The following points were among the insights elicited at our recent Reverse Mergers / Forward Momentum conference:
With regard to reverse mergers:
- The new 8-K rules will make full disclosure more onerous (since documents must be filed within 4 days of a transaction instead of the 70 days that was previously the rule) but will improve the quality of companies executing reverse mergers.
- Net operating losses are of very little value--as they can only be used when income is produced, they expire, and must be amortized over a long period of time--to companies that execute reverse mergers.
- Companies receiving PIPE financing from hedge funds must realize that these funds have very short-term time horizons.
- There is little merit into reverse merging into a pink sheet company other than cost savings.
- Shell providers should provide indemnifications when selling their shells. If they are not willing to provide the indemnifications, there are usually reasons relating to the lack of shell hygiene.
- High levels of free trading stock held by advisers such as PR firms and insiders is usually a sign of concern.
With regard to SPACs:
- Specified Purpose Acquisition Corporations are shell companies formed by management teams with industry experience and is organized with the purpose of effecting a combination with an existing business in the target sector.
- By law, 85% to 93% of the proceeds raised in the IPO for the SPAC are held in trust. The SPAC must sign a letter of intent for a business combination within 18 months of the IPO or it will be forced to dissolve and return the assets in the trust to public stockholders. If a letter of intent has been signed within 18 months, the SPAC can close the transaction within 24 months. The target of the acquisition must have a fair market value that is equal to at least 80% of the SPACs assets at the time of acquisition. Shareholders must approve the combination.
- The management team of the SPAC typically receives 20% of the equity in the vehicle at the time of offering, exclusive of the value of the warrants. The equity is typically locked up for 2-3 years. Management typically agrees to repurchase about 10% of the outstanding warrants once they start trading after the IPO. In many cases, management agrees to pay for the expenses in excess of the amounts outside of the trusts if there is a liquidation of the SPAC because no target has been found.
With regard to China's demand for reverse mergers:
- There are 10 million mid-sized private companies in China. There are at least 10,000 to 20,000 companies in China with roughly $30 million in revenue and $10 million in net income. Out of these companies, at least 1,000 to 2,000 will want to have publicly-traded stock in the U.S. American investment banks are far too understaffed to take advantage of this demand by Chinese companies to go public through the traditional IPO route.
- It is extremely difficult to conduct due diligence on Chinese companies. Beyond language and cultural barriers, many Chinese companies solely use cash to transact their business which makes auditing nearly impossible. It is also often unclear how thoroughly the Chinese government privatizes its companies - there is often residual government ownership and influence.
- Reverse mergers with Chinese companies is difficult because it is still complicated to get money out of China. Also, government approval is required to execute direct share exchanges with Chinese companies and it is unclear how to receive such governmental approval.
Conference materials can be obtained by contacting Neomi at 609-919-1895 x100 or neomi@incrementaladvantage.com. More this topic and more will be discussed at IncreMental Advantage's Alternative Exits Conference, December 12, 2006 in New York City. For more information visit www.incrementaladvantage.com/conferences or contact Neomi at 609-919-1895 x100 or neomi@incrementaladvantage.com.
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