There are three ways to obtain a public listing: an underwritten offering, commonly referred to as an IPO or Initial Public Offering, a self-underwritten offering, referred to as a Direct Public Offering and via Reverse Merger.
Underwritten Offering (IPO)
This approach requires a company to attract an investment banking firm to sponsor the offering. When an investment banking firm agrees to raise capital, and manage the public listing, it expects reimbursement for all of their expenses and earns a commission from the amount of capital raised.
If there are insufficient buyers for the stock, the investment banking firm will force a company to either lower the stock price or cancel the public offering due to “market conditions.” This can devastate a company relying on the capital and often damages their corporate credibility and brand image. These situations do not occur when participating in a direct public offering (discussed below) or even a reverse merger.
In addition to relinquishing a great deal of control over the process of going public, investment banking firms present another hurdle in that they often will not even consider helping small or medium sized companies go public. Instead, they choose to represent only those companies that they “know” they can raise capital for. Finding a properly licensed broker or dealer to facilitate a private or public offering for a small to medium sized company is extremely difficult, if not impossible.
Direct Public Offering (DPO)
Due to the risks involved in a reverse merger transaction, and the small likelihood of attracting an investment banking firm to facilitate an initial public offering, many business owners will benefit from this method: the direct public offering (DPO).
A DPO enables a company to go public without using an investment banking firm or shell company for a reverse merger transaction. The legal, accounting, and regulatory processes are handled by the private company and its advisors. DPOs can usually be completed in six to nine months.
In a DPO, the private company and its advisors manage the legal, accounting, and regulatory processes used in an Initial Public Offering (IPO), but without the assistance of an investment banking firm. A DPO is the least expensive route to becoming public, generates the most predictable results and offers the least risk.
Many companies planning a DPO do not have the knowledge, experience, or time to allocate to the project. Therefore, they decide to hire a consultant to ease the process and ensure that all of the appropriate regulatory requirements are fulfilled.
A start-up company can become publicly traded for $120,000 plus equity. Some clients had the financial resources to pay the costs of going public, but most engage our services, obtain our assistance in structuring a private placement and then raise capital from friends and family to cover all the costs. Larger companies will have the base expense plus incremental legal and accounting cost.
A reverse merger transaction is where a private company merges into a public shell and ends up with control of the public company. The result is that the private company is the surviving entity and inherits all financial and contingent liabilities. This method of going public can usually be completed within two months.
Before considering a reverse merger transaction, you should become familiar with what exactly a shell company is. A shell company can be either publicly traded or privately held. When a private company is seeking to merge into a publicly traded shell and thereby go public itself, it must file many legal and accounting details with the Securities and Exchange Commission (SEC). Alternatively, non-trading shell companies can also be used to become publicly traded, but the costs and time involved are extensive and thus provide little benefit.
Nonetheless, a reverse merger often looks like an attractive option at first glance: the process is much faster than the other two methods, so it is often used by companies in a rush to capitalize on favorable market conditions.
Unfortunately, companies using reverse merger transactions to go public often end up paying a higher than anticipated price for several reasons:
- The shareholders of the original public entity retain some of the outstanding shares and will generally sell their shares as soon as they can, making it very difficult for the stock price to increase. This can make it very difficult to raise investment capital or complete acquisitions.
- Acquiring control of a “clean shell” can cost about $400,000.
- The legal and accounting history of the public company must be incorporated into the private company documents filed with the government, a process prone to inaccuracy, incompleteness, and unavailability of information.
- The surviving entity of the private company merging into the public shell inherits all of the financial and contingent liabilities of the original public company.
While we have completed several reverse merger transactions on behalf of companies it took public via direct public offering, private companies are not encouraged to go public using a reverse merger transaction.