By S. Jeffrey Jones, CPA
Often times the last person that gets consulted about a reverse merger is the auditor. This article will attempt to convey, from an accounting viewpoint, some of the potential pitfalls of a reverse merger.
HJ & Associates specializes in auditing of small and emerging public companies. We have seen a myriad of different approaches to reverse mergers. Invariably each reverse merger comes with unintended consequences.
Some of the most common problems include:
1) Not being able to get the audit completed within a 71 day period when the merger is with a company that is not deemed to be ‘shell’ filer, or within 5 days when the merger is with a ‘shell’ filer.
2) Not realizing that an audit is required for a reverse merger. This is particularly the case when assets, but not the stock of a company, are purchased. The SEC has long taken the position that if the assets are integral to the operations of a business, then the operating history of those assets needs to be presented.
3) Completing the merger before the private company is audited and then finding out that the private company is not auditable, or that the results of the audit are not as expected.
4) Not having the infrastructure in place to continue public company filings in a timely manner. There are deadlines and time tables that are in place which are often new to the management of the operating company. Many times these deadlines conflict with family or personal plans such as vacations.
5) Not realizing that the Company is now immediately subject to Sarbanes-Oxley rules prohibiting related party advances or loans. There can be no new loans or advances to related parties and any advances outstanding at the time of the reverse merger need to be paid back in a consistent and timely manner.
6) Not having the infrastructure in place to be able to complete managements’ assessment of internal controls in a timely manner. With a reverse merger, the operating company is deemed to be the reporting company and thus continues to carry the requirements for the quarterly and annual assessments.
The Company auditors need to be consulted early and often when a reverse merger transaction is going to occur. Instead of considering auditors to be a necessary evil and another hurdle to get over, they should be considered to be a valuable part of the team. An auditor’s expertise and insight can save a company thousands of dollars and assist in avoiding regulatory pitfalls.
This article is not an attempt to dissuade persons from the use of a reverse merger, they can, and do, work effectively when they are approached in the proper manner and when management is aware of potential problems.
One key to a successful reverse merger transaction is to consult with the auditors early. Take advantage of their expertise and insights Ask questions and make sure that the Operating Company has an infrastructure in place to support the required financial reporting requirements going forward.
Editor's Note: S. Jeffrey Jones, CPA has been in public accounting for 18 years specializing in SEC reporting companies including first time audits, reverse mergers and registration statements. He is a founding partner with HJ & Associates, LLC located in Salt Lake City, Utah. In his spare time, he enjoys running and spending time with his wife and three daughters. Jeff can be reached at 801-328-4408 or at firstname.lastname@example.org.
For more information, check out their website: www.hjcpafirm.com
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