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Raising Capital Through Reverse Mergers – The Small Cap Secret

By Eric Dickson

Everyone reading this article is familiar with stocks and probably penny stocks in particular. But one of the most common questions I’ve had in dozen plus years I’ve been in this business is how do these smaller companies go public…

It’s a great question and by understanding it – you’ll get a better picture of how these smaller companies operate.

The primary reason for any company to go public is to raise capital. How they spend that capital is another story for another article.

As is the case with most penny stocks and small caps, not all companies have tens of millions of dollars to spend on going public. So how did they get their start and why is this little known market so lucrative?

Let’s see…

One of the major fundamentals of a successful IPO (Initial Public Offering) is that they’re generally not going to hit the markets cheap.

Look at some of the more famous recent IPOs – companies like Facebook ($38 a share) or GoPro ($24). No cheap by any means.

So the question remains, where can I get into a new issue that sits under $5 per share? A price point more appropriate for most small cap investors.

The answer is reverse mergers.

A reverse merger is the least known, least publicized, investment tool we have as investors. It’s where retail investors and venture capitalists pillage and take what’s theirs… far from the cry of greedy Wall Street fat cats.

Here’s how they work

Unlike an IPO where there is going to be larger, more robust companies with very large operating budgets who can afford to apply for a stock symbol and to hire a high profile underwriter like JP Morgan or Goldman Sachs…

Most of these private companies want the benefits of being publicly traded; they just get in the market without the national publicity, and also, less financial strain.

So what this type of company will do is find some investors (venture capital mostly) and present their case. Once all the ducks are in a line, financing is in place they make their move…

This private company is going to find a bankrupt or folded company that still has an active stock symbol and trades on the market.

Now once they find this defunct, but active company, they propose to buy them out, only for their respective stock symbol and this will only cost the acquiring company anywhere from $750k - $1 million, a far cry from the “start from new” stock application and symbol.

It’s a lot like this…

If you want to open a bar in town you would first go to the town or county to seek out a liquor license. But with a new liquor license, the local jurisdiction say, only releases 100 and to have a new one penned in your name would cost an absolute premium.

Seeking to avoid these premium costs you find a bar in town which is going out of business and being that the liquor license is transferable, you offer the owner a few bucks for his license since he won’t be need it anymore.

In the end, you avoid paying a premium and now you can open up your new business with more of your cash on hand.

Now you most likely never hear about this because media outlets are behind the trend (or downright just not interested), these new public companies are just too small to get national attention.

But as small cap investors this is what we live for. A small up and coming company with a inexpensive share price that could be ready to jump into the next level.

Retail investors in this arena have the buying power of a big wig at any Wall Street firm and this is where we, the average investors, make our stand and pillage profits.

The very best thing with a reverse merger is, you will find that a majority of these companies will be “debuting” way under $5 per share and most likely from a few cents to $1 per share, making a very lucrative opportunity because the upside is that much great in terms of buying power and percentage gains.

Now in closing its important to understand that these newly public companies, as all investments, can be volatile… but the risk verse rewards scenario must be tiled towards reward here – because we’re after the big money. And the more buying power you have the greater upside that leverage gives you.


Reverse Mergers; Part II – Discover, Pillage And Move Onto The Next

By Eric Dickson

In our latest discussion we talked about the reverse merger and explained all about how they work and explained what kind of potential lies within these “poor man’s IPO”.

Today let’s discuss what you should typically look for in spotting the next big reverse merger.

Signs of Reverse Mergers

The following are potential signals that you can use to find reverse merger candidates.

Marketing: This is by far the most essential ingredient in the formula. But don’t get hopped up on what the company provides or manufacturers, that’s nonsense.

You shouldn’t really care about this one bit. What you need to be aware of how effective the company is at selling their stock. If they’re not, they’re doomed to failure no matter how good of a product(s) they have or a unique service they offer is. That’s why marketing is so incredibly important with reverse mergers.

Underwriting: Simply put underwriting is the ability of the reverse merger in question to quickly raise private funds. This gives the company the flexibility it needs to aggressively sell its shares on the open market.

Often times underwriting provides the marketing budget necessary to do so. This is made up almost exclusively of top venture capitalists and private equity.

Structure: This is VERY important because it directly affects what any buying or selling pressure will do to the stock.

Share structure is how the reverse merger is organized internally. For instance, how many shares have they issued in total? How much of that is in the ‘float’, how much is restricted? What percentage is being held by company executives? These questions are critical to the reverse merger’s ability to absolute success.

Timing: If there’s one thing that’s certain with reverse mergers it’s this – you cannot fall in love with a one of them! You’ve got to ride the volatility when it works in your favor, and then get the heck out. For instance, getting in at the early stages of a marketing campaign can set you up nicely for fast profits. But get in at the end, and you’re left holding the bag for the initial investors who may have already begun to cash out their massive gains.

You see, often times these companies can stay relatively stagnate if there is no marketing/selling pressure to boost the volume. But volatility is our friend here – you’ve got a stock that trades 100k shares a day and then all of a sudden a group of 100 serious investors get the buy alert and all pick up 1000 shares… well that stock just doubled in volume.

