The Case For Form 10 Shells - Reprinted from The Reverse Merger Report

I now have permission to post the guest column I wrote that was included in the May issue of the Reverse Merger Report. In anticipation of my panel next week in LA (see last post), I thought it might be helpful for you blogees who may not have caught the RMR to take a look, so here it is:

The Case for Form 10 Shells
During the past three years, the formation of shell companies through the use of the Securities and Exchange Commission’s Form 10 has proliferated. Many in the reverse merger and PIPE space find these shells an efficient and valuable tool to take a company public. Some have defended and others have criticized, and there are certainly pros and cons to these so-called “virgin” shells.
Virgin shells take advantage of the fact that SEC restrictions on taking a shell company public do not apply to filings such as Form 10, which allows the creation of a fully reporting shell company with no history of operations to scrub in due diligence.
One perceived drawback is that virgin shell stock is not permitted to trade until after a reverse merger and subsequent SEC registration of shares. A further drawback often cited is that virgin shells have very few shareholders, and a shareholder base must be built to qualify for trading.
However, there are circumstances where a virgin shell can be valuable in comparison to a self-filing, where a company files its own SEC registration without a shell. Self-filing can take many months longer than a merger with a virgin shell. This matters if a company needs to close a larger sized financing sooner and an investor insists on being public to do so. In such cases, the shell merger’s speed is important. However, if a company is not in urgent need of financing, or can raise money while remaining private and waiting for completion of its self-filing, it may indeed be a better alternative.
A virgin shell also has several attributes that a “legacy” shell with a history of operations doesn’t have. Virgin shells are much less expensive to set up and maintain, and there are no past liabilities to worry about. Its shareholders, even if small in number, support the target merging in whereas legacy shell shareholders’ reactions to a proposed transaction can be unpredictable.
A legacy shell can, however, be valuable in several situations. First, if a company desires to apply to Nasdaq or the American Stock Exchange immediately following a reverse merger, the legacy shell could provide sufficient shareholders to qualify for a listing, whereas virgin shells typically do not. One exception to this is WestPark Capital’s WRASP structure, which is a way to work from a virgin shell directly to the AMEX.
Legacy shells also can be valuable where PIPE investors insist on being able to mark their investment to market every day. The lack of trading for several months following a virgin shell merger would not work for this type of investor.
I believe trading in a shell prior to a merger can actually be a negative, and that the market misperceives the value of trading. Illegal insider trading creates problems in too many deals. Thin trading following a merger can actually send a stock price down until shares are registered.
The public shareholder base represents only a tiny percentage of the outstanding stock following a deal and therefore cannot be depended on to provide any real trading until shares are registered. Some seemingly “clean” legacy shells, in fact, result from fraudulent attempts to bypass SEC restrictions on blank-check company IPOs, as noted in the famous footnote in the SEC’s reverse merger rulemaking.
Still, many continue to fork over $500,000 to $800,000 or more in order to acquire a controlling interest in a legacy shell. Unless one of the advantages above applies, all one buys is three months of trading. Trading in a virgin shell, which is sold at a significant discount and requires minimal due diligence, will most likely begin about three months after the merger.
In a merger where there is no concurrent imminent financing, a shell may indeed be unnecessary. But anytime there is a contemporaneous PIPE or other financing, a virgin shell can be a very efficient vehicle. The company does not care if trading takes a few months, because they have raised money. And investors’ primary concern is that there is a trading market by the time their shares are registered, which there likely will be.
There are absolutely situations where a self-filing or legacy shell makes sense, but there are just as many others where a totally clean, AMEX and SEC-favored virgin shell can put a company on the fast track to public status.

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