There are many areas to consider when you are thinking of investing in a company that has just completed a reverse merger. The first thing to examine is the total number of shares outstanding after the reverse is completed. The second area to review is the financials of the company. How long has the company been in business? Are they profitable or is this a startup. I will review each of these areas.

Total Number of Outstanding Shares

Some companies do not seem to understand the basic principal of a price to earnings ratio when forming the capitalization of their company. They issue millions of shares based upon the future valuation of the company without ever taking into account the company’s current earnings, if any. So, the smaller number of shares that are issued and outstanding, the better your chances is for the stock to rise. The number of outstanding shares also determines if the company’s CEO is grounded or he lives in fantasyland.

Audited Financials

Once a company has completed the reverse merger, they have to file an 8K, which, in this case, is a material change in Officers and Directors and transfer of ownership of the majority of the stock. An investor should read this filing carefully for it will lay out the entire reverse merger transaction and give you important information, including audited financials, on the new company that is taking over the Shell. The financials will disclose if the new company has revenues and more importantly, if it is profitable.

PIPE Fundings

If the new company has been funded by a PIPE, make sure you check the terms and conditions of the offering, the share price, the total number of new shares issued and total number of share outstanding after the transaction is complete. If a company has been funded by a PIPE that is simultaneous with the reverse merger and the price is above $5 per share and the business model can support the pricing then you may have discovered a substantial company. These types of deals usually come from Asia. Asian companies have a very difficult time finding an underwriter and getting approval from the SEC, so many of them opt to do a reverse merger and eventually move up to a NASDAQ listing.

Business Model

The business model of the company has to make sense to you, the investor. Because of the cost of Shells today, many companies have to be profitable just to be able to purchase the Shell. After taking into consideration accounting fee, attorney fees, ongoing SOX compliance along with the initial cost of $600K to $800K to purchase the shell, a company has to have about $1 million to complete the transaction.

This makes a compelling case for investors because it tends to make them believe that most companies that can afford go public through a reverse merger are probably profitable and would make a good company to invest in. Sometimes this is true and sometimes it’s not.

The single most important thing you, as an investor can do is your homework. The more information you gather the better investing decisions you can make. The beauty of the reverse merger is that if you discover it in the beginning you have a window of time to perform your due diligence before the stock gets noticed by the general marketplace.

The best deals to uncover are companies that have been in business for many years and have decided to expand by going public through the reverse merger process. They usually have a long history of revenues and profitability and they have considered all their options before taking this course of action.

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