• 2007 – First quarter results – 53 reverse mergers with $3 billion market cap – 100% higher than the prior year quarter!
• A new study at the University of Pittsburgh showed that 91% of the companies that performed a reverse merger are still in existence three years later. This contrasts with a previous study suggesting that the survival rate was about 40% to 45%.
• The University of Pittsburgh study also showed that the average time to complete a reverse merger was 51 days.
• The new SEC small public company proposals are having a positive impact. Lets’ hope the final rule proposal language is not revised to the point of non recognition.
• The number of reverse mergers reached 206 in 2006, a slight increase from the prior year.  This number outpaced the 198 traditional IPOs.
• The aggregate market value of reverse mergers in 2006 was $8.4 billion
• There were 59 trading SPACs at the end of 2006.
• In 2006 almost 50% of reverse mergers executed a financing or “alternative public offering”.  The average raise was $9.4 million per deal or an aggregate of $850 million.
• Chinese transactions increased to 26% of the total number of reverse mergers in 2006 but the total value of those deals dropped by almost 50% from 2005.
• The average traditional IPO in 2006 raised $216 million translating into average post IPO market cap of $750 million.

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1. The crash of IPO markets in late 2000.

The IPO markets were fueled by one thing in the late 90’s – The Internet.  From 1997 through the end of 1999 just about anyone who had an Internet concept for a company could go public.  You didn’t need revenues or earnings, just a concept.  Many of those “concepts” were funded for hundreds of millions of dollars until 2000 when investors came out of the ether and had a reality check.  By the end of 2000 the Internet bubble had burst and investors witnessed more public Internet companies crashing and burning than you could see at a NASCAR event.

2. The introduction of SOX
The crash of the IPO markets was then followed by the spectacular fall of some very large and well known public corporations such as Enron and WorldCom.  Sprinkle on several insider trading scandals and add a dash of overindulgence by the a few CEO’s and you have a recipe for – Government Intervention.

At the culmination of these events there were several government investigations which resulted in the passing of Sarbanes Oxley (“SOX”).  SOX was intended “to protect the investing public” by establishing a new set of rules for public companies.  However, the cost to implement and comply with those rules cost the average public company over $3 million a year.  Even though the SOX rules were intended for large corporations they also mandated that even the smallest public reporting company must adhere to the same set of rules.  This was a death blow for small emerging growth companies.

3. Risk/Reward for large underwriters

Under the new SOX legislation CPA firms (who caused this mess in the first place) and Underwriters suddenly became liable for public companies that they represented.  Therefore they suddenly changed their criteria for underwriting.  No more startups or emerging growth companies.  They now were only interested in old established brick and mortar companies with a history of revenues and earnings.  If you look at the average company going public today you will notice the average IPO raised over $200 million.  Therefore the average public company valuation averages over $700 million.

4. Consolidation of the stock brokerage business

During this time period there was also a consolidation of the stock brokerage business.  With the introduction of Schwab, ETrade and Ameritrade investors could now purchase stocks online for as little as $10 per trade.  They no longer needed their stockbroker to make a trade.  They now had Internet access to as much, if not more, information than their brokers.  The stockbrokers started to disappear.

5. Disappearance of the small boutique underwriter

The small boutique underwriter who performed many of the smaller IPO’s stated to disappear once the Internet bubble burst.  IPO’s dried up and the smaller players could not survive.  Their stock brokers who mad a living selling shares in new companies had no new company shares to sell.  Investors who were previously overly exuberant and game to invest in just about any deal were now taking huge losses and pulling out of the market.

So, basically the IPO markets were dead for small companies from the end of 2000 until about 2004.  This was about the time were started hearing rumblings about proposed exemptions for small companies concerning SOX reporting issues.  That is when Reverse Shell Mergers started making their way to center stage.

