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 What is a Reverse Merger with a Public Shell?

• What is a Reverse Merger with a Public Shell?
• Types of Reverse Merger Candidates
• Going Public The Traditional Way
• Going Public
• Aquisition Advisory Services
• Distribution
• General Questions

A Reverse Merger is a transaction whereby the private company shareholders may gain control of a public company by merging it in with their private company. The private company shareholders receive a substantial majority of the shares of the public company (normally 85% to 90% or more) and the control of the board of directors. The transaction can be accomplished in as little as two steps, resulting in the private company becoming a public company. The transaction does not go through a review process with state and federal regulators because the public company has already completed the process. The transaction involves the private and shell company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement. At the closing the public shell company issues a substantial majority of its shares and the board control to the shareholders of the private company. The private company shareholders pay for the shell and contribute their private company shares to the shell company and the private company is now public.

Reverse Mergers can be performed in most markets. AA Capital has a focus within the USA and the UK Alternative Investment Market (AIM). The process is similar in each market, the following information is related to a typical reverse merger within the USA.

Upon completion of the reverse merger, the name of the shell company is usually changed to the name of the private company. If the shell company has a trading symbol it is changed to reflect the name change. An information statement, called an 8-K, must be filed within 15 days of the closing. The 8-K describes the newly combined company, stock issued, information of new officers and directors, and financial information. The Financial statements must be audited to US GAAP, standards, and the SEC allows a maximum of 75 days to amend the 8-K with audited financials if necessary.

If the shell company is listed on the Bulletin board, the registered or "free trade" shares can continue to trade. The company can do a private placement immediately. To trade new shares offered by the public the newly combined public company must first register the shares with the SEC. This process takes three to four months and normally requires filing a Registration statement with the SEC under Reg. SB-2 or SB-1.

If the shell company does not have a symbol, an application for a symbol is usually made to the NASDAQ Bulletin Board. The application for a symbol requires filing a Form 15c211 by a market maker that is a member of the NASD. The Bulletin Board has no financial requirements. A listing will be granted if the affairs of the company are in order and the company and the questions posed by NASDAQ.

Advantages of Going Public Through a Reverse Merger or a Public Shell Purchase

Increased Valuation

Typically publicly traded companies enjoy substantially higher valuations than private companies.

Capital Formation

Raising capital is usually easier because of the added liquidity for the investors, and it often takes less time and expense to complete an offering.

Acquisitions

Making acquisitions with public stock is often easier and less expensive.

Incentives

Stock options or stock incentives can be useful in attracting management and retaining valuable employees.

Financial Planning

Public company stock is often easier to use in estate planning for the principals. Public stock can provide a long term exit strategy for the founders.

Reduced Costs

The costs are significantly less than the costs required for an initial public offering.

Reduced Time

The time frame requisite to securing public listing is considerably less than that for an IPO.

Reduced Risk

Additional risk is involved in an IPO in that the IPO may be withdrawn due to an unstable market condition even after most of the up front costs have been expended.

Reduced Management Time

Traditional IPOs generally require greater attention from senior management.

Reduced Business Requirements

While an IPO requires a relatively long and stable earnings history, the lack of an earnings history does not normally keep a privately held company from completing a reverse merger.

Reduced Dilution

There is less dilution of ownership control, compared to a traditional IPO.

Reduced Underwriter Requirements

No underwriter is needed: (a significant factor to consider given the difficulty companies face in attracting an investment banking firm to commit to an offering.)

Disadvantages of being Public either via a Reverse Merger or an IPO

Less Confidentiality - complete financial disclosure is required to become publicly held.
More Public Reporting - Reporting expense is greater because of the need for full disclosure.
Ownership Dilution - Owners give up some equity percentage.
Greater Time Involvement - Management must devote additional time to public company operations.
Greater Liability
Increased Expense - Higher costs of regulatory compliance for audit, legal and investor relations.

Preparation for a Reverse Merger or Public Shell Merger

Locate a Suitable Public Shell - Public shells can often be found by consulting with securities law firms or CPA - Audit firms that deal with public companies. AA Capital also maintains an inventory of public shells available for merger. Please contact us for more information.
It is important to start with a clean shell: Due diligence on the public shell cannot be over emphasized, advice from your securities counsel, auditors, and a financial consultant should be utilized. As was mentioned, many shells are created for the express purpose of merging with a private company. These shells have no predecessor entities, and, as a result, little baggage in the way of a business failure or other skeletons in the closets.
Comprehensive Business Plan - Potential investors, public shareholders, auditors, securities counsel, brokers and market makers will want to see a documented business plan.

