You’re an entrepreneur who started your company three years ago, have gone through the phases of developing your product, getting it to market, and becoming commercially successful, and your company is now generating profits. Meanwhile, you have been reading about the insane valuations of "dot com" company initial public offerings (IPOs) that have transformed talented-but-poor entrepreneurs into obscenely wealthy individuals. So, you’re motivated to do an IPO and buy your 100-foot yacht
in the Bahamas.

But wait … there’s more! Ask anybody who has taken a company public through an IPO and they’ll tell you it’s like walking barefoot on broken glass --- you may end up getting where you want to go, but it’s an uncomfortable process. This article will tell you about an alternative to an IPO using a public "shell" which is becoming more attractive because completing an IPO has grown into an expensive, complex, and time-consuming process.

How expensive? To pay for underwriter (broker), legal, and accounting services, and fees to the Securities and Exchange Commission (SEC) and Nasdaq, count on about 15 percent of the total amount raised (for example, $750,000 for $5 million raised). How complex? An IPO involves working with detailed accounting procedures, financial reports, and securities laws that are usually not within the expertise of the average entrepreneur. And, to attract an underwriter and institutional investors in today’s market, your company needs to have a story with investor appeal. It’s easier to attract investors if you are one of the current darling industries like Internet, biotechnology, telecommunications, and software development, or if you have an exciting proprietary product or service. An IPO is also dependent upon market timing. If the market is not performing well, you will want to put the process on hold until the market recovers.

How time-consuming? You’ll first need to create a well-written business plan and present it to the investment banking community to attract an underwriter’s interest. Once you have secured an investment banking firm to underwrite your IPO, the real work starts. Plan on spending nights and weekends drafting the offering prospectus in conjunction with your corporate counsel and auditors. This document is then presented to the SEC for approval. The approval process often takes several drafts and revisions, each one requiring precious time that normally would be used to run your business. Next, you will need to work with a public relations firm to develop an effective presentation of your company’s goals and objectives to be used to attract potential
institutional investors and brokers to invest.

Now its time to tell the story to potential investors on a "road show". During this last stage, your management team should count on several weeks of travel during which your team gives short presentations around the country to generate interest in your IPO. It usually takes about a year to complete an IPO from start to finish. Who
has time to run a business when all this stuff is going on?

People still do it, though, because there are a lot of good reasons to be a public company. Mainly, going public gives a company the ability to raise large sums of capital that would be unobtainable through other methods and gives a company liquidity for its current and future investors. Equity capital obtained from an IPO is a "permanent"
form of capital since there is not interest paid on the equity and it is not repayable like debt. The equity provides a solid financial base, freedom, and flexibility to finance growth and further development as well as expansion through future acquisitions.

Becoming a public company will create more publicity for your company that, in turn, creates more credibility and legitimacy with customers, employees, suppliers, competitors, and the community. And, it helps with employee retention because you can offer employee stock purchase programs and stock option incentive programs.

If you still really, really want to be a public company, don’t need lots of cash from an IPO but want liquidity for investors, and are interested in saving time and money, you may want to consider an alternative to an IPO, which is a reverse merger into a public"shell".

A shell is an existing public company that currently has no operating business. For whatever reason, the product or service of the company has ceased its business but the corporation (or shell) of the company still exists, as do shareholders and maybe some assets. The shareholders are looking for a way to create a new company so that the stock they still hold will have some value.

For your company, a reverse merger into a public shell can provide a fast and economical way for taking your private company public. If the shell does not have assets, it may not provide the cash usually raised with an IPO, but by becoming public you will be able to pursue other future investment opportunities like a secondary
offering that are unavailable to private companies. On the other hand, some shells have cash ranging from a few hundred dollars to millions.

To begin, your company needs a good business plan including historical and current financials, marketing programs, and a description of the management team. The board of directors of the shell company will want to be assured they will be able to increase their shareholder value, and your business plan must convince them that your company can do that.

Once a shell is identified, be certain that the shell is current with all required public filings and has a solid and stable shareholder base. Then due diligence is completed, and an agreement is reached as to the valuation of your company and the shell. This valuation will determine the ownership breakdown of the two merged entities following the merger. The reverse merger process will then take the following steps:

Step One

The two companies come to terms of agreement on the acquisition of your company by the shell company. If the shell company will be issuing shares to outside shareholders that will amount to an excess of 20% of the
outstanding shares of stock, the shell company may need to obtain shareholder approval for the proposed transaction. Letters of intent and agreement are signed contingent on shareholder approval.

Step Two

The deal is closed and ownership is established. For example, let’s assume the shell company has 5,000,000 outstanding registered shares trading on the Nasdaq SmallCap Market and assets including cash enough to result in 25% of the new merged company. The shell company acquires your company by issuing 15,000,000 shares of common stock of the shell company in exchange for 100% of your company’s outstanding common stock. The new company now has 20,000,000 shares of outstanding stock, with 25% ownership being held by the old shell company shareholders and 75% of the outstanding stock being held by shareholders of your company. If the shell has no cash, the split could be closer to 10% / 90%.

Step Three

The current board of directors and management of the shell company resign and a new board and management team is appointed (usually consisting of management from your company). The name of the shell company is changed to your company’s name or something very similar to it, and a share holder meeting is held to approve the transaction.

The challenge of making a reverse merger with a public shell successful is establishing a market for your company’s stock because you don’t have an underwriter supporting your stock like you would have in an IPO (unless you plan a future secondary offering). So, throughout this process it is important to communicate the
business strategy of the new company to existing shareholders and the company’s market makers to maintain a strong market demand for the stock, which in return creates a strong market capitalization.

The advantages of a reverse merger with a public shell include:

Saving time: A reverse merger can be completed in 3-4 months, versus about 12 months for an IPO.

Saving money: Depending upon the type of shell and what assets it has, the price you’ll pay for a public shell will be about half the cost of a typical IPO.

Creating liquidity: By becoming a public company with stock listed and traded on a public exchange, your current investors will have a vehicle by which to liquefy their investments. Also, it is often easier to attract future additional capital from outside investors or to have a future secondary offering.

Reducing legal work: A reverse merger may not require an offering prospectus or months upon months of working with accountants and attorneys. Oftentimes, preparation of a proxy for a shareholders vote is all that may be required.

Eliminates underwriter preferences: Certain industries have a difficult time attracting the attention of investment bankers and underwriters. Sometimes good solid companies miss the opportunity to acquire public capital due to lack of interest on behalf of underwriters and market conditions. This can be avoided with a reverse merger with a public shell.

Reduces Nasdaq listing requirements: As of February 23, 1998, Nasdaq increased the requirements for initial listing on its SmallCap Market that make it more difficult and dilutive for small companies to meet requirements for initial listing. However, the requirements for maintaining an existing listing are much less restrictive.

Taking a company public through an IPO can be very challenging and distracting for an entrepreneur. If your business is successful and you don’t need to raise cash but want to take your company public quickly and for less money in order to provide liquidity for shareholders, a reverse merger with a public shell may be an alternative way to bring your company public.