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First of all, get the company you are vending into the OTCBB shell audited BEFORE you try to buy the shell. Here are the reasons. As much as you distrust Americans they distrust you more. So if you can’t provide a business plan of the company with audited financials no one will believe you have a real deal and they will not sell you their shell. Most Sellers understand they have to perform proper due diligence on the Buyer prior to selling the shell in case something goes wrong after the transaction. Think of it from our point of view. If there is an investigation into a foreign Company trading on the OTCBB chances are the Seller is the one who is going to take the heat from the SEC because he lives in the US and you are thousands of miles away and out of jurisdictional reach of the SEC.

Secondly, why would anyone spend $600,000 on a shell but not $20,000 to $40,000 on an audit prior to the purchase of the shell. This one I am still trying to figure out. Now I know there are brokers or consultants out there that want to buy a shell and later identify the company they are going to vend in but, unless you are a licensed broker-dealer or can demonstrate a history of previous successes, most likely no one is going to take a flyer on a future unnamed company that is going to end up in their shell at some later date.

Lastly, you don’t have to purchase a 90% plus delivery shell. The PERCENTAGE OF OWNERSHIP DOESN’T MATTER! A Buyer can take any shell that has over 51% and perform a reverse stock split in conjunction with the reverse merger and end up with a 99% shell. If I sell you a 90% delivery shell with 100,000,000 shares you still have 10,000,000 shares left in the float after you purchase the shell which means you still have to perform a reverse stock split. So, unless your needs include free trading shares of stock, the percentage of delivery doesn’t matter as long as you are getting at least 51% of the shares.

If you would like further explanation please feel free to call me direct at:

Ventana Capital Partners

Ralph Amato

858-729-0075

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The first is called a “blank check company.” A blank check company is a development stage company that has no specific business plan or purpose or has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, other entity, or person.
The second is defined by the SEC, which says that a shell company is a company that has no or nominal operations, and either:
* no or nominal assets;
* assets consisting solely of cash and cash equivalents; or
* assets consisting of any amount of cash and cash equivalents and nominal other assets.
How is a company deemed to be a “shell”? The public company may be the remnant of a bankrupt or sold organization, its business plan was not executed correctly or it was unable to raise sufficient capital to continue its operations. Sometimes, a group of investors raise capital for specific purpose commonly referred to as a SPAC. A SPAC is a shell that has been pre-funded by investors and formed for the purpose of purchasing a private company and vending it into a shell. However, if the SPAC can not identify a candidate to purchase in eighteen months the SPAC will usually be disbanded and approximately 90% of the money is returned to the investors.

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Don’t suggest to Tim Keating, President of Keating Investments, that reverse mergers have a less-than-stellar reputation. He’s heard it all. He even used to keep a file of negative press clippings, until he got bored with it and stopped.
But in the past few years, several things happened: Sarbanes-Oxley legislation, which made it more expensive for companies to go public. A probe of Wall Street research practices by New York Attorney General Eliot Spitzer, which has resulted in many firms reducing analysis of smaller companies. And a lackluster IPO market that has discouraged all but large companies from attempting to go public.
“The IPO market is shot for small issuers,” Keating said.
The result? Many are turning to a once-spurned corner of the market. A reverse merger typically occurs when a private company merges into a smaller public company, often a publicly traded “shell” with no assets or operations.
One of the best-known reverse mergers happened in March, when the New York Stock Exchange combined with Archipelago Holdings Inc.
Read the rest of the article:
http://denver.bizjournals.com/denver/stories/2006/07/31/story4.html

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The following information has been compiled using statistics from the OTCBB activity reports.  To the best of our ability here is what we have been able to uncover.  This will give our readers an idea of where the OTCBB is heading.

In the first three quarters (nine months) of 2006 approximately 130 OTCBB Companies graduated from the OTCBB to exchange listings on AIM (London) NASDAQ, American or New York Stock Exchange.  Additionally, Over 300 companies moved from pink sheets to the OTCBB.

During the same time period, 262 securities were delisted from exchanges (like the NASDAQ, American and New York Stock Exchange) to the OTCBB and 307 OTCBB companies were demoted from the OTCBB to “other OTC” markets, like the pink sheets.