Strong Management Team - Public investors demand strong management teams.
Convincing Marketing Plan - Public companies need the ability to show good sales and earning growth.
Product or Service - Public companies should be able to develop strong or dominant position in their business segment.
Financial Audits - SEC qualified audited financial statements for your last two fiscal years.
Experienced Securities Counsel - Your attorney must be qualified to deal with regulatory compliance, and the ongoing reporting requirements of all public companies.

Have Public Company Experience

Your company should have at least one person in senior management that has significant public company experience. Financing consultants such as AA Capital, can often assist management in the complex issues of being a public company and maintaining a good relationship with the financial community. In fact, many actually have a couple of shell corporations and, upon request, can manufacture a clean public shell. A made-to-order shell without the baggage of a business failure in its background can sometimes be the way to go, but there's often a cost involved. You will most likely end up with the financing consultants as minority shareholders in the new company, holding 2 percent and 5 percent. In almost any reverse merger transaction, the principals of the shell company keep a small equity position in the company going forward. Therefore, this surrender of equity is simply a cost of doing business.

Devise your financing strategy

A reverse merger is an indirect route to raising capital. Entrepreneurs must first consider how additional capital will be raised after the deal is done. An experienced financial consultant, like AA Capital , can be very beneficial in this area.

Requirements Necessary to Close a Reverse Merger or Public Shell Merger

Business plan of merger partner. Sufficient information to complete and file the required 8-K with the SEC.
Management information, including completion of the "Officer and Director Questionnaire," for all Officers and Directors designated by the private company merger partner.

Agreement on structure and terms of merger.
Letter of intent with escrow payment made to public company or its principal shareholders. (This must happen for the public company to cease negotiations with other merger prospects.)

Audited Financial Statement, conformed to US, GAAP for the private merger partner. The audit statements of the private company have to be consolidated with the public company's financial statements.

Agreed merger fee in escrow with the securities attorney representing the merger partner.
Consent from the majority, preferably 100%, of existing shareholders of the private company to merge or exchange their shares for shares of the public company.

Agreement for the Officers and Directors of the public shell to be replaced with the Officers and directors designated by the private company merger partner.

List of all shareholders in the private company that will make the share exchange.
Number of shares to be outstanding "post merger", and a complete breakdown of share ownership post merger. Note: It is often necessary for the public shell to do a reverse split and/or cancel shares owned by the affiliates of the public share prior to completing the merger.
Agreement on state the company will be domiciled in post merger.

Satisfaction of warranties and representations between public shell and merger partner.
Designation of securities attorneys and SEC qualified auditors that will represent the private merger partner.
Preparation of the share exchange agreement, stock purchase agreement, definitive merger agreement, and all other documents necessary to complete the merger.

Final preparation of the 8K that is required to be filed with the SEC within 15 days of closing the merger. As stated earlier this is required to contain consolidated audited financial statements, but the SEC will allow an additional 75 days to file and amended 8K with the audited statements.

It has been our experience that the private company's ability to deal with all these issues is instrumental in determining the timing in closing the merger, and the long term success after closing a reverse merger or public shell purchase.

Examples of Successful Reverse Mergers with Public Shells

Armand Hammer, world-renowned oil magnate and industrialist, is generally credited with having invented the "Reverse Merger". In the 1950s, Hammer invested in a shell company into which he merged multi decade winner Occidental Petroleum.

In 1970 Ted Turner completed a reverse merger with Rice Broadcasting, which went on to become Turner Broadcasting.
In 1996, Muriel Siebert, renown as the first woman member of the New York Stock Exchange, took her brokerage firm public by reverse merging with J. Michaels, a defunct Brooklyn Furniture company.

One of the Dot Com fallen angels, Rare Medium (RRRR), merged with a lackluster refrigeration company and changed the entire business. This was a $2 stock in 1998, which found its way over $90 in 2000.
Acclaim Entertainment (AKLM) merged into non-operating Tele-Communications in 1994.

