Reverse Mergers (RM) go by a lot of names because there is an odor to them. The various names are meant to dispell the aroma the transaction implies….that there’s a reason the accounting acquiror did not or could not go through the front door to become public (IPO) and instead chose to use the backdoor (reverse merger of a private operating company with a public shell).

There are legitimate reasons that legitimate companies opt for RM’s. Underwriter cost of an IPO is at the top of the list. However, the history of RM’s is ripe with tales of the illegitimate. In recent times, the brand of RM that focused on bringing PRC (People’s Republic of China) entities public has emphasized the sordid characters and deals that are emblematic of regulator concerns surrounding the format. The Times ran this piece on The New York Global Group, which facilitated RM’s with PRC entities and is now the subject of the FBI’s interest.

Historically, these transactions have also been sold as “blank check” deals and SPAC’s (special purpose acquisition corp). The first form of blank checks I was involved with was while on staff of the SEC in the 90’s. They were often solicitations for limited funds ($5m or less) by an ownership interest with a very opaque business plan. Around 2005 this model was upgraded to include a roster of seasoned professional management and investors, where larger sums were being sought ($100m +). Again, there was no definitive business plan. The accumulated brand power of the gathered backers was supposed to be direct evidence of how great an idea would be developed…eventually…and you could get in before that was clear to anybody.

A bit later these were modified and became SPAC’s. This rendition of the RM was selling that same notion that its “best of breed” roster of management and investor power would seek out the best investment opportunities, choose one from that robust lot, and fund it with the SPAC’s money, that public investors would already have fronted to the SPAC. That money was being held in essential escrow and earning a risk free return, until the opportunity of great fortune was found by the best-of-breed consortium. If a period of time elapsed with no pot of gold found (e.g. 18 months), it would be returned to the investors.

The blank checks and SPAC’s were one of the canaries in the coal mine telling anyone who was watching that the big fall of finance was coming. That there could be so much liquidity being funneled to unfocused and indeterminate business plans, based on nothing more than the short term reps of a too large roster of players, was hint enough. This lesson was not learned well, as the aforementioned piece in the NY Times illustrates.

The right business model can use the RM as a step transaction toward public funding. The shell company’s ownership usually agrees to a merger because they want a liquid exit from their position. The operating company doesn’t get any new capital. They won’t have basis for a major index listing either, unless their asset/equity tests etc. already qualify them. The value is if they have a business model and operating level that can benefit from a public capital raise further down the road.