Reverse Triangular Mergers - Your Complete Overview

In the corporate world, mergers and acquisitions (M&A) shape industry landscapes, but they come in several types. Among these, reverse triangular mergers are a peculiar strategy for businesses to expand, merge, or acquire.

This short guide will go deep into the specifics of reverse triangular mergers, helping you understand the broader concept of a reverse merger, reverse triangular mergers, and the associated terms.

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What is a Reverse Merger?

A reverse merger is a business strategy that allows a private company to become public without the complexity and costs associated with an initial public offering (IPO) and the conventional process.

Through this process, a private company merges with an already public but typically inactive company. The private company's shareholders become the majority shareholders of the public company and control the new entity.

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What is a Reverse Triangular Merger?

A reverse triangular merger is a distinct type of reverse merger. In this, the acquiring company creates a subsidiary and merges it with the target company, thus leaving the target company as the surviving legal entity. However, the control of the resulting company is with the acquiring company's shareholders.

Who survives a reverse triangular merger?

The target company survives the merger but becomes a part of the acquiring company. However, the target company's shareholders then receive shares in the acquiring company as compensation.

Reverse Triangular Merger example

Imagine a tech giant, Company A, who wants to acquire a smaller creative Company B. Company A creates a subsidiary; let's call it Subsidiary A1.

Subsidiary A1 merges with Company B, which is the absorbed company. After the merger, Company B survives as the merged entity, now owning the assets of Company A1, while Company A1 ceases to exist. Technically, Company A now owns all of Company B's assets and liabilities.

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Reverse Triangular Merger Pros and Cons

Here are a few pros and cons of the reverse triangular merger:

Pros

• Non-Assignment Clauses: Contracts of the target that contain non-assignment clauses do not need consent to be transferred because the target company is the nominal survivor in the merger.
• Corporate Structure: The reverse triangular merger process preserves the corporate structure of the target company. It can be advantageous in regulatory environments where the target's operations depend on specific licenses or permits.
• Integration: Operational integration can be smoother and slower if preferred, since the acquired company initially maintains its separate legal entity status.
• Less Disruption: Less business disruption, as contracts, customer relationships, and operations continue under the pre-existing target entity.
• Tax Advantages: Potential for tax benefits depending on the entities and jurisdictions involved. The acquiring company can also benefit from tax liabilities, such as assimilating the target company's net operating losses in their tax statements.

Cons

• Minority Holdouts: Minority shareholders of the target company might not be squeezed out in certain jurisdictions, remaining as minority shareholders in the surviving subsidiary, thus sometimes complicating matters.
• Regulatory Approval: A reverse subsidiary merger can be subject to extensive regulatory approval processes, mainly if the large company impacts competitive market dynamics.
• Liabilities: The acquiring company may inherit known and unknown liabilities of the target company as it becomes part of the surviving entity. Depending upon the situation, it can be an advantage (such as reducing tax liabilities) or a disadvantage.
• Cost: The process can be costly and time-consuming, involving legal fees, merger financing, and due diligence expenses.
• Complexity: Triangular mergers can be complicated sometimes, requiring careful planning and experienced legal counsel.
• Employee Morale: Uncertainty during the merger process can affect employee morale and retention in the surviving company, impacting productivity and company culture.

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Reverse Triangular Merger Steps

Here is a step-by-step breakdown of the reverse triangular merger process:

1. Creation of a Subsidiary

The acquiring company, often a larger corporation, creates a subsidiary for the sole purpose of this merger.

2. Merger Initiation

The newly formed subsidiary merges with the target company. Unlike a standard merger, the target company doesn't directly merge with the buyer's entity.

3. Share Conversion

This is the reverse aspect of the merger. The subsidiary's shares are not distributed to the target's shareholders. Instead, the target's shares are converted into the acquiring company's shares (or cash or a combination of both), effectively transferring the target's shareholder base to the acquiring entity.

4. Operating Under the Target's Name

Post-merger, what was once the subsidiary now operates under the target company's name and has become a subsidiary of the acquiring company.

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Reverse Triangular Merger vs. Forward Triangular Merger

Let's understand the difference between the two.

Direction of Merger

In a forward triangular merger, Sub merges into Target, and Sub is the surviving entity. In a reverse triangular merger, this process is vice versa.

Surviving Company

A reverse triangular merger keeps Target intact, whereas a forward triangular merger does not.

Asset Transfer

Target's assets/liabilities are naturally transferred to Parent in reverse triangular mergers. Each asset/liability must be deliberately transferred in a forward triangular merger.

Contract Continuity

Unlike some forward mergers, reverse mergers maintain contracts without third-party consent.