Filing a Form 15c2-11 to Receive a Trading Symbol Rule 15c2-11 was designed to allow non-reporting public company's securities to be quoted on the National Association of Securities Dealers' ("NASD") Over-the-Counter Bulletin Board ("OTCBB") by filing some simple disclosures.

Now, companies seeking to obtain a quote on the NASD OTCBB are required to file reports with the Securities and Exchange Commission ("SEC"). Under Section 15 of the Securities Exchange Act of 1934 (the "Act"), as amended, a company who has filed a registered offering with the SEC, such as an SB-1 or SB-2 registration statement is required to file reports for one year. A company which files a Form 10 or Form 10SB (for small business issuers) becomes a reporting company under Section 12g of the Act and must file reports. To be eligible for a quotation of its securities, the company's market maker must file a Form 211 with the NASD, the company must have sufficient free trading stock in its public float to allow Rule 15c2-11. <> If you need assistance in having a Form 211 filed with the NASD so that your company can trade on the OTCBB, we can help prepare that paperwork and introduce you to a market maker. Contact us for more information.

There are numerous types of reverse merger candidates available. Some are trading, some are not trading. Some report to the Securities and Exchange Commission while others remain non-reporting. Some even have cash on hand and are looking for just the right private operating company to conduct a reverse merger. Below is a summary of typical public vehicles and their usual cost ranges (Note: All cost estimates assume the public vehicle has no assets and no liabilities. Public vehicles with cash on hand and other assets often cost many times more than those without such assets. Whereas public companies with outstanding liabilities can be purchased for lesser amounts, but come with a long list of "clean-up" problems. Additionally, private companies with significant revenues and earnings, or sizeable assets, can often negotiate a better price.

OTCBB

The most popular type of public vehicle for conducting a reverse merger is the OTC Bulletin Board public company. The OTC Bulletin Board is operated by the National Association of Securities Dealers (NASD) and requires that all companies whose stock is traded on the OTC Bulletin Board (or Nasdaq or Amex) maintain their current reporting status with the Securities and Exchange Commission (SEC), which includes current audited financial statements. OTC Bulletin Board vehicles come in various forms and packages, with some currently trading and some non-trading.

Cost: (non-trading) $200,000 - $350,000, plus 5 - 20% retained equity ownership (trading) $450,000 - $900,000+, plus 5 - 20% retained equity ownership

NQB Pink Sheets

"Pink Sheet", often referred to as "pinks", companies are listed by the National Quotation Bureau (NQB). Neither the NASD nor the SEC requires Pink Sheet companies to neither maintain current reporting status nor undertake costly annual audits. Pink Sheet vehicles also come in various forms and packages, including some that are currently trading and others that are non-trading.

Cost: (non-trading) $50,000 - $150,000, plus 5 - 20% retained equity ownership (trading) $100,000 - $200,000, plus 5 - 20% retained equity ownership

Registered Rule 419 "Blank Check"

A "Blank Check" company is one that was formed with the sole purpose of becoming a public shell company. Blank Check companies have no ongoing business activity and have no business purpose except to acquire and merge with an existing private business wishing to go public quickly. All of AA Capital Blank Check companies are fully registered with the Securities and Exchange Commission (SEC) under Rule 419 of the Securities Act of 1933, as amended. Blank Check companies are non-trading until after the reverse merger is completed, and then typically will trade on the OTC Bulletin Board

Cost: $200,000 - $350,000, plus 5 - 20% retained equity ownership

Nasdaq Small-Cap,
Nasdaq NMS,
NYSE, and
AMEX

While the OTC Bulletin Board is an excellent stock market and the NQB Pink Sheets are gaining a following, some clients are interested in trading on one of the more mature U.S. stock markets - Nasdaq Small-Cap, Nasdaq NMS, NYSE or AMEX. There are varying levels of qualification for each exchange including asset levels, number of shareholders, required Board level committees, and market capitalization. There are also secondary stock exchanges such as the Boston Stock Exchange and Pacific Stock Exchange. We can assess whether your company qualifies for one of these stock exchanges and, if not, help your company grow and obtain a listing when it does meet the minimum requirements for such a listing. Typically, though, a client wishing to trade on one of these exchanges will need a minimum of $20 - 100 million in annual revenue and net profits of at least $2 million annually.