Conclusion

To be a successful reverse merger investor, you need to stay alert. This by no means is a slow paced environment and is generally reserved for traders who aren’t scared by making “moment’s notice” trades.

But unfortunately following the mainstream financial media won’t help you. You’ll never see these issues covered or even mentioned on CNBC, MoneyWeek, FoxBusiness or the Wall Street Journal.

Instead you’ve got to know exactly where to look. Know where and the possibilities are literally endless.

There are benefits to investing in reverse mergers, but to be successful you first must ask yourself if you can handle this kind of high payout (high risk), extremely fast paced environment.

While this can be a time-consuming process, the rewards can be tremendous - especially if you find the diamond in the rough that becomes a large, successful publicly traded company.


Going Public

By Eric Dickson

There are two ways for a private company to go public:

  1. A reverse merger: where they’ll most likely end up trading on the Over-The-Counter market (OTC).
  2. IPO: where they’ll get listed on a major exchange.

What’s the difference between the two?

In the OTC market there’s typically less requirements to list and trade, meaning financial reporting and transparency. So it depends on which level the company trades, as the OTC market has different reporting tiers.

The 3 top tiers are as follows (according to theotcmarket.com):

The OTCQX marketplace offers the best informed and most efficient trading for U.S. and global companies. To qualify for the OTCQX marketplace, companies must meet high financial standards, be current in their disclosure, and be sponsored by a professional third-party advisor. Designed for the largest, most liquid, and investor-friendly companies, OTCQX ensures that investors have the information necessary to intelligently analyze, value and trade their securities.

The OTCQB marketplace offers informed trading for securities of smaller or developing companies that are reporting to a U.S. regulator (SEC, Bank, or Insurance). OTCQB has no minimum financial standards, therefore, it includes shells and penny stocks that are current in their disclosure to regulators.

The OTC Pink marketplace offers trading in a wide spectrum of equity securities through any broker. This marketplace is for all types of companies that are there by reasons of default, distress or design, which is why they are further segmented based on the level of information that they provide.

As for the IPO process, I think most of you are familiar…

A company enlists a top investment bank, goes through a lengthy process and has a lot higher listing requirements to trade on one of the major U.S exchanges, like the NYSE or NASDAQ. Then, they announce their terms, set a date and begin trading – think Facebook or GoPro.

Either way they end up trading on the U.S markets, the opportunities are garnering more attention as foreign companies are becoming more attractive to U.S investors.


Let The Strong Survive

By Eric Dickson

I wanted to get back to basics and talk about two investing strategies that every investor should be aware of and practice when searching for new opportunities.

When a market is fiscally healthy, some analysts recommend you use a top-down approach to investing. Find the strongest industries and then the best companies within.

On the other hand, if the markets are depressing, using the opposite could work… a bottom-up approach. Find the single company that is doing well and invest in it.

Both approaches are fundamental in nature and a good starting point for when you first evaluate an investment opportunity. From there, you can then move onto a more detailed analysis on both short-term benefits and long-term trends.

The first strategy is known as a top-down approach, or what I like to call a macro view. This takes into consideration geographics, geopolitics, sectors and economic trends.

Most commonly known as the “big picture” approach, an investor using this strategy would take a macro view of the global economy to dissect what industries and international markets will outperform.

The idea is that by understanding current market trends; you can find the top performing industries, basically separate the weak from the strong.

Once you find the best industries, you go from the top-down to decide which are the best stocks in the industry. Pretty straight forward.

The advantage of using a system like this is you will be able to ride along current trends by investing in only the best sectors at the best times… think short-term investing. Each quarter you can reevaluate and invest accordingly.

A good way to begin is to follow the daily industry leaders and laggards composite averages, where you can follow overall monthly performances and get a pretty good idea of which industries are on top at any given time.

The opposite approach is the bottom-up strategy, or micro view. As you can probably surmise from the name, this approach frowns upon the global economic view and tends to believe that individual companies, regardless of what industry they’re in, can outperform.

By disregarding economic cycles these investors believe that a strong company with growing fundamentals can outperform their peers, even if the industry they’re in is down.

It entails a thorough review of the company, their products and services, and earnings potential.

Using this strategy can be beneficial because while micro in focus, you avoid macro-economic trends influencing your ability to find strong companies.

In this volatile market, it’s the best approach, in my opinion, to find strong companies in the short-term. As I like say: find them, profit from them, and forget them.

For example, a particular company in a fledgling industry is about to report earnings and your research points to them outperforming – this would be a good short-term investment.

On the other hand, if a specific company has a growing trend of accelerating earnings, it might be a good long-term investment, but be mindful… because economic conditions could continue to be volatile and change the company’s earnings potential over time.

At the end of the day, both are solid beginning approaches to investing. With the top-down approach you’re focusing on the best global industries, and with the bottom-up strategy, you look for only the best companies.

If used in tandem, you might come to the same conclusion on an individual stock, which would be a great way to confirm that a stock is a sound investment.

In this market today, I would recommend using a bottom-up approach – let the strong survive.