23 Jun

WHY PIPE’S (AND REVERSE MERGERS) SUCK

  • Posted by Clear Rock
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Why PIPE’s (and Reverse Mergers) Suck
About once a quarter we are approached buy a client that has some verison of “so and so suggest that I do a PIPE or a “reverse merger.” Do you think its a good idea?”

Our resounding answer: hell no. And here’s why.

FIRST, DEFINITIONS

WHAT IS A PIPE?

PIPE stands for Private Investment in Public Equity. In a PIPE deal, a publicly-traded company sells a large number of shares not in the usual way, by conducting an open secondary offering (not just dumping the shares on the market, but close to it), but by selling a large block of shares to a single investor or syndicate thereof – generally,private equity.

WHAT IS A REVERSE MERGER?

An act where a private company purchases a publicly traded company and shifts its management into the latter – thus “merging into” the public company. Basically you are making a private company public without a public offering. However, it is important to note that a reverse merger only provides the private company with more liquidity if there is a real market interest in it.

AND NOW, WHY THEY SUCK

First, let’s discuss that line about “if their is real market interest in it.” As much as wel like to think the stock market is driven by Tom and Jane investing through e-Trade, it’s not. It’s institutional. And accepting that it is institutional, is a company with $7 million in revenue big enough to make a difference to Morgan Stanley? To Goldman Sachs? We’d posit not. And if it’s not, then there isn’t a lot of liquidity in the stock.

Taking that a step further, the structure and market are then ripe for manipulation. In the PIPE example, the investor will often say “I’ll happily pay you next month for your stock that is trading at X today.” And while this isn’t supposed to happen that investor immediatelyl shorts your stock. Your stock price falls and 1) he makes a killing on the short, but more importantly 2) the percent of shares you owe him based on the month prior price has drastically increased.

HERE’S A SCENARIO:

Investor: “Great. I will buy 20% of your shares for todays price of 10$ in one month.”

Company: “Awesome. That’s $2 million of found money.”

Fast forward 30 days when your stock is mysteriously trading at $3.33…. you just sold them 66% of your company. Ooops.

CONCLUSIONS

We’ve definitely seen people take these deals. And yes, the generate some cash at the outset. But our general takeaway is that:

They are generally distressed assets, so have few real options
The stock invariably is a penny stock with no liquidity
There is some sort of pump-and-dump funny business that manipulates the market
Bottom line: proceed at your own risk.

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