Private small- to medium-sized companies are all but unable to go public these days, but more and more of them are exploring reverse mergers as an viable alternative to an initial public offering.

Timothy Halter, president of Halter Financial Group Inc. in Irving, Texas, finds that the steep drop in IPO trading margins has caused many smaller brokerages to abandon the small-cap underwriting industry that they previously dominated, especially during the Internet boom. The small brokers' retreat from the marketplace has left private companies scrambling for alternatives.

At the same time, Halter says that increased regulatory scrutiny of the reverse merger process has markedly improved the quality of private companies considering reverse mergers. That is beginning to remove the historic taint associated with pursuing such back-door public listings.

'Previously our company would get more direct communication from companies beating the bushes for ways to access public investment,' Halter said. 'Now we hear from advisers or intermediaries such as private equity groups, investment banking firms or law firms inquiring on behalf of clients.'

Adds Margie Blackwell, vice president of Keating Investments llc in Denver: 'We get inquiries from companies with actual trailing revenues, as opposed to startups looking to raise capital, as was the case before.' She says the number of inquiries her firm has fielded has roughly doubled over the past year.

Still, to complete a reverse merger requires a unique set of financial criteria, notes David Nussbaum, chairman and CEO of EarlyBirdCapital Inc., a New York private equity-focused investment bank. 'If someone has a shell company with substantial cash in it and access to deal flow, there is a tremendous number of solid operating companies that would like to merge with this company,' he says.

This increased demand can prove costly for private companies searching for a reverse merger listing vehicle. Tim Halter says Over-the-Counter Bulletin Board shell companies are selling for around $350,000 to $400,000 these days. So-called pink sheet shells are valued at about $200,000 and non-reporting, non-trading shells are available for about $175,000. All of these prices are roughly double what they were in the mid-1990s — before the dot-com craze drove prices abnormally higher.

Halter says that during the Internet boom of the late 1990s some public shells were rumored to have changed hands at prices in the $1 million range. 'During the Internet craziness there was the mentality that a company had to go public as soon as possible, and the market lost all sense of normalcy,' Halter said.

David Nussbaum agreed that the 'speed premiums' of the Internet era were unlikely to recur. 'I think some people were disappointed after paying those high prices,' Nussbaum said. 'A reverse merger is not necessarily quicker than an IPO. But now it's really the only alternative for many companies.'

Case in point: Cirmaker Industry Co. Ltd., a Taiwanese company specializing in developing and manufacturing telecommunication products, electronic equipment and PC and electronic components, signed a letter of intent in January to do a reverse merger with Comet Technology Inc., a Salt Lake City-based public shell.

The current state of the IPO market, and Cirmaker's industrial sector and status as a foreign company, make an IPO impossible. So Cirmaker will instead acquire 92% of the outstanding shares of Comet, after which Comet is expected to take on the name and operations of Cirmaker.

Hard figures on reverse merger transactions are exceedingly hard to come by — the U.S. Securities and Exchange Commission and National Association of Securities Dealers do not track them specifically in regulatory filings — but private placement specialists and consultants agree there are many more inquiries by private companies seeking to merge with dormant or troubled public companies.

In another recent example, Global Genomics Capital Inc., a private holding company with minority stakes in Blizzard Genomics Inc. and Psynomics Inc., said in mid-February that it would merge with CytRx Corp., an Atlanta-based drug researcher under threat of delisting from Nasdaq. After giving up 10 million shares of its common stock in the merger, CytRx will be renamed Global Genomics Inc. and will be run by Global's current chief executive, Steven Kriegsman.

The current market for public shell companies has become so attractive that Nussbaum is considering reentering the shell formation market, where he was active in the early 1990s before regulators began to crack down on shells as vehicles for poorly executed back-door public listings.

'We're thinking of engaging in a dialogue with the SEC and the NASD on this,' Nussbaum said. 'We feel regulators' previous misgivings are misplaced now that disclosure rules for reverse mergers are just as thorough as for registration statements,' he said. 'The IPO market is so dead right now that there's little choice for companies that want to go public.'

Still, some industry professionals are actively discouraging companies from going public through reverse mergers. Lawrence Kaplan of Melville, N.Y.-based G-V Capital Corp., says he, too, has seen a marked increase in inquiries over the past two or three months, but he's advising caution.

'The quality of the companies hasn't improved as much as you might expect,' he said. 'There are thousands of companies trying to go public that shouldn't, and we're advising them to stay private.'

Instead, Kaplan counsels that these companies raise enough money privately to get them through the next eight to 10 months — after which they will be more mature. 'We only suggest reverse mergers if we feel it will really help the company,' Kaplan said. 'The public market is not a good place for a young company.'

Halter agrees some companies that choose to go public through reverse mergers would be better off staying private.

'In the IPO market the underwriter acts as a gatekeeper to keep out companies that don't belong in the public arena. With a reverse merger, there is no gatekeeper.'

Reporter E-mail Address: smosher@thedailydeal.com