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For many years some of the biggest gains ever see in the stock market have been from shell stocks trading on the OTC Market, due to large private companies that reverse merged into them. As detailed often within our penny stock blog, within the past 4 months alone as of 12/24/22 we have seen numerous penny stocks gain many thousands of percent per share due to reverse mergers. In this article we will fully explain reverse mergers and shell stocks, to explain why these stocks often see such large growth so quickly.
A reverse merger (“RM”) or reverse takeover (“RTO”) is a process in which a private company, acquires a publicly listed company, to become publicly trading. It is common practice in a reverse merger, for the public company being acquired to have little to no active business dealings in operation, often being known as a “shell stock” allowing the purchasing private entity to become the business that fills that empty shell with its own operations.
A shell stock is a term meaning a corporation that lacks any active business operations or significant assets, but they continue to actively trade on the stock market. These shell stocks are most often found as penny stocks trading on the OTC Market.
A solid example of how this could come to be, would be if a company were to for example sell off its assets. If you were to own a publicly traded company that owns schools, and then sold off the brick-and-mortar schoolhouse locations, your stock would still actively trade but would essentially be worthless due to no longer having any assets or business. These stocks can often be found at very low prices and market cap valuations due to essentially being worthless. It is these sorts of stocks that are most often utilized in reverse mergers for active private companies to fill those shells and become publicly trading.
The risk comes into play from the fact that most shells will never be merged into, meaning that buying stock of a worthless shell could remain worthless, or even eventually just be delisted if they do not maintain necessary regular public filings.
Investors like to take on the risk of purchasing shell stocks because although they come with steep risk of loss, they also come with some of the highest profit potential within reasonably short timeframes that can be found on the stock market.
The primary allure of shell stock investing is that shell stocks can have low market cap valuations in the low millions of dollars, to even well below one million dollars. If you are lucky enough to see a private company reverse merge into a shell stock that you are holding, the newly merged entity takes on the value of the private company that is now filling that former shell. What was once your buying shares of a stock with no business that was essentially worthless, now takes on the value of the formerly private company. If for example a private company worth $1 billion were to merge into your shell stock that had a total market cap of $1 million, this could mean that your stock is now valued at $1 billion, meaning a 1,000X value from where you began. If the company that merges in is significantly larger than that, the value of your stock could increase magnitudes more proportionally.
While most shell stocks will not see those sorts of mega reverse mergers into them, those few that do are the sort of stocks that could practically see many multiples in price over night. Shell stock trading can bear some similarities and differences to penny stock trading strategies, for penny stocks that are not operating as shells.
Reverse mergers are often a faster and more cost-effective means by which a private company can become publicly listed on a stock exchange, while avoiding the costs and obligations associated with going through the full Initial Public Offering (“IPO”) process. There is less obligation to raise capital to complete an IPO and also, the IPO process can take significantly longer than a reverse merger or reverse takeover. Reverse mergers can take a few weeks to complete in some cases, while IPO processes can often take months, to a year or more.
Heavy due diligence is needed to review each merging entity because without proper vetting the acquiring entity may unwittingly be taking on the liabilities of the other corporation involved. This could include debt obligations or legal issues that the company is in the midst of.
There is also the risk of shareholders of the former shell to sell their shares as soon as the private company is merged in, or for there just to not be the same sort of interest generated in trading, the same way that a traditional IPO would attract investors. Trading related issues in a reverse merger can truly be a wild card without any way to know how individual investors will react until it happens.
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