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Should Biotechs Consider a Reverse Merger?

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A reverse merger—also known as a reverse takeover—is where a private company acquires a public (shell) company that is typically in distress. The private company's shareholders pay for the shell company by transferring their shares to the new entity. Operational and financial control then rests with the private company leadership. 

While it sounds like a gamble for the private company, the public company really has little to lose. The incentive for the private company, however, is that the new entity is publically traded and has access to the capital markets.  

Benefits

When performed with the proper care and due diligence, reverse mergers can offer biotech firms a variety of benefits: 

  • A reverse merger can usually be performed more quickly than an IPO. 
  • It costs much less to perform a reverse merger versus an IPO, perhaps as much as 5 to 10 times less.
  • If the shell entity is SEC-registered, the private company does not have to go through governmental review.
  • One bad news headline can kill an IPO. Market conditions play much less of a role in reverse mergers. 
  • There is less ownership dilution than in an IPO.
  • There may be higher company valuation in a reverse merger.
  • There is usually a concurrent financing designed to give the new public company needed liquidity. Having a public market to trade in the stock even after a seasoning period (versus a private, totally illiquid market) is appealing to investors.  

Biotech Reverse Merger Success Stories

  • Cougar Biotechnology raised $47.5 million and was sold to Johnson & Johnson for $1 billion.
  • Puma Biotechnology raised $55 million and has a market capitalization of $1.6 billion.
  • ViewRay raised $26.7 million.
  • Synageva merged with Trimeris, which was acquired by Alexion for more than $8.4 billion. 

 

Drawbacks

With the good comes the bad. Here are a few possible downsides to going the reverse-merger route: 

  • The costs to public companies to meet SEC-reporting requirements.
  • Leadership may not have a comprehensive understanding of the publicly traded market, and the company may not have the appropriate personnel and controls in place.
  • The new entity generally has low trading volumes and investor liquidity issues. Companies plan to uplist to NASDAQ as quickly as possible, but this usually requires a follow-on financing.
  • The distressed public company may have a myriad of problems, such as pending legal action. Due diligence—even if mostly inactive—is required on a public shell.
  • There’s less opportunity to showcase a company to potential investors in a reverse merger versus an IPO.
  • Questionable deals in the 1980s have given reverse mergers a less-than-stellar reputation, which may make investors wary.  

“As someone who’s been involved in a fair share of reverse mergers or with companies that had previously completed a reverse merger, my best advice for biotechs considering a reverse merger is (1) consider reversing into a company that has never actually been a shell; (2) if it must be a shell, do your due diligence; try to ensure it has cash and/or is already trading and has a broad shareholder base; and (3) assuming it’s a private company, also consider a Reg A+ as an alternative to a reverse merger," says Jeff Eliot Margolis, President of Aurora Capital LLC. 


SEC

Due to some questionable deals, the SEC has taken a greater role in reverse mergers. In 2011, it issued a bulletin recommending potential investors (1) research the company; (2) review the company’s SEC filings; and (3) beware of non-reporting companies. 

Also in 2011, the SEC passed rules prohibiting a reverse merger company from applying to list until it completes a one-year “seasoning period” by trading in the U.S. over-the-counter market or on another regulated U.S. or foreign exchange following the reverse merger, and has filed all required reports with the Commission, including audited financial statements. The rules further state that the company maintains the requisite minimum share price for a sustained period, and for at least 30 of the 60 trading days, immediately prior to its listing application and the exchange’s decision to list.  

After completing the reverse merger, the public company must file a Form 8-K describing the new company. Thereafter, it must comply with Securities Exchange Act reporting requirements and meet applicable SOX requirements. The SEC can suspend trading and even revoke the securities registration of reverse merger companies, for example, due to their failure to make required periodic filings. 

Considerations

While biotechs enjoyed a bull market the past several years, the current U.S. presidential election has created some uncertainties going forward. For the private biotech interested in a reverse merger, the public entity should possess some cash that can be used for research and product development; no major red flags, such as litigation; agreement and clarity on the new leadership structure; and a company structure that can integrate technology and reporting systems. The private company must be honest with itself as to both why it wants to be publicly traded and why acquiring a distressed public company would be a good, long-term strategy.  


Catalyst - Fall 2016

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