There were 3,304 securities quoted daily on the OTCBB in July 2006 compared with 3,245 in July 2005.

The OTCBB continues to thrive.  During July 2006 over 37 billion shares traded in just under 1,000,000 transactions.  This is an amazing number considering that
broker dealers can not recommend OTCBB stocks to their customers because it violates the penny stock rules (recommending stocks under $5 per share).

Additional information can be found on the OTCBB website. A wealth of data is available there, including companies that have “graduated” to other exchanges, new additions to the OTCBB and other market statistics (click on “Market Statistics” and choose the data you want).

The OTCBB website is a great resource for information on OTCBB companies.  The site allows investors to research SEC filings, view stock charts, news and depth of trades on individual OTCBB listings.

While the “boiler rooms” and the pump and dumps have been replaced with more sophisticated types of illegal trading the SEC is cracking down hard on offenders.  Just this past week the SEC arrested 13 people including a husband and wife attorney’s (See article).  In a second, but unrelated, story W. Zehil, a former McGuireWoods law firm partner, was arrested on fraud charges for allegedly making almost $18 million in illegal trading profits in the securities of his clients.
(See article).

For more information . . .

. . . check out the Over-the-Counter Bulletin Board website (www.otcbb.com)

. . . visit the National Association of Securities and Dealers website (www.nasd.com) and/or

. . . visit the Securities and Exchange Commission website (www.sec.gov)

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So how did this ugly duckling transform itself into a swan? Over the past several years there have been several changes made by the Securities and Exchange Commission (the “SEC”) that actually helped to legitimize the reverse shell merger.

The Over the Counter Bulletin Board (OTCBB) was established in 1990. The SEC mandated the OTCBB as an electronic trading medium that revealed real-time quotes, volume, etc., which is identical to a stock exchange but the securities were not listed on an exchange.

The concept was great, but in reality there were some problems. Initially, the SEC did not require OTCBB companies to report any information on their company or its financials. No reporting, no compliance. Companies were not required to file quarterly (10Q) or annual reports (10K). This led to wide spread stock scams and established a reputation for shells that was less than desirable.

These scam artists were finally eradicated in the late 1990’s when the National Association of Securities and Dealers (the “NASD”) and the SEC took action by requiring all securities trading on the OTCBB to file quarterly and annual reports with the SEC. Now all OTCBB companies had to become “fully reporting” just like NASDAQ, American and NYSE listed companies. The only difference between a stock trading on the OTCBB and NASDAQ was that the OTCBB companies did not meet the exchange listing requirements – earnings, net assets and stock price.

These new rules had a positive effect on the marketplace. Prior to the new rules taking effect there were over 7,000 securities trading on the OTCBB. Afterwards, the number dropped to just over 3,300.

SOX and the OTCBB

The debacles of companies like Enron and WorldCom in the early 2000 led Congress to overreact and pass Sarbanes Oxley (SOX) legislation in 2002. The new rules almost put an end to companies listed on the OTCBB. Though the new stringent rules were designed for compliance purposes for large companies they did not take into account the cost factor for small OTCBB companies. The SEC has extended the start date for certain SOX compliance issues for smaller companies for the past five years. Today it appears that both Congress and the SEC are leaning towards some type of exemption for small public companies. Also, after the new rules were implemented it made it very clear that anyone involved in stock manipulation scam was going to jail. Since then the reputation of the OTCBB has slowly risen into positive territory.

The OTCBB is operated by NASDAQ and the NASD. Today there are approximately 3,300 securities listed on the OTCBB. They must adhere to the same stringent SEC reporting requirements as companies that are listed on an exchange.

Today, reverse mergers have replaced the small IPO. Last year (2006) there were more reverse mergers closed than IPO’s.

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By the way, David’s book is flying off the shelves. If you really want to educate yourself about reverse shell mergers and how deals are structured his book is definitely the place to start. I wish David much luck with his new Blog.

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