Cost: $3,000,000 - 100,000,000+, plus 30 - 70% retained equity ownership

Even under the most favorable market conditions, "going public" can be a complicated, expensive, and even overwhelming process for many business owners. Crucial decisions must be made in unfamiliar territory and at a time of financial and emotional uncertainty for everyone involved. AA Capital can help you prepare yourself and your company for the problems, pressures, and dangers of offering public stock.

Steps to "Going Public":

Decide If and When to go Public
Write a Business Plan Conducive to Raising Capital
Select an Underwriter and Negotiate their Fees
Select Auditors and Negotiate their Fees
Select Securities Attorneys and Negotiate their Fees
Select Printer and Negotiate Fees
Prepare Your Registration Statement (Prospectus)
Select the Time of Your Stock Offering
Price Your Stock
Select Transfer Agent
Schedule and Conduct Road Shows and Marketing Meetings
Complete SEC Review and "Blue Sky" Qualifications
Conduct Closing
Develop After Market Plan and Ongoing Investor Relations Plan
Expect the entire process to require 6 to 12 months and to cost from $200,000 to $500,000. Bad planning or advice may cause costly delays of several months and/or an additional several hundred thousand dollars. If the deal is not registered properly and executed smoothly, the price of the stock can easily be priced from $1.00 to $3.00 per share below what it should, costing the company equity.

We can Assist In All Phases Saving Your Company Time And Money

• Acquisition Strategy. We can assist in the development of an appropriate acquisition growth strategy
  
  
• Target Company Profile. We can help develop parameters for evaluating and prioritizing potential acquisition targets, with the aim of maximizing near-term shareholder value.
  
  
• Solicitation of Interest. We can work with client management to determine the most appropriate form of initial contact with targets. In most cases, we can make the initial call to potential targets, on an anonymous basis, if required.
  
  
• Preliminary Due Diligence. We can work with client management to determine the strategic opportunities and requirements of the target, then conduct preliminary due diligence to guarantee that the merger will make a good fit.
  
  
• Valuation. We will perform independent financial due diligence of the target and provide reasonable valuation estimates.
  
  
• Letter of Intent. We can help prepare, negotiate and execute an appropriate Letter of Intent or Memorandum of Understanding.
  
  
• Comprehensive Due Diligence. We will help conduct and coordinate financial, operational and legal due diligence, calling on the talents of leading audit and legal experts, where needed.
  
  
• Financial Analysis. We will prepare historical and pro forma financial statements, seller EBITDA adjustment analysis, consolidation cost savings analysis, and assessments of earnings accretion or dilution, as well as final purchase parameters and transaction structure.
  
  
• Financing. We will help the client company access capital markets to obtain needed acquisition or working capital, as needed, and can assist with the negotiation of term sheets.
  
  
• Negotiation and Documentation. We will work with company management and advisors to actively manage the structuring, negotiation and documentation of the proposed transaction.
  
  
• Communications Plan. We can assist in the design and execution of a communications strategy designed to secure the support of employees, customers, investors and other stakeholders.
  
  
• Regulatory. We can help prepare and file regulatory compliance, disclosure, financial reporting, solicitation and information documentation.
  
  
• Closing. We will coordinate and participate in the closing process.
  
  
• Integration. We can assist in the conception and execution of an integration plan that aligns diverse corporate cultures develops training, compensation and incentive programs, and helps retain customers and build market share
  

Unlike an IPO, where going public and raising capital are completed in a single step, a reverse merger involves two phases. First, the reverse merger is completed. Then, capital is raised, either through a private placement (PIPE) or a registered public offering. We have a team of experienced institutional salesmen who are dedicated to raising capital for our reverse merger clients.

Our Distribution services include:

• Development of a capital markets strategy
  
  
• Identification and evaluation of various financing alternatives
  
  
• Review of private placement memorandum (for a private investment in public equities, or PIPE) or prospectus (for a registered public offering), as applicable
  
  
• PIPE placement or registered public financing offering, as applicable
  

In addition to raising capital for our reverse merger transactions, we also:

• Raise capital for public issuers through PIPEs
  
  
• Participate in underwriting syndicates for registered public offerings
  
  
• Maintain relationships with a select group of sophisticated investors, both institutions and high net worth individuals, who actively participate in special situation lending opportunities.