Aftermarket Performance For Your Reverse Merger

Small, growing companies that are private and need to raise money merge with an OTC shell in a reverse merger. They hope that the stock price will be high in the public market and that they can then sell stock privately, perhaps in a classic PIPE deal. The price in the private deal is usually a discount to the public price.

Unfortunately, whether or not the company does a PIPE deal, the stock performance of the new public company after a reverse merger with a public shell is often dismal. The usual reverse merger stock chart looks like a profile of a waterfall as the stock starts trading on high expectations, only to sink to near zero bid after a time.

Many reasons exist for a bad aftermarket stock price. First, the shell promoters will almost certainly be selling their stock. This stock will be a substantial part of the company. Even making an agreement to lock up their stock may not help much if they have given stock to others or kept stock in other accounts that are not part of the lock up agreement.

Next, the market makers may have accumulated the stock when it is down. When I was making markets in over 300 stocks, inevitably one of them would sink to next to nothing. When the stock went to a very small bid, I would accumulate the stock on the chance that the company would later be used in a reverse merger. As the price was extremely low, it cost me little to accumulate a large number of shares. When the reverse merger was announced, I would be eager to sell my position. After selling the position, I would cease making a market in the stock. So the company that anticipated having me as a market maker lost on both counts - I was a seller and I left the market.

There were also other market makers who specialized in low priced stocks. Unlike our firm, they had limited funds to take positions in stocks. These dealers supplied little if any liquidity in the market. When the stock went up, they would also sell and possible cease making a market.

Thus, many reverse merger companies that thought they were buying a shell with market makers were in fact getting no real market.

The only reason for a market maker to trade a stock is because he believes he will see a volume of trading that will allow him to profit from the spread. He knows that unless the company engages in aggressive investor relations, there will be no volume in a small company's stock and the price will go down. No new buying = price declines.

This bring us to the next reason reverse merger companies have bad aftermarkets - they have been told by their attorneys, their financial consultants, and the people who sold them the shell that once they are public, the company will have unlimited access to money.

In actual fact, all the company gets is an exit strategy that may be used to entice investors. You still have to grab an investor, wrestle him to the ground and extract his wallet. As the attorneys, the financial consultants, and the reverse merger company all make their money when the shell deal closes, they somehow neglect to explain what happens after the close. That is not their problem; it is yours.

The final reason reverse merger companies do not do well in the after market is the most evil. They may fall victim to short sellers.

Wall Street, as everyone should be aware, is not a place where mercy reigns supreme. It is a place inhabited by sharks. Sharks prey on the weak and the unwary.

Short sellers know that small companies need to have a continuous stream of money to grow. Growth requires constant new money, even profitable growth.

You need to make sure the stock price is up to get your money. When the shorts raid the stock, they know that pushing the price down can destroy the company. A low stock price is a bad reflection on a company. It says that this company is weak and likely to fold. It says that this company cannot raise money at a good price. Customers, employees and investors will exit and avoid a company with a low stock price. If you do not know how to survive the ravages of short sellers, your company is in dire jeopardy.

In sum, doing a reverse merger without a complete plan for the aftermarket is a trap for the unwary. A reverse merger company that is sold a bill of goods about a reverse merger being the total solution is likely to find its stock price headed down. You must have an investor relations and fund raising plan that includes recruiting investors and market makers and fighting off attacks by short sellers.