We recently interviewed several experts on Reverse Mergers in connection with our April 25, 2006, Alternative Exits Conference which will feature panel discussions on Reverse Mergers, SPACs, PIPEs and Chinese Reverse Mergers. Among the interesting findings from these interviews are the following:
- The average cost to execute a reverse merger on the bulletin board these days is anywhere from $600,000 to $1 million. The alternatives, you could do those for $200,000, $300,000, and with a little bit of time and effort, make it into a bulletin board.
- Bulletin boards transactions make up only about 9% of the overall marketplace of shells and the other 91% are the alternatives. The alternatives are pink sheets, other OTC or what people refer to as grays, non-trades that are non-reporting but have a shareholder base, and non-trades that are reporting that have a registration statement on file.
- One area of potential concern for companies conducting PIPE transactions is EITF-0019, that is from the Emerging Issues Task Force and it deals with Accounting for Derivative Financial Instruments index to and potentially settled in a company's own stock. Now, this has been around for about five years. However, for some reason, it got the attention of the SEC's accounting staff in late 2005 in connection with a PIPE transaction and what the accounting staff is focusing on are really two issues, one are registration rights agreements in connection with a PIPE transaction, which is a standard feature of a PIPE transaction, and in particular, the liquidated damage clauses in those registration rights agreements, that is, if your registration statement is ineffective by a particular period of time, then there are liquidated damages payable back to the investors in the PIPE for not having their shares registered or their securities registered and tradable. The staff has looked at this and concluded, they think that these liquidated damages clauses constitute a derivative and as a result that characterizes the PIPE issuances as a liability rather than equity capital on the issuers' balance sheet. The real significance here is that it could force a re-characterization of all the previously issued PIPEs as well on an issuers' balance sheet, and in today's post Sarbanes-Oxley world, having to go back and restate your financials is not something that issuers want to do. So, it is really wreaking havoc on PIPE deals at the moment until this issue gets sorted out. It is a accounting issue, it is something that the SEC has to work out with the accounting community and this FASB itself is going to be looking at this issue during the course of this year, but not before June. So, for PIPE transactions that are being conducted between now and probably through the third quarter of this year, this issue is going to be looming out there.
- The other aspect of a PIPE transaction that this particular accounting issue affects is convertible securities where there is a variable mechanism in the convert, and if the same issue arising whether it constitutes a liability or equity and you have to re-characterize all your previous convertible securities as liabilities on your balance sheet as well. So, it is certainly something to be aware of and stay tuned to as you are conducting your PIPE transactions.
- Section 16 provides that various classes of corporate insiders or beneficial owners owning more than 10% of a class of securities, they have to disgorge their profits earned from the short-swing transactions in those securities over a six-month period of time. Now, the key here is beneficial owners owning more than 10% of a class of securities. If you look at PIPE investors as a group, you may well easily exceed that 10% threshold, right, whereas if you look at them individually, the likelihood is no individual PIPE investor is going to exceed that 10% threshold. If they then are viewed as a group and exceed the 10% threshold, then they require to disgorge profits.
More on 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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