Tax Implications

Both types of mergers are structured to be tax-free to the shareholders of Target under certain conditions.

Complexity

Reverse triangular mergers are legally more complex than forward triangular mergers, but both require careful due diligence.

Stockholder Approvals

In reverse mergers, only Target stockholders typically vote. In a forward triangular merger, Target and Sub's stockholders might need to vote depending on the law and the deal terms.

Liabilities

Rever triangular mergers may protect Parent from Target's liabilities compared to forward triangular mergers.

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Reverse Triangular Merger vs. Stock Purchase

A quick overview of the difference between a reverse triangular merger and a stock purchase:

Control of Assets and Liabilities

In a reverse triangular merger, the acquiring company automatically assumes all of the target company's assets and liabilities.

In a stock purchase, the buyer purchases the target company's shares from its shareholders, and the target company becomes a subsidiary. Still, the assets and liabilities remain within the target company.

Shareholder Approval

A reverse triangular merger typically requires the approval of the target company's shareholders, whereas a stock purchase only requires the shareholders' agreement to sell their shares.

Third-Party Consents

In a reverse triangular merger, existing contracts of the target company usually do not require third-party consent to remain in effect post-merger; however, in a stock purchase, some contracts may have change-of-control provisions that could require consent.

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Reverse Triangular Merger Tax Treatment

The tax treatment of a reverse triangular merger is often similar to that of a direct merger. It can be structured to qualify as a tax-free reorganization under the Internal Revenue Code (IRC).

Tax-Free treatment in certain circumstances

To qualify for tax-free treatment in a reverse triangular merger, particular IRS conditions must be met:

• Continuity of Interest: A substantial part of the consideration paid to the target's shareholders must be in the acquirer's stock. Generally, it is non-taxable if the acquiring company purchases at least 80% of the target's stocks.
• Continuity of Business Enterprise: The acquiring company must continue the target company's business or use a significant portion of its assets in a business.
• Business Purpose: There must be a sound business reason for the merger besides tax avoidance.
• No Step Transaction: The transaction can't be part of a larger scheme that would disqualify it from tax-free treatment.
• Holding Period: Shareholders of the target must adhere to specific holding period requirements for the stock they receive.

Tax considerations for shareholders

Here are a few aspects you should consider about reverse triangular mergers:

• Capital Gains: In a reverse triangular merger that qualifies for tax-free treatment, shareholders only recognize a capital gain once they sell the stock. However, if they receive cash or other non-stock consideration ("boot"), they may have to recognize gain to the extent of the boot received.
• Basis: In a tax-free reverse triangular merger, the shareholder's basis in the target company's stock is carried over to the stock they receive in the acquiring company.
• Holding Period: The holding period for the new shares includes the period the original shares were held, which is relevant for determining long-term vs. short-term capital gains when the shares are eventually sold.

Always consult a tax professional because each merger has unique attributes that may affect tax treatment, and the rules can be complex and subject to change.

Exitwise can help you find the right legal, corporate, and financial experts to conduct a reverse triangular merger or other merger and acquisition transactions.

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Frequently Asked Questions (FAQs)

Find the answers to some commonly asked questions about mergers of companies in the section below.

What happens to stocks in a reverse triangular merger?

In a reverse triangular merger, the parent company creates a subsidiary to merge with the target company. The target company's shareholders receive appropriate stock, cash, or a combination of compensation from the acquiring parent company.

Is a reverse merger good for stock price?

A reverse merger can be positive for the stock price if the market perceives the merger as beneficial due to synergies, entry into new markets, or improved financials. However, it can also negatively affect the stock price if the merger leads to concerns about integration, debt, or dilution of shares. The market reaction varies per individual instance.

Is a reverse triangular merger a statutory merger?

Yes, a reverse triangular merger is a type of statutory merger. This means it follows specific statutes that govern the merger process, including the legal requirements of each state involved, ensuring the protection of shareholders' rights and the approvals necessary to complete the merger.

Is a reverse triangular merger an assignment?

Generally, in a reverse triangular merger, the rights and obligations of the target company are not considered "assigned" because the target company survives as a subsidiary, maintaining its existing contracts and obligations. This contrasts with an assignment, which implies transferring rights or property from one party to another.

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Conclusion

Reverse triangular mergers offer a strategic way for companies to consolidate assets and expand their operational reach while preserving the target company's identity and existing relationships. When executed correctly, this structure can be smooth for both parties, with careful attention to legal, regulatory, and financial implications.

Consider working with Exit Wise if you plan a reverse triangular merger or any M&A deal. We will help you find and hire the right corporate and legal help, creating a dream M&A team that fetches you the most value possible.