Reverse Triangular Mergers

Reverse Triangular Mergers

A reverse triangular merger is an M&A structure in which the buyer forms a subsidiary that merges into the target company. After the merger, the subsidiary is dissolved and the target survives as a wholly owned subsidiary of the acquiring company. This structure preserves the target’s corporate existence while giving the acquirer control.

How it works (step by step)

1. The acquiring company incorporates a wholly owned subsidiary.
2. That subsidiary purchases and merges into the target company.
3. The subsidiary is dissolved; the target company remains as the acquirer’s subsidiary.
4. The buyer issues its stock (and possibly other consideration) to the target’s shareholders.

Following completion, the acquirer obtains the target’s assets and liabilities, and the target continues operations as a subsidiary.

Why companies use reverse triangular mergers

• Continuity of contracts and licenses: Because the target survives, nontransferable contracts, franchise rights, leases, and licenses often remain intact without renegotiation.
• Fewer shareholder approvals for the acquirer: The intermediary subsidiary has only one shareholder (the acquirer), so the acquirer generally does not need its own shareholder approval to complete the deal.
• Separation of liability and ease of future disposition: Keeping the acquired business as a distinct subsidiary can isolate some liabilities and make a later sale of the acquired business simpler.
• Potential tax benefits: The structure can allow the acquirer to preserve and use the target’s tax attributes (net operating losses, credits) subject to tax-code rules.

Drawbacks

• Higher transaction costs: Forming and integrating a subsidiary, plus additional legal, accounting, and advisory work, can increase costs.
• Integration challenges: Cultural, operational, and systems integration remain complex and time-consuming.
• Regulatory and due-diligence burdens: The acquirer must identify contingent liabilities and comply with merger and antitrust rules.

Legal and tax requirements

Several legal and tax tests can determine whether a reverse triangular merger qualifies as a tax-free reorganization under U.S. tax law (Section 368 of the Internal Revenue Code). Key concepts include:

• Continuity of interest: A significant portion of the seller’s shareholders must receive equity in the acquiring company (i.e., the transaction is not mostly cash). Transactions typically involve a majority of stock consideration; specific tax tests may impose higher thresholds.
• Continuity of business enterprise (COBE): The acquirer must continue the target’s historic business or use a substantial part of its assets in the combined business.
• Bona fide business purpose: The merger must have a legitimate business purpose beyond tax avoidance.
• Board approvals and corporate formalities: Both companies must observe required corporate governance steps (board approvals, shareholder approvals when required).

Tax treatment can vary:
– Some reverse triangular mergers are taxable transactions.
– Others qualify as tax-free reorganizations if they meet the Section 368 tests. For certain reorganization classifications, acquiring a high percentage (commonly cited is 80% in some contexts) of the seller’s stock in voting stock can be relevant; non-stock consideration is limited under those rules.

Example

Amazon’s acquisition of Whole Foods used an indirect subsidiary structure consistent with a reverse triangular merger: a subsidiary was used to effect the purchase, and Whole Foods survived as a subsidiary.

How it differs from similar transactions

• Reverse triangular merger vs. forward triangular merger: In a forward triangular merger the acquirer merges the target’s subsidiary into itself (or the acquirer’s subsidiary into the target), and the target typically ceases to exist. The reverse triangular keeps the target as the surviving entity.
• Reverse triangular merger vs. reverse merger: A reverse merger (different concept) occurs when a private company acquires a public company to become publicly traded without an IPO. It is unrelated to the triangular subsidiary structure described here.

Bottom line

A reverse triangular merger is a common M&A technique when the buyer wants to preserve the target’s corporate identity (to keep contracts, licenses, or franchises intact) while obtaining control. It can offer operational and tax advantages but requires careful planning to meet governance, regulatory, and tax-reorganization requirements.