Reverse Mergers – Costs

Posted by on November 07, 2016

Reverse Mergers – Costs- Today I am talking about the costs of the transaction, including acquiring a controlling interest in the 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 cash, equity or both. In addition to the cost of the controlling interest, the private entity must complete an audit and pay attorneys fees associated with the transaction and closing 8-K or super 8-K. I generally suggest clients budget $125,000 for costs and expenses above and beyond the cost of the public vehicle, though many transactions are completed for less. Although attorney time is similar for transactions big and small, the audit and accounting fees vary greatly depending on the maturity and complexity of the company.

As for the cash price of a public entity can vary and changes over time, currently the average cash value of a fully reporting public entity with no liabilities and which is otherwise “clean” in today’s market is between $275,000 – $375,000. The cash is usually paid to the public company control shareholders in exchange for relinquishing their control ownership, however it may also be paid to the public company itself and used to satisfy debts.

The price variance depends on many factors, such as whether the public entity is a shell or has an existing operating business and even if it does not claim itself a shell, whether it could be considered one under SEC footnote 32; the necessity to complete changes to the capital structure of the public vehicle in the form of a stock split; the existence of liabilities; negative history of the public entity such as prior regulatory actions against the company or its former officers, directors or control shareholders (though as a side note, in today’s regulatory environment, negative history is simply a deal killer); the ultimate percent ownership that will be owned by the private operating company shareholders; how quickly the transaction can close; whether the entities have complete due diligence packages; and whether any broker-dealers or investment bankers must be paid in association with the transaction.

Where the private operating business is paying for the public shell entity with equity, the current shareholders of the public shell company keep a negotiated portion of their pre-closing equity and therefore own a greater percent of the new combined companies post-closing. For example, in a cash transaction, the operating business shareholders may end up owning 90% or more of the combined entities post closing, whereas in an equity transaction, the operating business shareholders may end up only owning 70%. No matter what, for the transaction to qualify as a reverse merger – and result in the private company going public – the private company shareholders must end up owning over 50% of the combined entities post closing.

The percentage of ownership maintained by the public company shareholders will depend on the perceived value of the private operating company and an expectation of what the value of their share ownership could be in the future. Accordingly, in an equity transaction, the parties to the reverse merger will negotiate the value of the private operating business. In an equity deal the public company shareholders may have to decide whether to accept $350,000 today or maintain a stock ownership level that they hope will be worth much more than that at some time in the future. From the private operating company’s perspective, they are diluting their current ownership and giving up a piece of the pie.