1. The Determinants and Survival of Reverse Mergers vs. IPOs Richard Oluoha - Greg Werthman - Kapil Jain - Aaron Cyr - Jen-Chiang La May 6, 2015 FIN 680

2. Introduction The most common means for private firms to go public is by an Initial Public Offering. IPO considerations - Include high costs versus potential benefits ●High costs - Include direct fees, underpricing ●Benefits include - Liquidity and marketing from underwriters and a signal about firm’s quality and risk The reduced benefits of an IPO for smaller companies have led some small companies to go public via an alternative method such as a reverse merger (RM).

3. What is a reverse merger ? ●A reverse merger is when a private company takes control of a public company (or vice versa), and the merged company is a public company. The private company doesn’t go through an IPO process ●The owners of the private company receive a majority stake in the public company (over 50%), and have control of the Board ●Reverse mergers are thought to be a “back door” to becoming a public company. Many documents are not filed with the SEC such as registration statements

4. Why do a reverse merger? ●Reverse mergers are a quick and inexpensive alternative to an IPO. They can be done for as little as $50,000. ●IPOs can be expensive due to underwriting spreads. Spreads have been 7% for about 90% of the $20-$80 million IPOs in the last decade ●Businesses that are either young or small can still grow. These business will likely not be able to get underwriters to assist them with an IPO or raise capital, especially if they are struggling

5. Problems with reverse mergers ●Companies that use reverse mergers have lower performance afterwards than companies that use IPOs ●After only 3 years, 42% of companies involved with reverse mergers are delisted from stock exchanges. IPOs have fewer, at 27%. Reverse mergers also have a probability of delisting sooner than IPOs, with the most likely time around 24 months. IPO’s are at 37 months ●Many reverse mergers don’t meet SEC listing requirements. They have a “lemons problem” (The buyer and seller have asymmetric information) ●Micromet did a reverse merger with CancerVax to form Micromet, Inc. in 2006. Within six months, the share price dropped from $9.33 to $2.19

6. Hypothesis - IPOs vs. Reverse Mergers ●There is a “separating equilibrium” that poorly performing business will choose reverse mergers and high performers will choose IPOs ●When reverse mergers are listed, they do not meet listing requirements on the exchanges where they’re traded ●Smaller businesses will choose reverse mergers because using underwriters does not have an adequate NPV. IPO costs are high ●IPOs will survive longer than reverse mergers

7. Data Analysis ●A study was done that compared reverse mergers and IPOs. o 10-to-1 ratio of IPOs to reverse mergers (2860 to 286) o Private company was not a subsidiary after the merger o Information was available for assets, ROA, age of private company through 10-K paperwork o Stock data for the merged company available in CRSP o 1990-2002 time period o Companies’ performance analyzed for 3 years

8. Data Analysis ●A regression was used to determine why companies choose reverse mergers ●Y* i is the dependent variable, with 1 for reverse merger and 0 for IPO ●Independent variables are total assets, company age, ROA, and a “hot market” dummy variable to account for economic conditions ●Other formulas used to find probability of delisting

9. Results of the Study RMs IPOs Mean total assets value$136.3M $674.9M Mean ROA(t-1)8% 14.5% Mean age when going public7.9 years 13.3 years Conclusion: Businesses that choose reverse mergers are smaller, younger, and have lower performance that businesses that choose IPOs. There is a “separating equilibrium” between the two

10. Results of the Study ●Some RMs met none of the listing requirements ●41% of RMs did not have adequate assets and revenues, as compared to 22% of IPOs ●Private businesses need to meet only one requirement to be listed; can violate all others ●Conclusion: RMs and IPOs are similar in meeting or violating requirements for listing

11. Results of the Study ●From the regression, p-values were negative (p<0.0001), for total assets, ROA, and age. Hot market dummy variable not significant ●Results indicate that smaller businesses use RMs, they are younger, and have lower performance than businesses that use IPOs ●Results were different for NASDAQ than for NYSE or AMEX ●For the probability analysis, 31% of RMs delisted after 1 year. Only 4% of IPOs delisted in 1 year

12. Failure Percentages: IPO vs. RM

13. Conclusion ●RMs are riskier than IPOs, are a “back door” to going public ●Because most RM businesses are able to list on exchanges, inability to list on an exchange is not a reason for choosing a RM ●RMs differ by exchange, with NASDAQ looking at size, history, and performance to define a RM. AMEX and NYSE only emphasize size and history ●Investors should be concerned about RMs because of their higher probability of delisting. They are riskier than IPOs

14. Works Cited Adjei, F., Cyree, K. B., & Walker, M. M. (2008). The determinants and survival of reverse mergers vs IPOs. Journal of Economics and Finance, 32(2), 176- 194.