Let's imagine for a moment that we're playing intramural basketball. Your team is scheduled to play a game this afternoon, but you're the only player that's available. My friends and I arrive at the gym and we want to play, too. But unfortunately, since we haven't registered with the league, we can't join the tournament. To overcome this obstacle, we put our heads together to figure out a solution. After discussing a few ground rules, you invite my group to join your team and, happily, we're now eligible to play in the tournament.
This analogy stacks up nicely: Registering a team is like an initial public offering and joining an existing team is like a merger. But joining an inactive team is more in line with the subject at hand – a reverse merger (also known as a "reverse takeover").
As explained by Investopedia, "Reverse mergers are often the most expedient and cost-efficient way for private companies that hold shares that are not available to the public to begin trading on a public stock exchange."
Typically, what happens is that a private company seeking public listing will approach an inactive company that had gone public previously. After negotiating various terms, the private company merges with the public company and voilà! The private company is now public and available for trading (it's a little more complicated than that, but these are the basics in a nutshell).
While IPOs can take upwards of six months to a year because of the convoluted logistics (e.g., hiring an underwriter, marketing shares, etc.), reverse mergers can be accomplished in a matter of months, if not weeks.
"The expediency and lower cost of the reverse merger process [as compared to undertaking an IPO] can be beneficial to smaller companies in need of quick capital," Investopedia explains further. "Reverse mergers allow owners of private companies to retain greater ownership and control over the new company, which could be seen as a huge benefit to owners looking to raise capital without diluting their ownership."
So, what is the salience to blockchain technology and cryptocurrency? Why should you, dear reader, care about reverse mergers?
Our primary concern is that private companies purporting to work on or invest in blockchain-related projects have recently utilized reverse mergers to become publicly traded, possibly to the detriment of investors.
For instance, UBI Blockchain Internet, a Hong Kong-based, Delaware-incorporated company, merged into another company called JA Energy, based in Las Vegas, Nevada. According to a Form S-1 registration statement filed with the SEC, UBI Blockchain explains, "We have a limited operating history and we are subject to all risks inherent in a developing business enterprise. The Company has no revenues and has yet to develop any products for sale." Also revealing, the company anticipates a "burn rate," or negative cash flow, of $220,000 per month.
At the time of publication, UBI Blockchain Internet Ltd is currently priced at $35.00 per share, giving it a market cap of approximately $1.3 billion. Earlier this month, shares traded for just about $6 each. The stock has experienced substantial, if unwarranted, growth to say the least.
If this were an isolated event, then it would not be overly concerning. However, at least one other blockchain/cryptocurrency-focused company has utilized a reverse merger to become publicly traded. That would be The Crypto Company, which had the trading of its shares suspended by the SEC on December 19, 2017.
Even as cryptocurrency stakeholders air concerns about fraudulent token offerings, there are factors in the conventional market which are ripe for abuse and manipulation. Reverse takeovers are worth noting and examining carefully to ensure that you remain an intelligent investor.