The Reverse Merger Process

I’m attorney Laura Anthony founding partner
of Legal & Compliance, a full service corporate securities and business transactions law firm.
Today is the third segment in a multipart securities LawCast© discussing reverse merger
transactions. In the first segments I explained what a reverse merger transaction is, and
broadly described confidentiality agreement, letter of intent, and definitive merger agreement.
Today I am talking about the cost of the transaction, including the cost to acquire a controlling
interest in a public vehicle. In a reverse merger transaction, the shareholders of a
private operating business obtain a majority controlling interest in a public company,
and must pay for that controlling interest. That payment may be in either in cash or equity
or both. In addition to the cost of acquiring the controlling interest, the private entity
must complete an audit and pay attorney fees associated with the transaction in the closing
8-K or Super 8-K. I generally suggest clients budget $100,000 for costs and expenses above
and beyond the cost of the public vehicle, though many transactions may be completed
for less. And although attorney fee time is generally the same for transactions big and
small, the audit and accounting fees vary greatly, depending on the maturity and complexity
of the underlying private business going public. As for the cash price of a public entity it
can vary greatly. However today and currently the average price for a fully-reporting public
entity with no liabilities and which is otherwise clean is between $350,000 and $475,000. The
cash is paid to the public company control shareholders, in exchange for giving up and
relinquishing control ownership. The price variance depends on many factors. Factors
include whether the public entity is a shell company, or has an existing business operation,
the necessity of completing changes to the capital structure, such as through a reverse
or forward stock split, the existence of liabilities, negative history of the public company, such
as prior regulatory actions against the company, or its former officers, directors or control
shareholders, the ultimate present ownership that will be owned by the private operating
company shareholders upon closing, how quickly the transaction can close, whether the entities
have completed the diligence packages on each other, and whether any broker dealer or investment
bankers must be paid in association with the transaction. Where the private operating business
is paying for the public shell and entity with equity, the current shareholders of the
current shell company keep a larger portion of the post-closing equity, and therefore
own a greater percent of the new combined company. For example, in a cash transaction
the operating business shareholders may end up owning 90% of or more of the combined entity’s
post-closing, whereas in an equity transaction the operating business, the shareholders may
end up only 60% or 70% of the combined entities post-closing. No matter what the transaction
in order to qualify, the transaction must result in the private company shareholders
owning 50% or more of the combined entity’s post-closing. The percentage of ownership
maintained by the public company’s shareholders will depend on the perceived value of the
private operating company that is completing the reverse merger transaction. And in expectation
of the value of the share ownership will increase in the future. Accordingly, in an equity transaction,
the parties in a reverse merger will negotiate the value of the private operating business.
In an equity transaction the control shareholders of the public company will have to decide
whether to accept a $400,000 today, or maintain a stock ownership in the company, in the combined
companies that they hope will be worth much more than that in the future. Obviously the
valuation is a very important factor in determining the cost of acquiring a public company and
going public via a reverse merger. In the next segment of this LawCast© I will discuss
factors in determining valuations. And in the final segment in this series I will go
through the advantages and disadvantages of completing a reverse merger. I’m securities
attorney Laura Anthony, founding partner of Legal & Compliance. Should you have any questions
about today’s topic, please visit or contact me directly. Inquiries of a technical
nature are always encouraged.

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