Naturally, going public with a reverse merger has all the disadvantages of going public any other way: the cost of annual audits, SEC filings and disclosure, investor relations expenses. These costs weigh heavily on any new venture that is short of capital and income.

For reverse mergers in particular, as opposed to an initial public offering or self-registration IPO, the following discusses the disadvantages.

First, when you buy a shell company, you have the expense of paying for the shell, which I includes the cash you pay and the amount of the company you have to give up to the shell shareholders.

Second, you have the risk of merging into a shell with a hidden defect. These defects could undisclosed legal judgments against the company, other liabilities, undisclosed shares of stock that will be dumped on the market, undisclosed warrants to buy cheap stock, contracts that create liabilities, lawsuits that will show up only after the company has assets, etc.

Third, the shell company may have bad or missing records that prevent the company from being audited. This limits the options and growth of the operating company.

Fourth, in decades past there was a stigma associated with reverse mergers, the idea that if you were a real company you would do an IPO. That stigma dissipated with the use of public shells for PIPE (private investment in public equity) financings. However, the reverse merger stigma has returned from the recent discover of a number of Chinese reverse merger frauds, most certainly after the SEC warning to investors about any kind of reverse mergers. This is important because as raising money is the primary goal of a reverse merger, the willingness of investors to invest is a paramount consideration.

Creating a Market

All these disadvantages are well known, but the biggest problem with reverse mergers, as well as self-registrations, is the creation of a trading market in the stock.

The importance of creating a trading market in the stock is often ignored by shell merchants and attorneys attempting to sell their wares.

Kindly be advised that while your company has substantial value, there is also value in having an active trading market.

Without an active investor interest in the stock, you cannot find large investors who will give you money. These investors want to know that they have an exit strategy to sell their stock. They will not purchase stock privately or even publicly without a market for their investment down the road.

I have seen actively trading companies command as much as $1 million in market value beyond the value of the company alone.

Even a large shareholder list with little volume will have value.

Knowledgeable CEOs will spend hundreds of thousands of dollars in stock or cash for investor relations to create the market because they know that having that market will create millions in market value for their shareholders.

Developing a trading market using investor relations firms is not only a cost in money, it has a cost in time. When you do a reverse merger with a shell what has few shareholders and little or no volume, you may spend months to get the stock widely held and actively traded. These months will be spent telling the story of the company and getting people to buy stock. The time will be spent on large campaigns of publicity and investor relations.

During this period, your company will have to survive more and more scrutiny from investors. Not only must the story be good, it must be true.

Short Sellers