A reverse triangular merger occurs when an acquiring company forms a subsidiary in order to purchase a target company, which then absorbs the subsidiary to create a new company. This differs from a reverse merger, which involves a smaller private company absorbing a larger publicly-listed company.
The reverse triangular merger process is simpler than a direct merger, mainly due to the acquiring company being the sole shareholder of the subsidiary. A reverse triangular merger is advantageous when the target company’s continued existence is necessary for non-tax reasons, which can include franchising rights, licenses, leasing or contracts, or the ability to continue operating in a foreign country.
The Reverse Triangular Merger Process
The reverse triangular merger moves forward after receiving approval from the boards of directors for all three of the companies involved. Shareholders for the target company must then provide their approval, with any dissenting shareholders given buyouts of their shares.
An Agreement and Plan of Merger is then drafted and given approval, essentially greenlighting the subsidiary to merge with the target company. Following the merger, the subsidiary is dissolved into the target company. This new entity becomes the new subsidiary, as the acquiring company is now its only shareholder. It also acquires all the assets and liabilities of the target company. Shareholders of the target company are then issued stock in the acquiring company.
The acquired target company resumes its normal operations, acting as a subsidiary of the purchasing company without the need for signing new contracts, licenses, or authorizations.
Advantages of a Reverse Triangular Merger
- Contract retention – In most cases, the target company possesses several business contracts that the acquiring company would like to retain. A reverse triangular merger ensures seamless continuity of these contracts and proposals for the purchasing company going forward
- Faster Process – Mergers generally require approval via shareholder votes from the target company. Reverse triangular mergers have a lower number of shareholders involved in the decision, which makes the merger faster to execute.
- Reduced Liabilities – By avoiding a direct merger, the acquiring company can create a comfortable distance from the target company’s potential liabilities. Keeping the target company as a subsidiary provides protection to the assets of the parent company.
- Easier Selling – It’s possible for the acquiring company to consider the acquisition a mistake later on down the road and decide to sell it. Doing so is much easier with a subsidiary than selling part of a fully integrated company.
Potential Drawbacks of a Reverse Triangular Merger
While a reverse triangular merger offers some protection from the target company’s liabilities and legal issues, it’s not fully guaranteed, as problems affecting the parent company could still come to light. Additionally, any new tax regulations for the company can be difficult to navigate due to their complexity.
Is a Reverse Triangular Merger Taxed?
The taxing of a reverse triangular merger is dependent on the structure of the acquisition. For instance, if the purchasing company acquires at least 80% of the target company’s stock, it is typically nontaxable. During this type of merger, a minimum of 50% of the payment consists of the stock of the acquiring company, knowing that the acquiring company will be gaining both the assets and the liabilities of the target company—a key distinction from a forward triangular merger.
The target company’s shareholders must also have an equity stake in the acquiring company for the merger to be nontaxable and meet the continuity of interest rule.
Insurance Needs for a Reverse Triangular Merger
After the completion of a reverse triangular merger, company ownership should prepare for ongoing regulatory compliance and revisiting their insurance coverage, especially in coverage areas like property insurance, tax liability insurance, cyber liability insurance, and others, depending on the company’s business.
Woodruff Sawyer is a nationally recognized leader when it comes to Representations and Warranties Insurance (RWI), a crucial aspect of the merger process. Woodruff Sawyer is also the market leader for placing Directors and Officers (D&O) insurance for IPO companies.
Read more about Mergers & Acquisitions, including SPACs, reverse triangular mergers, and shell companies.