Virgin Shell Creation Escalating; They’re Easy to Set Up - Right?

Here’s the good news. The pace at which virgin shells are being created is escalating, as the market continues to recognize the value of these straightforward vehicles. And that value is increasing with the potential elimination of the so-called Worm/Wulff restrictions; the SEC will shortly approve a rule making Rule 144 resale of shell shares available six months after a reverse merger and release of information (currently shell shares can never be resold under the Rule 144 exemption from registration).

Many clients who have already created virgins are “running out,” and making more. Others who were on the fence have moved forward. More and more mergers with virgins have closed, and are trading. This thing works, especially when a private company is seeking to close a contemporaneous PIPE with a reverse merger, rather than wait for a self-filing, which can take time and is appropriate when a company has that luxury.

To recap, a virgin shell (so dubbed by the Reverse Merger Report, in my book I simply called them “Form 10-SB Shells”), is created when a corporation set up to be a shell (typically in Delaware, but I have seen other states) goes public with the filing of Form 10-SB with the SEC. After the effectiveness of the filing, the company becomes fully reporting with the SEC, but its stock cannot trade prior to a reverse merger and subsequent registration of shares with the SEC. (Disclaimer: I personally own an interest in six virgin shells.)

Why is this better than a self-filing? It’s all about timing. If you know you don’t need to raise a large PIPE for 5-8 months, a self-filing might make sense. If you need to raise a larger PIPE sooner, a merger with a shell allows that PIPE to be raised upon closing the merger, which takes only a few months. This is the value of merging with a shell.

Why is this better than a trading shell? In a prior post which you can find at http://www.reversemergerblog.com/2007_04_01_archive.html, I outline the pros and cons of each. There are situations where a trading shell makes sense, but frankly, less than you might think. If there’s an urgent need for a shareholder base (such as if you wish to go right to Nasdaq or Amex immediately) or an investor who insists on trading going on even though his securities will not be tradable until registered, there may be no choice. But the costs and risks associated with trading shells are significant compared to virgins, hence the attractiveness. Plus we know the SEC disfavors shells that trade, and favors those that don’t. The proof is the fact that our Form 10-SB filings are now greeted with a hard to obtain “no review.”

Here’s the bad news (which is also sort of good). More and more people are setting up virgin shells with either limited or no legal assistance and in some cases with auditors who charge low fees but have very limited SEC experience. I believe our firm has set up more than any other (we’ve been hired to create over 120 virgin shells in the last 2 years), so of course we have the flattering problem of seeing our carefully developed Form 10-SB copied by others. Amazingly, even when that happens people make mistakes, are careless, etc. Copiers don’t realize how many things are going on behind the scenes to make our virgin shells truly pristine.

I do not wish to catalog the various issues and problems we have encountered with virgins created by those with little experience. I simply wish to warn the marketplace that, while the process of creating these is very straightforward for someone who has done quite a bit of it, there are a variety of issues to deal with if you are doing it for the first time, and there are several traps that the uninitiated fall into that in some cases are not reparable.

My very very strong advice is: don’t do this at home. If you are thinking about setting up virgin shells, please make sure you hire competent auditors and counsel who have real experience in doing this, even if there is a slightly higher cost. My mother always said, “You get what you pay for.”

To those of my brethren observing, I wish you all a Happy and Healthy New Year. And to all, Happy Fall!

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