Quick Test 5 seeks investors through reverse merger. (Up Front).

In today's funding environment, the founders of many startups figure their only choice is to tighten their belts and tough it out for three, four, five years on a shoestring.

Quick Test 5 Inc. officials took another route.

In July the Westlake Village company completed a reverse merger that took QT5 public even before it made its first sale. The company hopes the move will open the door to private investment funding that will help it launch a cache of health care products.

"The market is in desperate need of new companies and new products," said Steve Reder, president of QT5. "We have products going out in the market in six months. That's the reason we wanted to get out into the market faster."

QT5, which was founded in 1999, had acquired the patent for Nico Water, a nicotinelaced water the company says can quench the craving for cigarettes during those times when a smoker can't light up.

QT5 was so enthusiastic about Nico Water that it put what it expected to be its first product to launch, a urine analysis drug test that could be sold over the counter, on the back burner. It then turned to the public trading arena to help finance what it figures will be a sizeable marketing bill for its product introductions.

In a reverse merger, the publicly held company technically acquiring a private company, for all intents and purposes, becomes the entity being acquired.

The private company is acquired by a shell corporation, a publicly traded company that has no assets or liabilities, providing the formerly private company with stock shares and a position on the OTCBB. Companies typically execute reverse mergers in order to obtain stock shares which they then can use to attract other, private investors, or to acquire additional companies through stock swaps.

The transaction is less costly and less time-consuming than an initial public offering, and can be used by firms that have not yet generated any revenues. But that doesn't mean it is easy.

It took QT5 three tries before officials found a middleman who could identify and deliver the type of publicly traded company it sought.

"Call it a shell game," said Reder. "There's people out there that say, 'If you give me a retainer, I'll go ahead and put you in touch with shells.' I put $10,000 up and waited six months, and there was nothing there."

After the first company failed to deliver, Reder got in touch with an attorney who worked as an investment banker. He put together a dossier on a suitable company and then told Reder he'd need a retainer of $8,500 to proceed with the transaction. But after paying the fee, Reder says he was told that the company initially presented wasn't available after all. The investment banker offered up an alternative, but that company was laden with debt.

Finally, Reder came across Strategic Capital Consultants, a group willing to locate a suitable shell in exchange for equity in the company, and QT5 merged with a defunct company called Moneyzone.com.

QT5 expects to change its name and its trading symbol in coming weeks, but its hurdles are not over.

In July the FDA said that Nico Water, which had been marketed by another company until QT5 acquired the patent, required its approval before it could be sold. QT5 is still awaiting that approval.

Company officials say they are confident the FDA will green light the product, and they have already begun to mine the finance community for potential investors.

"Now we're going out and raising private placement for major advertising and products," said Reder. "We believe you have to brand a name and, in order to do that, it takes serious cash."

Financiers who invest in private companies must wait until the company is actually generating profits or until it grows large enough to issue an initial public offering in order to see a return on their investments.

But by investing in a publicly traded company, investors find some comfort in the fact they can sell their shares at any time.

"It's an easier exit strategy," said Reder. "I can come up with a business plan as a private company and say, 'If I live with my plan, I believe I can get you paid off in five years.' In the public arena, (investors) can go ahead and, let's say a year from now, if they want to unload, it's easier to unload."

There is little data on the number of reverse mergers currently being transacted. A Web site called reversemergers.com lists 54 such transactions, but the operators of the site concede tracking such deals is virtually impossible.

There is little doubt that reverse mergers have become more attractive for companies seeking capital in the current marketplace. Shrinking venture funds mean more companies are vying for less capital. And the stock market is so volatile, the investment community has soured on initial public offerings.

A reverse merger allows a company to go public virtually instantly even if it has no revenues, as is the case with QT5. According to Halter Financial Group Inc., Irving, Tex.-based consultants who specialize in reverse mergers, an OTCBB shell company can be had for $350,000 to $400,000; half that for a nonreporting shell.

What's more, private placements in public entities, PIPEs, have skyrocketed in recent years. Last year, PIPE transactions totaled about $15 billion and another $9 billion in PIPE deals were completed so far this year, according to PlacementTracker.com, an online financial database.

But the data doesn't distinguish between revenue-generating public companies and those like QT5.

Investing in a company that has gone public through a reverse merger "makes the company more attractive to an investor from a liquidity point of view, knowing that at least there's a market (for the shares), but it doesn't guarantee the success of the investment if the underlying value of the company does not appreciate," said James M. Jimenez, an attorney and founder of Business Venture Law Group, which assists emerging companies. Jimenez was not familiar with QT5, but he and others say that while some reverse mergers can be successful, the public trading aspect is only one criterion.

"Most of what I've seen are private placement deals virtually guaranteeing a return to the person putting money into private placement," said Robert V. Green, an investment analyst with Briefing.com, "which to me says if you need to guarantee that person a return it means the risk is extremely high."

To issue an IPO, a company must subject itself to thorough scrutiny by the SEC, said Green, who also was not familiar with QT5.

"You don't have that situation at all with a reverse merger. You have a company with zero revenues become a public company without any SEC review at all. Not every company that's done a reverse merger is a bad deal, but there's been so many (that are bad deals) that reverse mergers have gotten a bad name."

Reder says what differentiates QT5 is a growing stable of products for which there is a ready market. Nico Water has already received extensive media coverage, and Reder said he expects it to hit the market within 60 days after what he considers a simple administrative wrinkle is ironed out with the FDA.

"The minute we have approval, we'll be all over the place," Reder said.

In addition to Nico Water and its over-thecounter urine analysis drug test kit, QT5 also plans to launch an at-home HIV test currently in the final phases of FDA approval. According to Reder, the test has an accuracy rate of 98.5 percent.

"We want to be a health and awareness company," said Reder, a longtime San Fernando Valley resident who previously owned a printing company. "We've aligned ourselves with a manufacturing company that doesn't have the marketing experience and has come to us as the marketing group. They've got several patents they haven't been able to bring to market. We'll be a $100 million company very soon."