In August, Mount Tam Biotechnologies merged with a defunct cigar company in order to attain public trading for its stock. It was an odd coupling. The biotech startup needs money to fund research. Cigar company Tabacalera Ysidron failed in its plan to distribute Nicaraguan cigars.
Using a transaction called a reverse merger, the private company Mount Tam Biotechnologies bought the majority of shares of public shell company Tabacalera Ysidron then changed its name, gaining access to public markets.
Tabacalera Ysidron became a shell company because its business failed. According to a February 2014 letter from the Securities and Exchange Commission, in 2012, Tabacalera Ysidron issued 5 million shares of stock to founder Steven Ysidron for $500 — a hundredth of a penny per share. The company, based in Raleigh, North Carolina and incorporated in Nevada in 2011, issued 105 million shares at that price, as declared in its articles of incorporation, for a total of $10,500. In 2013, the company issued 1.7 million shares for $167,650 at 10 cents a share.
Tabacalera had thin capitalization. The SEC found numerous discrepancies in Tabacalera’s disclosures of its operations, cited in its letter to Ramon Tejeda, CEO and sole director. “We note your disclosure that the company currently has $23,623 cash on hand, and that you expect costs of SEC and corporate governance compliance to be approximately $80,000 per year. Please revise to disclose how you plan on meeting these requirements if you fail to generate revenues from your business,” the SEC said.
In another July 2014 letter, SEC staff said, “Please clarify what business you are in, including whether you are a distributor or a manufacturer” of cigars.
Tabacalera Ysidron struggled to last even three years in business, acknowledging in its disclosure that “net revenues are not sufficient to fund operating expenses.”
TRICKY BUSINESS OPTIONS
Biotech startups face tricky business choices. The designer molecules they invent and test hold huge potential to save human lives and curb suffering caused by diseases while reaping millions or billions in revenue. But the route from lab research to marketable drug is treacherously long and expensive. It can take a decade to wade through testing on mice to clinical trials that establish safety and efficacy for people to the satisfaction of the Food and Drug Administration. Meanwhile, a company must pay millions of dollars in salaries to scientists, management and other staff, facilities costs, overhead, expenses for clinical trials and administration.
Such fledgling companies might find seed funding from venture capitalists — either individuals or investment funds — but these profit-hungry investors expect major control over the companies into which they plunk money. Outside investors also might not want to wait a decade to realize a return, and further funding rounds might require turning even larger chunks of the company over to investors.
To raise capital, a startup can borrow money and then carry that liability. It can do an initial public offering, which can take a year and cost $2 million, and be subject to timing risks of the public stock markets.
Reverse mergers offer a quick route to public stock trading, but they carry different risks. Tabacalera had unpaid bills of nearly $100,000 that surfaced after the reverse merger. Sometimes investors in a shell company dump their shares soon after the merger. There can be tax liabilities, financial liabilities and legal risks, such as customers that sue the shell company after the reverse merger. Problems of the defunct shell company become the problems of the newly merged acquirer, such as Mount Tam Biotechnologies.
To handle the reverse merger, Mount Tam hired a company called Wells Compliance, based in Santa Monica. David Wells, founder and CEO of Wells Compliance, had background in public offerings, private placements, and mergers and acquisitions. Wells Compliance also handles preparation of SEC reports for its clients. David Wells became Mount Tam’s second CFO, and took the company through the reverse merger.
Jim Stapleton became Mount Tam’s third CFO in May, some nine months after the reverse merger. As financial manager in previous companies, he went through four previous reverse mergers, including a biotech company and a Texas-based retail electric provider. He has managed finances and operations for growth companies since 1987, including handling non-public transactions.
IPO OPTIONS SLIM
“In a lot of cases, your opportunities to go public are slim to none,” Stapleton said, “because you have no revenues, you don’t have a history. You’re not the hottest, latest, greatest thing coming along. You need a format that gives you access to capital. That’s what a reverse merger does.
“I can give you the good, the bad, the ugly,” Stapleton said. “I wish it had taken place a bit cleaner or better,” he said of Mount Tam’s reverse merger.
“It got done.That’s a positive. Mount Tam is now a public company. We need to raise capital to move these products that the Buck has discovered.”
Mount Tam’s TAM-01 drug is licensed from the Buck Institute. In June, Mount Tam reported an application with the Food and Drug Administration to investigate using TAM-01 for lupus, a disease that plagues some 5 million people worldwide, primarily women.
“I need to go out and get the capital in so we can start to advance what is done with TAM-01. It’s darn-good science,” Stapleton said. Mount Tam’s objective is to commercialize some of the Buck drugs under development.
