9. Are you planning on raising a round of financing through a PIPE transaction?

One of most difficult parts of the going public through a reverse merger process is the capital raise. Many of today’s shell financings are done through what is commonly referred to as a PIPE – Private Investment in Public Equity. There are two main types of PIPEs - traditional and structured. A traditional PIPE is one in which stock, either common or preferred, is issued at a set price to raise capital for the issuer. A structured PIPE, on the other hand, issues convertible debt (common or preferred shares). PIPEs are usually sold at a discount to market – anywhere from 10% to as steep as 50%.

The problem with PIPE financings, in general, is that it attracts hedge funds whose chief objective is to get out of your stock as soon as possible. In the past there have been horror stories about firms like Cornell Capital who will fund your deal but use a convertible debt instrument. The problem with this type of financing is that it creates what we like to call “the death spiral”. There is a “hook” to this type of financing. Basically the funding source reserves the right to constantly “adjust” the bid price of the stock to approximately 80% of the current bid. On the surface this sounds fair and equitable but here is the real deal. They could care less whether your stock goes up or down. Their traders start hitting the bid price of your stock knowing full well that they can buy it back at 80% of the bid – so there is no downside for them no matter how low the stock goes. At the end of the day you may get funded but you will also have a stock trading at less than a penny, 500,000,000 shares of stock outstanding and you will have lost control of your company and any hopes of raising additional funds. The SEC has recently clamped down on these types of funding structures by invoking their new interpretation of Rule 415.

The best way to judge a funding source is to ask for the stock symbols of the last three to five deals they have funded. This will allow you to assess the structure, terms and conditions of their deals and how the deals performed. If they funded a deal in April of 2007 when the stock was trading at $2.00 and the stock now trades at $.10, this is not the type of company you want to get in bed with.

The SEC has recently introduced a new proposal to reduce the time that an investor will have to hold his stock in a private equity transaction from 1 year to 6 months. The comment period for this new proposal end September 4^th, 2007. The new rule has a lot of support by professionals in the reverse merger industry and it is anticipated that the new rule will go effective before the end of this year. You can read the details of the rule at the SEC site. Here is the title and the link.

REVISIONS TO RULE 144 AND RULE 145 TO SHORTEN HOLDING PERIOD FOR AFFILIATES AND NON-AFFILIATES

http://www.sec.gov/rules/proposed/2007/33-8813.pdf

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