REVERSE TRIANGULAR MERGER: Definition, Pros and Cons Explained

REVERSE TRIANGULAR MERGER: Definition, Pros and Cons Explained
REVERSE TRIANGULAR MERGER: Definition, Pros and Cons Explained

The reverse triangular merger is by far the most common merger structure in public corporation mergers. 

It has the advantage of isolating the liabilities of the acquired company in a separate subsidiary (unlike a straight merger). It also has the advantage of keeping the acquired company as a legal entity (unlike a forward triangular merger).

What Is Reverse Triangular Merger?

A reverse triangular merger (also known as a reverse subsidiary merger) is an acquisition agreement in which one corporation buys another with the help of one of its subsidiaries. 

The target company undergoes a reverse triangular merger in which the merging unit of the acquiring company merges with the target company. 

The acquired business continues to operate as a separate corporation, albeit as a wholly owned subsidiary of the acquiring company, which is somewhat controversial. 

As a result, this arrangement achieves the same result as if the acquiring company bought all the shares of the acquired company.  A forward triangular merger, in which the acquired business ceases to exist, is different from a reverse triangular merger. 

The subsidiary merges with the target in a reverse triangular merger, with the target remaining and the subsidiary disappearing.  All ownership of the facility passes to the buyer and the target becomes a subsidiary of the buyer. 

Both the buyer and the acquired businesses continue to operate, and the buyer does not assume the facility’s liabilities.

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How Does Reverse Triangular Merger Work?

A reverse triangular merger allows the acquiring firm to gain control over the target company’s non-transferable assets and contracts, which is not always possible with other acquisition methods. 

Buyers typically have difficulty handing over contacts, particularly contracts with government or government agencies, when dealing with assets.  This technique, i.e. using reverse triangular fusion, while not perfect, helps. 

The downside is that the acquiring company gets all of the company’s liabilities because it’s essentially a stock transaction.

Reverse triangular mergers, like forward mergers and direct triangular mergers may or may not be taxable, depending on how they are executed and other complicating factors set forth in Section 368 of the Internal Revenue Code. 

If a reverse triangular merger is not taxable, it is considered reorganization for tax purposes. In a reverse triangular merger, the buyer creates a subsidiary that merges with the selling company and then dissolves, leaving the selling company as the surviving company and the buyer’s subsidiary. 

The buyer’s shares are then issued to the seller’s shareholders. Because the reverse triangular merger preserves the legal entity of the seller and its business contracts, the reverse triangular merger is used more often than the triangular merger.

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What Are The Types Of Mergers?

Conglomerate merger

A conglomerate merger is a combination of companies engaged in different activities.  A merger will only happen if it increases the welfare of the shareholders.

Congeneric/product extension

Such mergers take place in the same market between companies.  A merger results in the addition of a new product to the existing product range of one company.  As part of the alliance, businesses can gain access and increase their market share by gaining access to a larger customer base.

Market extension merger

To gain access to a wider market and a larger customer base, companies that operate in different markets but offer the same products merge.

Horizontal merger

Companies with fewer such companies merge to gain a wider market.  A horizontal merger is a type of merger of companies that sell goods or services.  This leads to the elimination of competition and thus economies of scale.

Vertical merger

When companies operate in the same industry but at different levels of the supply chain, a vertical merger occurs.  These mergers increase synergies, supply chain control and efficiency.

Triangular merger

The buyer creates a wholly-owned subsidiary through a three-way merger, which in turn merges with the selling company.  Then the selling company stops working. 

The buyer is the sole stakeholder of the subsidiary.  A three-way merger may reduce the effort required to obtain shareholder approval for an acquisition, depending on the nature of the transaction.

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Reverse Triangular Merger Tax Treatment

Before examining the tax implications of a reverse three-way merger, the transaction itself should be explained.  Assume that P wishes to acquire T stock in a tax-free reorganization and retain T as a subsidiary, but P cannot structure the transaction as a Type B reorganization because of the voting stock-only requirement. 

One approach to this dilemma is for P to create S by contributing its P voting stock, and then for S to merge with T in an agreement that provides that T stockholders will receive P stock (and possibly other compensation) in exchange for their T stock.

With respect to the tax consequences, T shareholders who exchange T stock for P stock in a reverse triangular merger are entitled to nonrecognition under Section 354 and are subject to the loading rules of Section 356. T, as the surviving corporation, receives the assets of S after the merger of S with T. As a result, there should be no gain or loss on the acquisition of these assets.

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Reverse Triangular Merger Benefits

  • Contract Retention – In most cases, the target company has several business contracts that the acquiring company would like to retain.  A reverse triangular merger ensures the continuity of these contracts and offers for the acquiring company in the future
  • Faster Process – Mergers generally require approval by vote of the target company’s stockholders.  Reverse triangular mergers have fewer shareholders involved in the decision making the merger faster.
  • Reduced Liabilities – By avoiding a direct merger, the acquiring company can create a comfortable distance from the potential liabilities of the target company.  Keeping the target company as a subsidiary protects the assets of the parent company.
  • Easier sale – the acquiring company may later consider the acquisition a mistake and decide to sell it.  With a subsidiary it is much easier to do this than to sell part of a fully integrated company.

ALSO CHECK: Stakeholder Vs Shareholder: Differences Explained!

CONCLUSION

A reverse triangular merger is an ideal model for buyers, as the seller retains its identity and even its business contacts, allowing the buyer to benefit from existing customers.  In this type of merger, the buyer acquires ownership rights to all types of assets and liabilities of the target company and pays at least 50% of the purchase price in its shares.  The buyer is obliged to comply with the rule of bona fide needs.

However, if legitimate needs arise in the fiscal year of acquisition, fiscal year appropriations may be mandatory.  Having previously stated that the buyer will have rights to the assets and liabilities of the target company and will retain its identity and business contacts, the buyer will have to carry on the business of the target company or use a reasonable part of the assets in their activities.  The buyer may also be eligible for a tax-free merger if the shareholders of the selling company own shares in the acquiring company.

Reverse Triangular Merger FAQs

Is A Reverse Triangular Merger Taxable?

The taxation of a reverse triangular merger depends on the takeover structure.  For example, if the acquiring company acquires at least 80% of the shares of the target company, it is usually tax-free.  In this type of merger, a minimum of 50% of the payment consists of shares in the acquiring company, with the understanding that the acquiring company will receive both the assets and liabilities of the target company—a key difference from a forward three-way merger.

How Does Forward Triangular Merger Work?

When the buyer finds a suitable merger target, the buyer creates a subsidiary and the seller merges with the entity.  The buyer’s shares are issued to the seller’s shareholders.  The seller’s assets and business then become the property of the buyer.  In this scenario, the selling entity is dissolved and the selling shareholders receive the buyer’s shares.  The tax consequences in this scenario are the same as in the case of merger reorganization.  Section 368 allows such three-way mergers to be treated as tax-free reorganizations.

What Qualifications Are Required To Perform A Reverse Triangular Merger?

Most of the qualifications required to perform a reverse triangular merger are the same as in a forward triangular merger scenario.  The main exception is the amount of non-stock compensation that can be awarded to shareholders.  For a reverse triangular merger to qualify as a tax-free reorganization, 80% of the seller’s stock must be acquired along with the buyer’s voting stock.

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