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Reverse Merger Strategy

The following Qwoter stock market advice topic discusses investment and trading strategies that can be effectively applied to penny stocks (read what is a penny stock). You should read over the following strategies a few times over. After reading the trading strategies and becoming familiar with them you should select the strategy that fits your tolerance for risk. The strategy should fit your overall investment philosophy and preferably match up with your skills. Some people prefer long-term strategies to short term strategies.

The following trading strategy may entail a great deal of risk, but like the saying goes, no pain no gain.

How to Use the Reverse Merger Strategy

Buy stocks that are being used for reverse mergers. When a company that has no operations announces that it will be acquiring a private company and then changing its name to the name of the private company, it is undergoing a reverse merger.

So what is a reverse merger? In the reverse merger, the private company is being taken over by the public company. Once the public company takes over the private company, it transfers a majority of the shares of the company to the private company. Since the private company now has a majority of the shares it now controls the public company. In effect, although the private company was taken over by the penny stock, the owners of the private company now own the penny stock. They have merged their business with the penny stock and now are the majority shareholders of the penny stock.

Reverse Merger Advantages

There are advantages to doing a reverse merger with a public company. A reverse merger takes less time compared to an IPO. An IPO requires extensive paperwork that can take up to a year to file while a reverse merger can be done in a matter of months. A reverse merger also saves considerable money. The cost of the shell is under $200,000 including lawyer fees. The cost of an IPO can start at $750,000 excluding the underwriter fees.

The business owner can raise money privately before the registration and can sell shares to the public after the registration is completed. The shares can be used for acquisitions. The public company can now use its shares to acquire other business and grow through acquisitions. A private business is limited in its ability to buy other existing businesses to the cash on hand or to the access it has to financing.

By going public, the same business can use its stock to buy a business that is for sale. The seller receives a liquid security that can further appreciate in value while the cost to the buyer is only his original cost to purchase the shell. If the buyer paid $200,000 for the shell, and now 3 months later the shell is worth $500,000 his cost basis is still only $200,000. He can use 10% of his stock to acquire a $50,000 business without having to spend $50,000. The 10% of his company that he is exchanging for the private business will only cost him $20,000 based on the 10% of the total purchase price of the shell.

Companies that have used reverse mergers to go public will build up their business before making acquisitions. By building up their business they can increase the price of their stock and leverage its value in further acquisitions. The reason that investors will sell a shell to a private company is because they receive upwards of $100,000 in cash for the stock and they keep a minimum of 5% of the stock in the post merger company.

The shells, or penny stocks, that private companies use to go public do not have any ongoing operations. They are referred to as shells because their only reason for existing is to be used for a merger. Therefore, the price of stock that is nothing but a shell is very low. The price of a penny stock that is used for a reverse merger is often below .10. The stock starts appreciating in price once the public company announces that it has acquired a private company. Investors now will value the shell according to the operations of the business that it has merged with. If the private company has a strong product that is in demand investors will start buying shares of the company sending the price up. The shareholders who sold the shell now own 5% of a stock that has value and the buyers of the shell now can raise money using their appreciating stock. The investors who buy in early can benefit from the price appreciation that will result as investors realize that the penny stock is no longer a shell but is now an operating business. If the private company has earnings, the stock will appreciate much faster due to the intrinsic value of the stock and the scarcity of profitable penny stocks.

A profitable penny stock will stand out from most penny stocks. This penny stock has revenues and earnings while most penny stocks are still at the stage where they are developing their product. By buying early and holding stocks used for reverse mergers you are buying a worthless stock that now owns a valuable asset. By definition, the valuable asset will increase the worth of the cheap stock – hopefully making you money!

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I saw an article in today's New York Times describing start-up companies in the UK which have matured to a point where they are seeking to go public in the U.S. Would the strategy of a reverse merger by these maturing start-ups be better than a full registration?

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