What Is a Reverse Triangular Merger?

What Is a Reverse Triangular Merger?

Let me explain what a reverse triangular merger is. It's an indirect merger in the mergers and acquisitions world where you, as the acquiring company, create a subsidiary that then acquires and merges with the target firm. This approach is often easier than a direct merger because your subsidiary has just one shareholder—your company—and it lets you gain control over the target's nontransferable assets and contracts without much hassle.

Key Takeaways

Here's what you need to know right away. In this setup, you form a subsidiary that buys the target company, and then that subsidiary dissolves, leaving the acquired company as your new subsidiary. You get benefits like potential tax savings, operational continuity, and simpler execution. Whether it's taxable depends on Section 368 of the Internal Revenue Code. Remember, at least 50% of the payment must be your stock, and you take on all the target's assets and liabilities.

Understanding Reverse Triangular Mergers

Let's break down how this works. You create a subsidiary that merges into the selling entity, and then you liquidate that subsidiary, so the selling entity survives as your subsidiary. You issue your stock to the seller's shareholders. The steps are straightforward: form the subsidiary, have it acquire the target, merge them, dissolve the subsidiary, and the target becomes your new subsidiary. After that, the target keeps operating normally under your control. Again, at least 50% payment in your stock, and you get all assets and liabilities.

This is particularly useful when you need the seller to keep existing for non-tax reasons, like franchises, leases, contracts, or licenses that only they can hold.

Advantages and Disadvantages of a Reverse Triangular Merger

These mergers might sound complex, but they're often chosen for their simplicity. Let me tell you why companies like them. First, continuity: it helps you keep the target's business contracts running smoothly post-merger. It's easier to approve because the subsidiary's only shareholder is you, so you might not need broad shareholder permission. Keeping the business separate as a subsidiary creates distance from your assets, making future sales easier. And tax-wise, it's treated as a stock purchase, letting you use the target's tax perks like net operating losses or credits.

On the downside, transaction costs are higher due to creating the subsidiary and extra advisory fees. Integration can be tough—combining cultures, tech, and processes often leads to inefficiencies, conflicts, and extra time and money. Plus, you have to navigate regulatory hurdles, doing due diligence to avoid liabilities and comply with federal rules.

Reverse Triangular Merger Requirements

You must meet certain rules. For the bona fide needs rule, any fiscal appropriations have to address legitimate needs from the year they were made. The continuity of business enterprise rule means you continue the target's business or use a big part of its assets. The continuity of interest rule allows tax-free status if the acquired company's shareholders get equity in your company. Also, both boards of directors need to approve it.

Reverse Triangular Merger Tax Treatment

Like other mergers, this can be taxable or nontaxable based on execution and IRC Section 368 factors. If nontaxable, it's a reorganization. It qualifies as tax-free if 80% of the seller's stock is bought with your voting stock, and non-stock consideration is no more than 20%. The tax benefits include acquiring the target's attributes like credits or net operating losses.

What Is an Example of a Reverse Triangular Merger?

Take Amazon's buy of Whole Foods—it was a reverse triangular merger. Amazon used an indirect subsidiary, and Whole Foods survived the merger as the subsidiary.

What Is a Reverse Merger?

Don't confuse this with a reverse merger, where a private company takes over a public one to go public without an IPO.

What's a Forward Triangular Merger?

The opposite is a forward triangular merger, where the target merges into your subsidiary, the target disappears, and you assume all its assets and liabilities.

The Bottom Line

To wrap up, in a reverse triangular merger, you form a subsidiary to buy another company, merge it, dissolve the subsidiary, and keep the acquired company as yours. Beyond tax benefits, it's easier on shareholders and maintains continuity.