Wednesday, April 30, 2008

What is a reverse shell company?

Question asked:

What is a "reverse shell", how does it work, and why is it a bad thing?

Comments follow posted by various persons, which IS NOT legal advice, but mere general information to be verified by a professional:

1. A Google search leads me to think he is referring to a public shell corporation involved in a reverse merger. Here's one explanation:

2. A reverse shell merger is a shady way for a corporation to go public on a national stock exchange. Basically, someone sets up a shell corporation (no assets/operations) and registers it with the NYSE/NASDAQ/OTCBB etc.

Then after it has built up some history as a seemingly legitimate registered corporation, the owner starts to market it as a reverse shell available for sale. A company comes along who wants to get listed on a national stock exchange but without all the hassles of actually applying for registration with the SEC and regulatory bodies.

So the company meets the reverse shell owner, they work out a merger whereby the company is merged into the shell and company stock is exchanged for shell company stock. In the end, the company stockholders and the shell company owner become joint stockholders in the merged entity.

The ratio of shares is driven by the value of the merged company relative to the price which the shell owner is charging for his shell.

Usually, companies which become listed via reverse shell merger are tainted by the shadiness of the process, although some of them have gone on to become successful, well-known companies. Most companies opt to go public via the usual, more orthodox route of registering directly.

3. While the view above is correct for some reverse mergers, as he notes, it is not true for all.

The problem is not the process itself, and there is nothing shady about the process, it is a perfectly acceptable process, permitted by all securities regulations.

What is "shady" is some of the players who are in the space.

I usually urge my clients who want to do a reverse merger into a shell not to do so, but it can work. In some instances we have spent more time doing due diligence on proposed merger partners than we would have spent taking the company public from scratch!



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