Interesting article - Reverse shell mergers.
The shell game: working around the IPO pipeline
By R. Scott Raynovich
Redherring.com
May 28, 1999
It's glamorous to be in the IPO pipeline these days, but for many technology companies there are pitfalls -- investment banking and administrative fees, inflated marketing budgets, and the risk that the market could turn sour by the time the company is ready to go public.
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For companies nervous about the IPO game, there's an alternative: the reverse-shell merger.
A reverse-shell merger sounds a lot more painful than it is. It usually starts with a company that is looking for some additional cash and the currency of publicly traded stock that can be used for acquisitions. Enter the shell company, a virtual entity that often consists of nothing more than a skeletal corporate structure, a stock symbol, and some cash. Common on the OTC stock markets, many shell companies are looking for merger partners that can contribute ideas, technology, and a business model.
FutureLink, an ASP that calls itself the first utility computing company, is emerging from the billboard stocks.
By building a database that ranks user expertise in guessing the outcome of sports events, Predict It hopes to become a prediction engine for the Internet.
Recent shell-merger activity has yielded companies like Predict It (OTC BB: PRIT) and FutureLink (OTC BB: FLNK). More are on the way -- in the next month or so, GraphOn, a thin-client software company that hopes to compete with Citrix Systems (Nasdaq: CTXS), intends to merge with a shell company called Unity First Acquisition (OTC BB: UFAC). Endogen, a biotech company that was sold today to Perstorp AB, started several years ago as a reverse-shell merger with an OTC-listed company before succeeding in getting listed on Nasdaq.
NEED FOR SPEED
Most companies involved in shell mergers cite them as a way to speed up and control the process of going public.
"There are a lot more unknowns in an IPO," says Walt Keller, CEO of GraphOn. "And you can spend in excess of $1 million -- outside of the investment banking fees -- and you don't even know if you're going to be successful."
GraphOn was looking for a way to acquire some key technology it needed for its business model, and it had neither the cash nor the stock equity to make such an acquisition, according to Mr. Keller. That was the plan for the reverse-shell merger: earn the equity to make acquisitions.
OTC AS VC
Often, shell companies behave much like VCs, only they can supply both cash and stock equity. It is a way to raise a specific amount of money and go public at the same time, without being subjected to the whims of market conditions.
"One thing I like about deals like this is that there's a fixed amount of cash we're going to get... you never know what's going to happen in the IPO market," says Ed Becmer, GraphOn's chief financial officer.
With the IPO pipeline crammed full of technology companies and the stock markets becoming more volatile, reverse-shell mergers are getting a second look from a new breed of VCs and investors who don't want to waste time or risk timing the markets.
"The advantages are that it saves the company time and money from doing an IPO," says Ned Carlson, associate at Dawntreader LP, the New York-based venture capital firm that invested in Predict It and assisted it in its reverse merger with an OTC company called WDC Development, before the symbol was relisted under Predict It's name.
Despite the advantages, Mr. Carlson says that reverse mergers only meet the needs of specific companies. "Each situation is fairly unique," he says. "It's a financing strategy, and for a lot of companies it doesn't make sense. But for others, it saves time and money. There's always a backlog of IPOs."
MONEY, NOT FAME
Once a company merges with a shell entity, its very nature has changed. It can use stock to make acquisitions and it can issue secondary offerings to raise more capital -- two things small private companies cannot do.
But the drawbacks are apparent: there's little fanfare involved in a shell merger, so the companies do not receive the free publicity associated with a blockbuster IPO. The thinly traded OTC markets are of little repute and stock prices are often very low, so the newly formed company must engineer a reverse split of the stock and tighten financial reporting so that it can make a bid to be posted on larger exchanges like Nasdaq.
For companies like FutureLink, a small Canadian firm that had a difficult time drawing venture capital or investment banking interest, it was the only option. "There was no other way we could get financing," says Cameron Chell, president and CEO of FutureLink.
CH
By the way, I hope everybody realizes that FNTN did a reverse
shell merger. |
