A "shell" is a company that is already public but usually has no operating business at the present time. For example, a company might have had what seemed to be an exciting product at one time, perhaps even substantial sales, and affected a public offering to raise money for development and marketing of the product. For some reason the company terminated or reduced its business operations. However, the corporation of the company did not cease to exist, and the company still has shareholders and may be still quoted on an exchange, either the Pink sheets or the OTCBB. A shareholder base of a public company can be from 30 shareholders to thousands of shareholders. The "shell" may have no assets at all or have a substantial amount of cash or other assets. The “shell” may be a very old company or a brand new company.
Shells are usually sold for an amount of money and perhaps the principals retaining some stock in the new company after a merger.
A “Reverse Merger” is when a private company acquires the controlling interest in a public company, usually a “shell” company, and then effects a merger of the private company into the public company, with the public company being the surviving company.
Certain things usually happen and some SEC rules must be met upon the completion of the reverse merger. The name of the shell company is usually changed to the name of the private company. If the shell company has a trading symbol it is changed to reflect the name change. Many times, a reverse stock split will be done and additional shares issued to give the new principals more control of the Company. An information statement, called an 8-K, must be filed within 15 days of the closing. The 8-K describes the newly combined company, stock issued, information of new officers and directors, and financial statements audited to US GAAP, standards. The 8-K must disclose the same type of information that it would be required to provide in registering a class of securities under the Securities Exchange Act of 1934.
After the reverse, the present directors and officers resign and new directors and officers are appointed representing the new owners of the Company.
There are certain advantages for a company to acquire a "shell" as a means of becoming a "public company".
Advantages of going public through a “shell”
Saving time - Acquiring a "shell" can save an enormous amount of time over the company doing an initial public offering (IPO) of its stock. A shell can be completed in 1 to 2 month versus 6 to 12 months of doing a public offering.
Saving money - Depending on the type of a "shell' that is acquired and the assets that may be in it, the cost can range from $70,000 to $700,000. There are usually no underwriter fees or commissions to be paid.
Saves on legal work required - The acquisition of a shell can require far less legal work and expense than an IPO.
Does not have to be an exciting company - A company attempting to do an initial public offering of their stock would usually have to be a very exciting company or have substantial revenues and profits in order to attract the interest of an underwriter. Any company of any size can become a public company if the company has the financial ability to acquire a "shell".
Raising additional dollars - After acquiring a "shell" a secondary offering of company stock to raise additional operating capital can be started immediately. This can usually result in receiving more money at a higher valuation of the company than would otherwise be possible through a private placement.
Converting debt to equity - Being a public company may allow for an easier conversion of some debt to equity.
Acquisitions of other companies - Acquisitions of other companies can be made easier with publicly traded stock, usually for less equity than would be required from a private company.
Liquidity of stock - The shareholders and investors can freely buy and sell the company stock. The "insiders" of the company will more easily have a means of receiving a return on their investment or an "exit", as their stock can be sold to the "public" under certain circumstances.
Stock incentives - The company can offer certain management incentives by offering stock bonuses and/or stock options. This is a means of keeping and motivating employees and attracting new personnel.
Control of the Company - Being a public company, with many shareholders, usually means that the insiders, even if they own less than 50% of the company stock, will maintain strong control.
Growth through Acquisitions - A public company can usually make acquisitions with stock, or a combination of stock and cash, allowing for rapid growth of the company.
Estate Planning - Estate planning can be much easier because of the ability to establish a value on the stock held and to liquidate that stock if necessary.
If the shell company is listed on the Bulletin board, the registered or “free trade” shares can continue to trade. The company can do a private placement immediately. To trade new shares offered by the public the newly combined public company must first register the shares with the SEC. This process takes three to four months and normally requires filing a Registration statement with the SEC under Reg. SB-2 or SB-1.
Disadvantages of going through a “shell”
The disadvantages of going public through a public “shell” company offers all of the disadvantages of being a public company. However there may be some distinct disadvantages. The first negative is that usually no capital is raised by merging into a shell company as would be the case with an IPO.
Locating a “shell” public company. Shells are not just sold to "the highest bidder". Usually those that control the shell have a substantial investment in the shell and they are looking for a company that has an excellent chance of success, thus making the stock which they and the public shareholders still hold after the reverse merger, have some value.
The company looking for a "shell" to become a public company should have products and services that show good growth potential and a comprehensive Business Plan and Marketing Plan to show the investors in the company and the stockbrokers that will be making a market in the stock that the potential of the company is strong. The company should have a strong management team and have the knowledge or advisors to the company to take full advantage of the opportunity of being a public company.
Be very careful of a “Bad Shell” - Of the types of public shells that are available, some present far more risk than others. If a shell company is quoted on the OTCBB, it means that the company is fully reporting and that audited financial statements are posted on EDGAR. The risk of hidden or unknown facts are less than a shell company that is not fully reporting. For example, a “pink sheet” company does not have to file reports with the SEC and usually does not have audited financial statements. There is far more risk of there being skeletons in the in the closet that can haunt the company long after the reverse merger is completed. This could include debts that have not been disclosed, shareholders that might dump their stock, and numerous other important factors.
There may also be other particular problems with a shell that must be addressed. For example, there may be restrictions on the sale of securities, especially if the SEC determines that the company was formed for the purpose of being a “shell” company.
It is vitally important that a company and their legal counsel do a thorough due-diligence on the company, including a search for liens and judgments.
If the shell company does not have a symbol, an application for a symbol is usually made to the NASDAQ Bulletin Board. The application for a symbol requires filing a Form C211 by a market maker that is a member of the NASD. The Bulletin Board has no financial requirements. A listing will be granted if the affairs of the company are in order and the company answers the questions posed by NASDAQ.
Preparation for a Reverse Merger or Public Shell Merger
Locate a Suitable Public Shell – Locating the proper public shell can be a difficult process. Sometimes attorneys and CPAs may be aware of a few public shell companies. There are a number of companies and individuals that specifically deal with public shell companies. VentureVest Capital is usually aware of a number of shell companies that are seeking a merger. These include companies trading on the OTCBB, Pink Sheets and Grey Sheet companies. VentureVest Capital can help you locate the right shell company.
Make sure the shell is clean. - It is extremely important that complete and thorough due-diligence is done by professionals on the shell company. While a company trading on the OTCBB will have all of their filings on EDGAR, it does not always mean that every important factor is disclosed. A Pink Sheet shell does not usually have any of their information shown on EDGAR. This means that much more due-diligence must be done and in far more in-depth. Research by some firms that specialize in finding out if a company has any liens or judgments outstanding must be done. The Stock Purchase Agreement should have the principals indemnify the shell and the buyers against any debts that might show up within the next 12 months.
If a company has been recently organized, even perhaps created as a company created for the express purpose of merging with a private company, the company would have very little operating history and far less chance of having something negative surface after the merger.
If the public company is a fully reporting company and trading on the OTCBB, the private company must have audited financial statements. Consolidated financial statements must be filed with the SEC in four days after the merger is completed. Most principals of the public shell company will not even talk to a private company unless they have current audited financial statements.
If the shell company is considered to be “deal-driven” there may be many more requirements by the sellers. A deal-driven shell simply means that the sellers want to retain stock in the company after the merger is completed. Therefore, they are looking for a private company that has strong future potential. The management of the private company should have a strong management team, a good business plan and projections, a good marketing plan, and good SEC qualified attorneys and accountants on board.