The challenging initial public offering market has given rise to a new trend among small private companies. Businesses that have been experiencing difficulty in going public and are finding it hard to raise money in the capital markets are now looking to reverse mergers combined with PIPE financing to get the capital they need. Hedge funds are capitalizing on this new opportunity, known as alternative public offerings, by getting involved in underwriting and financing these transactions, which some are already calling "the new IPOs."
Lately the bar to accessing the IPO market has been raised, especially with the credit crunch. Small private companies seeking a listing on an exchange need to find alternatives to IPOs. One popular alternative consists of combining a reverse merger and a private placement equity capital raising, also known as PIPE (private investment in public equity) financing.
In a reverse merger, a publicly listed company acquires all the stock of a private company in exchange for approximately 90% to 95% of the shares of the public company. This transaction requires that the acquiring public company reorganize, a process that gives complete control to the private company by installing the private company's directors and officers onto the board of the newly merged corporate entity. The process the private company goes through is similar to an IPO, in that upon completion of the transaction it is a publicly listed company with newly raised equity capital.
A Lucrative Niche
Regardless of their lack of mainstream acceptance, reverse mergers coupled with PIPE financing represent a specialized, labor-intensive, yet potentially lucrative, niche for hedge funds. Demand is growing from small private companies that need an exit strategy and that cannot find one via the regular IPO market.
