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An alternative to venture capital financing: handing over control to the company

Using reverse mergers instead of venture capital for venture financing

The more you look at reverse mergers, the more you begin to understand that reverse mergers compare favorably to the classic venture capital model for venture financing.

Venture financing is obviously key to the success of any new or growing business. The classic venture capital model seems to work like this: The entrepreneur and his team formulate a business plan and attempt to present it to a venture capital firm. If they are well connected, they can be successful, but most venture capital firms are overloaded with requests for funding.

If the entrepreneur is not in a business that is the latest trend among venture capitalists, they may not be able to find funding.

If the entrepreneur is very lucky, he will be invited to launch the VC. If the company survives this test, it will receive venture capital term sheets. After lengthy and adverse negotiations, an agreement is reached and the venture firm signs hundreds of pages of documents. In these documents, the entrepreneur and his team give up most of the control of the company and, in general, most of the capital stock of the operation. Their shares are locked and if they want to sell for some cash, they probably have to offer the buyer to the VC first. Time from start to finish: 90 days or more.

If the business needs more money, it must negotiate with the VC and the business team may lose ground on the deal. The business may have to reach certain milestones to obtain funding. If the company falls behind on the schedule, it may lose share of the capital stock.

As the business develops, the venture capitalists may or may not add value, and are more likely to question the entrepreneur and his team. If the venture is successful, the venture capital firm will reap most of the rewards. If the business is unsuccessful, most of the capital will be lost forever. Some companies end up in the land of the undead, not bad enough to end, not good enough to be successful.

In the worst case, the venture capitalists take control early on, become dissatisfied with the management, and oust the original management, who loses most of not all their positions and their jobs.

The reverse merger model

The entrepreneur finds a public shell. You have to get some cash to do this and pay the legal and accounting bills.

He buys the control and merges with the shell on the terms he determines. It maintains control but has the burdens of a public company.

He determines how to run your business, including wages. You can offer stock options to attract talent. You can acquire other companies by shares. He determines when he will get paid.

Instead of having to inform the hedge fund, you have to inform the shareholders.

Subject to the limitations of securities laws, you can sell part of your shares for cash.

You can look for money whenever you want; he is in control.

Problems: You can be attacked by short sellers. You can buy a shell with a hidden flaw. You have to pay for the shell.

From the investors’ point of view

Venture capital funds are often financed by institutional investors seeking professional management. They don’t have the time to run a number of small businesses and delegate this task to venture capital partners. Small investors are rarely allowed. Venture capital funds allow institutional investors to diversify.

Venture capital fund investors are trapped for a period of years. If they get a return of 30% per year, they have done very well.

The venture capital model encourages the venture capital firm to negotiate hard for a low price and strict conditions. A venture team seeking funding and knowing they have a great future may not be bound by those terms. However, for a weak company that is only looking to collect salaries for a few years before retiring, in other words, a company that is a bad investment, you can accept any term, no matter how harsh. Therefore, the venture capital model leans towards selecting the worst investments and rejecting the best ones.

Small investors can buy shares in reverse merger companies. They should take the time to research these companies, but they may lack the resources to do it intensively. Most small investors lose money. If they win, they can win big. They can, if they wish, diversify their investments. They have no influence on management, except to sell when they are upset.


The reverse merger model compares very favorably with venture capital. While venture capital is a perpetually in short supply, reverse mergers are always available to any company that investors may be interested in. Generally, the company can raise money on better terms from the public than from venture capitalists.

In general, the great advantage of a reverse merger is that the company has full control over its destiny. The team can be sure that they will receive a good reward for success. The company establishes the terms, it can sell shares whenever it sees fit on the terms it deserves, insiders can also sell, and the venture team is not questioned by fans in their field, and the venture team does not have to fear. to lose. equity or jobs.

Another advantage is the lower risk for the investor. The investor is in a publicly traded stock. If the investor does not like what is happening, he can sell. You can sell at a loss, but you can get out. The investor can also choose companies for himself, rather than making just one investment decision – the decision to back the venture capital firm, which then takes control of the rest of the decisions.


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