Blog : 'Blank Check' IPOs

by Ed Zwirn on June 14th, 2013

Over the years, these companies, many of them penny stocks, have raised billions by going public...

According to the SEC's definition, a "blank check" company is a development stage company that has no specific business plan or purpose, or has indicated that its business plan is to eventually engage in a merger or acquisition with an unidentified company or companies.

These companies typically involve speculative investments and often fall within the SEC's definition of "penny stocks" or are considered "microcaps" even though some of them actually raise more money than in a typical IPO. In this way, penny stock investors can indirectly get in on the action of the private equity market.

And, as dodgy as they may sound, these IPOs are not illegal, provided they include adequate disclosure of their risks in prospectuses.

But, legal or not, these investments usually wind up being much more lucrative for their management than they are for the penny stock investors who buy them.

According to a paper by Vijay Jog and Chengye Sun of Ontario's Carleton University, these IPOs wind up being a "home run for management."

Jog and Sun looked at IPOs of 62 "blank check" companies and found that the shareholders who invested in them earned 3% below normal annualized rates of return, that is, returns below what these investors could have garnered through the general market, while management earned approximately 1,500% because of the very low "insider" prices at which they buy shares.

"It looks like the investors essentially wrote a blank check to management," they conclude.

On the other hand, as the authors are quick to point out, the investor returns in these cases may actually compare favorably to those of IPOs in general. Penny stock investors deciding whether to take the plunge and buy penny stocks like these, while they have no business plan to use for guidance, usually rely on the track records and, indeed, the "star power" or the managers.

These managers may or may not prove trustworthy over the long haul, and the companies they run may or may not score big in the merger and acquisition space. What's called for in cases like these is a different kind of due diligence, one in which penny stock investors must pay more attention to the biographies of managers than to the operating results (which are nonexistent) of the investment vehicles.

Reminder: The Peter Leeds penny bank contest is coming down to the wire. Enter before the end of this month and you get an excellent chance of winning $500 cash and a host of prizes. For more information, click here.