Reverse Triangular Merger Explained

A reverse triangular merger is a type of acquisition structure in which the acquiring company forms a new subsidiary with which to acquire the target company. The subsidiary, known as the ‘merger subsidiary’, merges with the target company, allowing the target to survive the merger process as a continuing entity. The result is that the target company becomes a wholly-owned subsidiary of the acquiring company.

Note that a reverse triangular merger and a reverse subsidiary merger are the same thing.

Advantages of a Reverse Triangular Merger

Reverse triangular mergers comprise the majority of public company mergers. Beyond that, their popularity has recently surged thanks to the SPAC (special purpose acquisition company) phenomenon, most of which employ the technique. This pervasiveness is understandable given the number of key benefits the method provides:

• Entity Preservation & Asset Transfers — A significant benefit is found in the preservation of acquired company’s corporate entity. This eliminates the need to transfer assets from the entity to the acquirer as they are able to remain with the existing entity. Reverse triangular mergers are particularly helpful in situations where acquired business contracts have anti-assignment clauses (as there is no need to assign the contract away from the existing entity).
• Timeline and Certainty of Close — Another benefit of the reverse triangular merger is a quicker process timeline and greater likelihood of successful execution. This is because the only shareholder approval required is that of the target company, as opposed to a direct merger where approval is also needed for the acquirer. Reverse triangular mergers sidestep this step in the process as the sole shareholder of the subsidiary is the acquiring company (rather than all public shareholders at the parent company level).
• Liability Isolation — In conjunction with survival of the existing entity, the acquired entity is also able to retain its liabilities. Conversely, in a direct merger, the acquiring company would need to take on those liabilities. Avoiding this transfer of liabilities by holding them in the subsidiary provides additional protection to the assets of the parent company.
• Simplified Exit — Another advantage of maintaining the original target entity is the ease of a future divestiture. In a situation where the acquired company is later sold, it is much easier to divest the original entity than to untangle a direct merger.

The Reverse Triangular Merger Process

To proceed with a reverse triangular merger, the boards of directors for all three entities must approve the transaction. Target company shareholders must also approve the sale.

In the next step, an Agreement and Plan of Merger is drafted. Once approved, the subsidiary is free to proceed to merge with the target company. In conjunction with the merger, the subsidiary is dissolved into the target company. The new combined entity becomes the new subsidiary, with the acquiring parent company as the sole shareholder. The subsidiary now holds all assets and liabilities of the target company.

Normal operations continue largely uninterrupted (again, one of the benefits of the approach). There is no need to renegotiate contracts, licenses, or other client or regulatory matters.

Tax Considerations

In a reverse triangular merger, if more than 80% of the acquiring company’s stock is used to fund the transaction, the merger may be considered a tax-free reorganization, providing no tax liability for the acquiring firm.

Note that, in a reverse triangular merger, at least 50% of the payment to the target company must be in the form of stock of the purchasing company (one of the differentiators vs. a forward triangular merger).