PHIZER‘S INTEREST IN TAM-01
A true investor bonanza is a buyout. Big drug companies such as Pfizer, based in New York, with 2015 revenue of nearly $49 billion, “will pay more later for something that is more proven,” Stapleton said.
Pfizer apparently had financial interests in technology under study at Mount Tam. “The Buck Institute ended up with TAM-01,” Mount Tam’s drug aimed at lupus, Stapleton said, after Pfizer bought Wyeth, a drug company founded in Philadelphia, in 2009 for $68 billion. TAM-01 was part of Wyeth, he said, and Buck Institute bought the drug, which was too early in its development for Pfizer.
“We may at some point in the future do a transaction with Pfizer,” Stapleton said, “on a product that they gave up in their acquisition of Wyeth. Pfizer is perfectly content with that — pay more later rather than risking a lot now. They have very deep pockets and a great machine (for drug distribution). They’ll buy something that comes out of Phase II (human trials), ready to go into Phase III. Even if you have to put $100 million in to get a percentage of it, they’ll do that rather than putting $20 million in it four years earlier.”
If Pfizer jumped into a drug developed by Mount Tam, celebratory cigars might be warranted.
Beyond lupus medications, “the real value of Mount Tam is the platform that will allow us to have many more products to address indications,” which are valid reasons to use a certain drug, Stapleton said.
For example, Allergan’s Botox drug is indicated in numerous maladies, including: upper-motor-neuron syndrome, incontinence, chronic migraine, focal hyperhidrosis (excessive sweating), strabismus (improper alignment of eyes), blepharospasm (uncontrolled eyelid twitching), vaginismus (spasm of vaginal muscles), bruxism (teeth grinding and jaw clenching), movement disorders caused by Parkinson’s disease, and cosmetically to reduce wrinkles by paralyzing facial muscles. Each indication poses a fresh market opportunity.
$1 MILLION DEAL
In the reverse merger, publicly traded Tabacalera Ysidron, based in Nevada, acquired privately held Mount Tam Biotechnologies, based in Delaware. Each share of Mount Tam was converted into 2.67 shares of Tabacalera stock, and its convertible notes converted into shares of Tabacalera at 50 cents a share. The whole transaction was valued at $1 million. David Wells was interim CFO at the time. The management of Mount Tam became the management of the public company.
Before the reverse merger, Tabacalera stock traded on the over-the-counter market bulletin boards under the symbol “TQBY.” After the reverse merger, the emergent corporation’s name was changed on August 31 to Mount Tam Biotechnologies, and the stock symbol changed to OTCBB:MNTM.
Over-the-counter securities trade on a bulletin board regulated by the federal Financial Industry Regulatory Authority. FINRA sold certain assets of the OTCBB to Rodman & Renshaw Capital Group, an investment bank, in 2011, to continue providing a trading market for unlisted securities.
Shares on the bulletin board are not traded on the NASDAQ or any national stock exchange. The bulletin-board market is typically for smaller companies or micro-cap growth companies such as Mount Tam. Companies delisted from stock exchanges because they fell below requirements for minimum capitalization or minimum share price may end up on the OTCBB. The bulletin board operates on a bid-ask format, where traders who want to sell shares ask for the price they seek, and those offers are matched with traders who bid for certain shares.
Sometimes a shell company has cash holdings that can be worth a lot to the acquirer. Tabacalera had no cash.
“The public company (Tabacalera) was supposed to not have any liabilities,” Stapleton said. But it did. “Sometimes a few things float over, and then you resolve it with the shell.”
There are two types of shell companies, according to Stapleton. Some shell companies are created solely to function as shells in a reverse merger, with no business history and “weren’t really a company,” he said. Other shell companies have an operating history, such as Tabacalera. “They ran into financial difficulties or strategic issues. They bet on a technology that went one way and they went a different way,” he said. “Those companies get wound down.”
Stapleton believes that Tabacalera was founded with the objective to make money. “But it didn’t,” he said. “His intentions were always good.”
Reverse mergers were popular in the 1980s and early 1990s. Ted Turner used a reverse merger to launch Turner Broadcasting System. Other companies that used reverse mergers include Burger King, Jamba Juice, Blockbuster Video, Texas Instruments, Tandy Corp. (Radio Shack) and Waste Management. The SEC clamped down on reverse mergers in the mid-1990s, curbing the practice of setting up shells purely to structure a reverse merger. Reverse mergers are cheaper and faster than initial public offerings (IPOs). “It has worked out for a lot of companies,” Stapleton said.
