By Scott A. Walters, CPA

With an unprecedented global pandemic disruption to capital markets and the mixed results of the once-hailed small business program intended to help start-ups and small businesses sell securities exempt from registration under the Securities Act of 1933 under Regulation A+, the time may be right for privately held companies to consider a reverse merger.  

Like an Initial Public Offering (IPO) or Regulation A+ transaction, a reverse merger can monetize your investment, transition your business to the next generation, finance your growth, and/or provide flexibility for strategic acquisitions. However, based on our experience with each of these capital raising scenarios, you should carefully analyze factors such as business culture, technical ability, urgency, and your available professional resources before choosing one of these vastly different options.

Despite its initial hype, only a small percentage of Regulation A+ filers moved to uplisting to a public exchange like NASDAQ or NYSE according to Barron’s. Of the few that made it, they saw their average stock price fall 40% in the six months following their listings. Further, the few companies that successfully raised funds reported unexpected delays and ongoing frustration with the prospect of ever making it on to a public exchange.

Going public using an IPO remains the traditional method of leveraging equity to secure public capital. Companies who choose this path must be prepared to deal with the onerous regulations and tedious process that can take as long as two years to complete. Companies must also be prepared to make significant up-front investments to develop the required policies, processes and internal controls needed to launch an IPO.

In a reverse merger transaction, a privately held operating company (“target”) agrees to be acquired by a corporate buyer for shares of buyer’s stock as the purchase consideration, resulting in the acquired company shareholders receiving a controlling voting interest in the post-merger, combined entity.

Legally, the buyer has acquired the shares of the target (which has become the buyer’s subsidiary). For financial reporting purposes, however, it is the buyer that has experienced an indirect change in ownership control (controlled by the target’s shareholders), and so the buyer will be treated as the entity acquired.

If the buyer happens to be a “public company” (has issued registered securities and is a publicly reporting entity under the ’34 Act), then the target has become a publicly reporting entity overnight, literally, with a “stroke of the pen.”

Consider the benefits and challenges of the reverse merger structure.

Benefits:

  • Quick access to be a publicly reporting entity,
  • Ability to use its registered stock as currency for transactions,
  • Corporate infrastructure in place,
  • Existing shareholder “float” immediately available, and
  • Accelerated timeframe to become a public company (as compared to time required in a traditional public sale of securities).

Challenges:

  • Company and its officers will be immediately subject to the United States federal securities laws,
  • Critical due diligence is strongly recommended to ensure the merger candidate is considered “clean” without hidden creditors, disgruntled shareholders, or other contingent liabilities, and
  • Additional funding will require the filing of a registration statement with the SEC.

Finally, private companies flirting with the excitement of going public and weighing these three options should begin with a clear understanding of what going public means for their business. From tax implications to regulatory burdens, companies must face the stark reality of becoming accountable to the public through the long arm of the SEC and other regulators.

It is important to understand the SEC’s premise to protect the investing public. Our professional team includes a former SEC accountant who will triage with your securities counsel to navigate correspondence to SEC inquiries, and auditors with foundational “Big Four” experience and technical knowledge to certify financial statements required to maintain compliance with financial and disclosure reporting requirements of the federal securities laws.  For over 25 years, Daszkal Bolton has played an integral role in helping companies access the U.S. capital markets and navigate the labyrinth of government regulations for its clients. Let us know when we can help you and your company succeed.

Scott Walters, CPA, Daszkal Bolton

Scott A. Walters is a partner in the Audit and Accounting Services Department where he guides clients on GAAP reporting and SEC compliance. Scott previously was responsible for the SEC filings for a DAX 10 Company and a capital markets partner at a Big Four firm.  

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