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By Catherine Hollingsworth
With the initial public offering market slowing, many private biotech companies are going the reverse merger route, seeking to combine their operations with either public companies that have fallen on hard times or public shells to gain access to capital markets.
Though often considered a more efficient and sometimes cheaper route than a traditional IPO, a reverse merger has its own requirements. Industry and financial experts caution that succeeding beyond a reverse merger takes certain amount of cash on hand, a diverse portfolio, and a mix of Wall Street and public relations savvy.
While there is "no real classic profile" for a private biotech company seeking to enter a reverse merger, the company should meet certain parameters, said John Chambers, co-head of investment banking and senior managing director at Rodman and Renshaw. There should be some sort of "catalyst" or "news flow" surrounding the product, such as advancement to the clinic, Phase IIb proof-of-concept, or other data showing its progress over time, Chambers said.
In some recent examples in the biotech industry, reverse mergers were concurrent with private financing: Cleveland-based Athersys Inc. raised $65 million in a private equity offering to complete its merger with public shell company BTHC VI Inc. in June 2007, and Nile Therapeutics Inc. went public through a reverse merger in September after raising $20 million.
Statistics on reverse mergers vs. IPOs are hard to come by, but several sources said they believe more biotech companies are considering this option amid a slow IPO market. Ben Bowen, managing director of investment banking, said reverse mergers are becoming "more vogue," but he sees the dominance of PIPEs (private investments in public equity) as driving the reverse merger option.
An obvious benefit of a reverse merger, as with an IPO, is the currency of shares that the company can leverage in a deal. The advantage over an IPO, several company executives said, is the quicker path to the public market and a wider array of funds that may invest in the company.
"It's a faster, less expensive way to get a company into the public market," said Philip Young, chief executive officer of bone disease company Osteologix Inc., which closed its reverse merger with Castle & Morgan Holdings Inc. in 2006.
With the closing of that, Osteologix completed a $10 million financing that the company said would help move its lead product, NB S101 (strontium malonate), into Phase II trials.
The company also said at the time that the financing, led by Rodman and Renshaw, would expand Osteologix's investor base beyond its initial supporter, Copenhagen, Denmark-based Nordic Biotech.
Young, who was not the CEO at the time of the reverse merger but is familiar with the concept, said going public the reverse merger route can open the door to new shareholders, the broad array of funds that trade in public stock. It also can allow the company to share its story with a broader community, but that requires spending "a lot of time in New York" meeting with fund managers, he said.
Ken Aldrich, chairman, CEO and co-founder of International Stem Cell Corp., said the company's 2007 reverse merger with Texas-based holding company BTHC III Inc. has worked out well. "We're pleased that we did it because it gave us the momentum we needed at a critical time in development."
At the time, Aldrich said, venture capital firms were wary about the use of embryonic stem cells. Though that would be less of a concern today, he said, explaining that the company now uses a base of stem cells that does not come from fertilized eggs. Still, he said, "I don't think we could have raised that kind of capital in a private market."
Concurrent with its reverse merger, ISC raised $11.2 million in a private placement, according to Halter Financial Group LP, the Dallas firm that closed the transaction and eight other alternative public offerings in 2007. "I would not want to do a reverse merger for less than $10 million," ISC's Aldrich said, adding that it could be difficult to find an underwriter.
There are other key factors to consider in a reverse merger, including understanding SEC reporting requirements and having enough cash for operating expenses at the front end of the merger, company sources and others said.
Aldrich said he sees no reason to opt for a reverse merger, unless a company has raised enough money to last a year or two before having to tap capital markets.
Kim R. Tsuchimoto, chief financial officer at Raptor Pharmaceutical Inc., of Novato, Calif, pointed out that, "Unlike an IPO, a reverse merger does not necessarily automatically provide operating funds to the company, so having a solid funding strategy either concurrent or following the merger is essential."
Raptor's merger with nutritional drink distributor Highland Clan Creations Corp. closed in 2006, concurrent with a $5 million PIPE financing.
"In our case, with early preclinical programs, a reverse merger was a good vehicle for raising funds, as traditional private funding sources (i,e., venture capital funding) were not able to fund our early-stage technology," Tsuchimoto said. "Establishing a public entity allowed us to tap into public sources of capital that are not readily available to early stage companies."
She added that the share currency it generated allowed the company to acquire later stage clinical compounds to accelerate the pipeline.
Raptor's management was familiar with public company reporting and already had established legal and auditor contacts, Tsuchimoto said. "The reverse merger was probably cheaper than the IPO route. It was definitely faster, as our SB-2 was not reviewed by the SEC."
She estimates it took eight weeks from the closing of the reverse merger to having an effective SB-2 for the concurrent PIPE. "An IPO would have probably taken twice as long and likely would have been potentially multiples of the cost."
Jason Kolbert, an analyst with Susquehanna Financial Group LLLP, said one of the "first lessons" for a public company is to understand the need for investor relations and the legal ramifications of certain statements to the media.
ISC's Aldrich said a company should budget for accounting and legal reports to the SEC and spending on investor and public relations (about a couple hundred thousand dollars a year for public relations) plus a minimum of $100,000-$200,000 to get through the initial placement.
One potential pitfall is merging with a company that has significant debt or lawsuits pending against it, said George Steinfels, chief operating officer and executive vice president of clinical operations at RemeGenix Inc. He emphasized the importance of exercising due diligence and choosing a "clean shell" with no outstanding liabilities.
Steinfels said Remegenix is considering alternatives to an IPO, also known as "back door" IPOs. The firm, based in Rockville, Md., is working to bring compounds into the clinic for the treatment of traumatic brain injury and Alzheimer's disease. "When you're going to do this [reverse merger], you have to be thinking in terms of diversification of your portfolio," in case a project fails, he said. | 