Private investors typically expect a “liquidity event” in three to five years, according to Stapleton, in a company that might be acquired or go public in the future. After a reverse merger, every investor “has a marketable security” at the time of investment. “There may be restrictions on selling that. But if you invest $100,000, you get a share certificate, you put it in a brokerage account and your value is $105,000 or $110,000 or $90,000 or $95,000. There’s value there right then, instantly. That helps people who need to feel that the money didn’t just disappear.”
The cost of a reverse merger is commonly measured by the amount of the newly merged company retained by the former shareholders of the private company. That amount is typically 80 percent to 90 percent, Stapleton said, and former owners of the shell hold on to 10 or 20 percent. “If the shell has cash in it for some reason,” shell investors may get 40 percent to 50 percent of the surviving entity.
BELIEF IN BUSINESS
In the Mount Tam-Tabacalera reverse merger, the shell retained 40 percent even without cash, Stapleton said, suggesting that Tabacalera shareholders wanted to own the emergent company. “They have a belief in our business and the opportunity there,” he said. “We had to sell the shell shareholders on why this transaction should take place.”
To keep shareholders in place after a reverse merger, the company can seek “lockup” agreements with owners of the shell company, who often have a very low cost basis. In such an agreement, shell shareholders agree not to sell their shares — up to five years.
“That eliminates them from selling, selling, selling all the time,” Stapleton said. “It aligns their interest with management and new shareholders. That helps so much in going through one of these transactions.”
Tabacalera shareholders were asked to sign lockup agreements of varying lengths. It’s shareholders with minuscule cost basis “that you really want to lock up,” Stapleton said. He aims to extend the lockups and make them more encompassing.
Even with a lockup, a shareholder might sell shares short — betting that the stock price will drop and then reaping profits from a decline. Shareholders can be asked to surrender their share certificates to a transfer agent or to the company, a move that blocks shareholders from shorting the stock. ”They have no stock to short because the shares are not sitting at a depository,” Stapleton said, “where they can loan them out.”
Both moves can help to stabilize a company after a reverse merger.
In a 2013 filing, Tabacalera listed 39 shareholders of record who owned 35 percent or 2.7 million shares out of some 7.7 million outstanding shares. “The public company was supposed to be free of liabilities,” Stapleton said. “It has been determined that there were certain liabilities we assumed. I am going to have a remedy with the shell owners to resolve that with us. They may have forgotten a couple of bills. Those are liabilities. The new company ended up paying them.”
He’s trying to determine which liabilities on the books from August to December 2015 were from Tabacalera and which were from Mount Tam. “Some of those were part of the shell,” he said. “The shell is being very receptive to work with us to resolve that. In most cases there’s not an intent to defraud. It’s just that things got missed or something happened. You catch up with it and resolve it.” The total of unresolved liabilities discovered with Tabacalera is about $100,000 so far, Stapleton said. “These are minor things that usually come about.”
Mount Tam’s business mission could help millions. Systemic lupus erythematosus strikes mostly women, especially African Americans and Asians, and causes widespread tissue damage and inflammation, including chest pain, hair loss, joint pain, sun sensitivity and “butterfly” skin rashes, especially on the nose and cheeks. Nearly 1.5 million Americans and 5 million people globally suffer from lupus. The company will soon start manufacturing its TAM-01 drug for lupus, and plans human clinical trials.
Trading in Mount Tam began in September 2015 with a share price range of 71 cents to 93 cents since then, on June 15 at 84 cents. Market capitalization is about $36 million. In March, the company obtained a secured promissory note to borrow up to $1 million and on June 14 increased to $5 million.
The chairman of the board of Mount Tam Biotechnologies is Brian Kennedy, CEO of the Buck Institute for Research on Aging. In March, the company hired Richard Marshak as CEO. Marshak worked previously at Abbott Laboratories Pharmaceutical Products, now called AbbVie Biotherapeutics. Mount Tam also hired as chief scientific officer Tim Powers, previously employed at Amgen.
AbbVie, a 2013 spinoff of Abbott, developed adalimumab under the trade name Humira, used to treat autoimmune diseases. When the drug first emerged, “no one would have said we are going to do $14 billion a year 10 years from now,” Stapleton said. “They have nine indications. They probably have quite a few more going through trials.”
With its reverse merger accomplished and better access to financial capital, Mount Tam Biotechnologies is positioned to capitalize on its science.
“My goal is to have more shots on goal,” Stapleton said. “I want to take more items that the Buck has worked on, specifically Brian Kennedy’s portion of the Buck. We have the opportunity to have a very strong platform, some very good large-market products. But it’s going to take time to get there.”