Last year, when he wanted to take his new company public, Andrews, a triathlete, didn't follow the initial public offering track, in which an investment bank underwrites the sale of a company's shares to investors. Instead, Andrews and his backers chose what's known as a reverse merger. That is, they acquired a corporate shell that had shareholders and had been filing the necessary reports with the Securities and Exchange Commission but didn't have any assets or operating businesses.
By merging with the shell -- a Nevada company called High Hopes -- privately held e-MedSoft.com became a public company. Unlike the IPO process, in which investors pay for an equity stake in the company, the reverse merger didn't produce any new capital for e-MedSoft.com. It did provide a different sort of currency, however -- the publicly traded shares of e-MedSoft.com -- that Andrews used to acquire other firms. Instead of cash, the shareholders of the selling company received shares of e-Medsoft.com. "We were able to grow rapidly," Andrews says.
An abundance of deals
There were 323 reverse merger transactions completed in the U.S. last year vs. 570 IPOs, according to Thompson Financial Securities Data Publishing. In Florida, there have been more than a dozen reverse mergers in the past two years. Chadbourn Securities, a Jacksonville investment banking firm that handled Orlando-based Paladyne's reverse merger, expects to do at least four reverse merger deals this year for companies in Florida and elsewhere.
The number of reverse mergers in Florida and nationally is expected to pick up as dot-coms and other technology companies find it harder to go the traditional route of getting venture capital funding and then going public through an IPO. "The quality of the deals is increasing," says Timothy P. Halter, president of Halter Financial Group, a Dallas firm that specializes in the transactions. "There's a better perception of reverse mergers in the market."
Reverse mergers are legal and can be financially successful. But a number of factors make reverse mergers risky -- for both companies and investors -- and many reverse mergers don't work out. In one recent case, Snake Eyes Golf Clubs, a Ponte Vedra Beach golf club maker, went public by buying an Idaho shell corporation in 1996. But two years later, the company cratered because it couldn't manufacture its popular club fast enough to meet demand. It's now out of business but sold the Snake Eyes brand name to another company.
For companies, the biggest attractions of reverse mergers are speed and cost. A traditional IPO can take six to eight months and cost 12% to 15% of the total amount raised through an offering. A reverse merger, by comparison, can be done faster for much less. When Paladyne owner Ron Weindruch took his software company public through a reverse merger three years ago, for example, it cost him no cash. He did have to give up nearly 10% of the stock to the owners of the shell -- formerly a Utah mining outfit.
Surprise, surprise
Companies that buy corporate shells can find they come with ugly surprises, however. A dormant company may come with litigation problems that could resurface when lawyers discover the reverse merger creates assets to go after. Another issue limiting success is visibility: During an IPO, investment bankers and research analysts help sell a company to large institutional shareholders such as mutual funds and pension funds. Ongoing coverage by the analysts helps maintain a market for a stock.
The reverse merger process, by contrast, leaves a company with a much lower profile. Shares of most reverse mergers are first listed on the OTC Bulletin Board. Companies that don't file financial statements with the SEC -- commonly referred to as reporting companies -- can no longer be listed on the Bulletin Board; they are listed on the pink sheets, along with 6,000 other small-cap firms that can languish unless they find a way to attract investors' attention.
"People think all public companies are the same," says Gordon Tunstall, president of Tunstall Consulting, a Tampa firm that helps companies go public. "They're not."
Just ask Forrest Travis. He's chief executive officer of Intrepid Capital Corp., a Jacksonville Beach investment management firm that used a reverse merger to go public in late 1998. Travis says he went public to create a currency to make acquisitions and to create liquidity for his firm's owners. No analysts cover Intrepid, and the company's stock, which is listed on the OTC Bulletin Board, may go days without trading. In recent months, the stock has bounced around $2.
While he says he's "satisfied" with the decision to do a reverse merger, Travis wishes "we had more capital." But, he adds, "We may be the turtle in the race. I really believe in five years we'll look back and say we made the right decision."
At e-MedSoft.com, Andrews acknowledges that going with a reverse merger has been a "tough road." The company has attracted one investment research firm. San Francisco-based Sutro & Co. has issued upbeat reports, yet it also sold 200,000 shares in June. E-MedSoft.com also has raised $67 million in new equity since its reverse merger to fund its growing operations and make acquisitions. Still, after hitting a 52-week high of $24 last October, the company's stock price has since fallen below $3 a share. The company has laid off some workers. Time, of course, will tell the future. But Andrews is convinced he can see it: "We went into it with a long-term view."
Investor pitfalls
Whatever difficulties they pose for corporate managers, reverse mergers also pose issues for investors. Many companies that look to reverse mergers are small-caps, thinly traded stocks on the edge of undercapitalization. Over the years, reverse mergers also have been tainted by stock manipulators who create the illusion that a "hot" company's share price is rising by trading shares among a small group of insiders.
When unwary investors bite and begin buying shares at the higher prices, the insiders sell, reaping nice profits. "There are a lot of scams in this part of the market," says Cameron Funkhouser, vice president of market supervision at the National Association of Securities Dealers. "Don't rush into anything," he advises.