitting general solicitation or advertising in Rule 506 offerings, subject to conditions imposed by the SEC. The SEC has now done its imposing, establishing rules to become effective in September 2013.

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Use of General Solicitation and Advertising in Rule 506 OfferingsRead More »

There is something weirdly contradictory about Rule 506(c) under Regulation D, which has been available for less than 10 years. Regulation D was adopted years before that as a safe harbor for private offerings under Section 4(a)(2) of the Securities Act. In other words, for companies who didn’t want to undergo the costly and involved process of registering their offering publicly, they could do a simpler offering that’s not marketed widely. That process is reflected in what is now Rule 506(b). However, Rule 506(c), even though it’s within the rule that’s supposed to be for private offerings, expressly permits “general solicitation or general advertising” – so, public marketing of the offering.

There are two conditions for the use of Rule 506(c) that aren’t requirements for Rule 506(b):

            1.  Every single participant in the offering must be an accredited investor (up to 35 non-accredited investors can be included under Rule 506(b)); and

            2.  The accredited investor status of each investor must be verified, e.g., through examination of tax returns or brokerage statements, to confirm income or net worth, so, the company cannot just rely on a written representation by the investor.

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The Advantages of Rule 506(c)Read More »