In reality, some public companies fail. And in the world of biotechnology, failure is more frequent than in other industries where firms typically generate revenue and/or profits before seeking a stock exchange listing.
As such, there always seem to be a slew of biotechs, usually after a negative data event has undermined the value of a company’s development pipeline, whose principal or even sole asset is their NASDAQ, OTC or NYSE listing.
At this stage in their life cycle, such companies typically either invite interest from would be reverse-acquirers, possibly engaging a financial advisor to assist in the process, or else are the recipients of unsolicited interest from private companies wishing to “go public.”
Either way the logic is simple. Shareholders in the “failed company” get to salvage some residual value from their investment, and the reverse-acquirer obtains a stock market listing without having to pay several or tens of millions of dollars in banking fees to a syndicate of banks.
Although no two reverse mergers are the same (a banker intimately involved in such transactions once commented to me: “Once you’ve seen one reverse-merger, you’ve seen one.”), going public by means of a reverse-merger comes with a lot of disadvantages. These can be overcome with a great deal of effort (or a great IR partner), but any biotech CEO or CFO contemplating such a transaction should be familiar with the associated pitfalls. In this article, I’ll be highlighting five considerations to make:
IPOs are a known quantity. Bankers, lawyers, accountants, stock exchanges, and the SEC all conduct due diligence on would-be public companies, and this combined scrutiny is perceived to be leaps and bounds better than that which governs reverse-mergers. Cynics–and there are understandably a lot of those in the promise-heavy field of biotechnology,–tend to be skeptical of biotechs undertaking reverse mergers. Their principal concerns include questions like what is this company trying to hide? What is wrong with this company that they weren’t ABLE to go public via a traditional IPO? In other words, what didn’t institutional investors that are typical IPO buyers not like?
Trust is an important asset for development stage biotechs since they depend on the public markets for their lifeblood: funding. Do you really want to your public life with people questioning the motives behind your financing strategy? Reverse-mergers typically make more sense for biotechs whose assets are further along in development. In such cases, clinical data can fill the validation deficit that might otherwise have been filled by financial sponsors as part of a traditional IPO.
You might save millions of dollars in banking fees, but in truth, those IPO fees bring support from the full weight of the banks that comprise your syndicate – including research analyst support through their vetting process that ultimately and most often leads to research coverage. Replicating this bench of expert attention takes time and is by no means guaranteed. Without a pack of covering analysts, it’s possible that any good news you report is either misunderstood or incorrectly valued by the market. In addition, without a continuum of views on your stock it’s possible your secondary market liquidity could also suffer.
IPOs are typically the final step in a sequence of (initially private) financings that slowly crystallize the value management creates through the development of a company’s pipeline. For example, a company will have a valuation at its Series A, a higher valuation at its Series B, a higher value still at a mezzanine/crossover financing, followed by a banker-and-analyst validated valuation at IPO. There are broadly accepted step-ups at each of these junctures, which allow funds to judge whether offerings are fairly priced. By undertaking a reverse merger, a company bypasses this valuation system. Instead, reverse-merger participants typically share their mutually-accepted valuations of each involved party within the press release announcing the merger. There is no guarantee, however, that the (typically illiquid) market in the target/small cap’s stock will subsequently reflect these assumed valuations.
Not having a syndicate of bankers when you go public will affect your life as a public company. This could mean you are invited to fewer healthcare conferences that you might otherwise have been, which will likely affect you access to investors and how well your story is understood. Bankers are also a key source of intelligence for public companies and reverse-merger companies typically find themselves underbanked versus their traditional IPO peers.
Lastly, undertaking a reverse merger is a bit like missing out on a giant party held especially for you, at which you are the center of attention. IPOs are a chance for previously private biotechs to raise the largest financing haul of their lifetimes. By contrast, reverse-mergers are typically accompanied by much smaller financings that are typically limited to existing supportive investors.
There are, of course, examples of successful reverse-mergers in the biotech world, but I would argue they typically create an uphill battle for management in their first year of being a public company. Reverse-mergers may be tempting in tough markets, but a company’s better option is usually a traditional IPO.
If you would like to talk through the options available for financing your public or private biotech company, or just to discuss your investor relations strategy more broadly, please contact us today.
Laurence Watts, Managing Director
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