Many middle-market businesses ($1 million-$25 million) have used reverse mergers as a perceived low-cost means of listing on capital markets. Experience has shown that for most middle-market businesses there are alternatives such as filing a registration statement on Form 10-SB to register a class of equity securities or filing a registration statement on Form SB-2 to conduct a direct public offering (DPO) or register the resale of shares held by shareholders as a result of one or more private placements. These alternatives are both less expensive and more effective means of listing on capital markets.

Defining terms

Reverse mergers are a business technique that permits companies to gain access to capital markets by merging with an existing public company. It is often chosen as a less-expensive way to enter the market than an initial public offering (IPO), even though there are other alternatives that offer both the capital acquisition of an IPO and lower cost than a reverse merger.In a reverse merger, a private firm is acquired by a public "shell" company; that is, a public company that has no ongoing operations. The shell company may be a failed company or one that has filed for Chapter 11 bankruptcy, or it may have been set up for the express purpose of facilitating a reverse merger. Whatever the case, the shell is a public company and its common stock is usually quoted in the over-the-counter market or listed on a national exchange and traded. The owners of the private firm swap their shares for the majority of the shares of the public company (the shell). From an organizational point of view, the public shell company is the parent, but the owners of the private firm (its subsidiary) take control of the parent. The private firm goes public at a lower cost than with an IPO.

There is a critical difference between a reverse merger and an IPO. An IPO accomplishes at least two objectives: it allows the company to be traded publicly, and generates capital for it. A reverse merger separates these two objectives. It only allows for public trading of the shares. No capital is generated in a traditional reverse merger.

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