Corporate Finance & Accounting

reverse triangle merge

What is a reverse triangle merger?

A reverse triangular merger refers to a new company formed by the acquiring company establishing a subsidiary, the subsidiary acquiring the target company, and then the subsidiary being absorbed by the target company.

A reverse triangle merger is easier to accomplish than a direct merger because the subsidiary has only one shareholder – the acquiring company – and the acquiring company may gain control over the target’s non-transferable assets and contracts.

key takeaways

  • A reverse triangular merger is a new company formed by the acquisition company establishing a subsidiary, the subsidiary acquiring the target company, and the target company absorbing the subsidiary.
  • Like other mergers, a reverse triangular merger may or may not be taxable, depending on the factors listed in Section 368 of the Internal Revenue Code.
  • In a reverse triangular merger, at least 50% of the payment is in the acquirer’s stock, and the acquirer acquires all of the seller’s assets and liabilities.

Reverse triangular mergers, such as direct mergers and forward triangular mergers, may or may not be taxable, depending on how they are executed and other complex factors set forth in Section 368 of the Internal Revenue Code. If not taxable, a reverse triangular merger is considered a reorganization for tax purposes.

A reverse triangle merger may qualify for a tax-free reorganization when 80% of the seller’s shares are acquired with the buyer’s voting rights; non-stock consideration must not exceed 20% of the total.

Understanding Reverse Triangular Mergers

In a reverse triangle merger, the acquirer creates a subsidiary that merges with the seller and then liquidates, with the seller as the surviving entity and a subsidiary of the acquirer. The buyer’s stock is then issued to the seller’s shareholders.

Reverse triangular mergers are used more frequently than triangular mergers because reverse triangular mergers preserve the seller entity and its commercial contracts.

In a reverse triangular merger, at least 50% of the payment is in the acquirer’s stock, and the acquirer receives all of the seller’s assets and liabilities. Because the acquirer must meet the bona fide needs rule, it may only be obligated to meet a fiscal year appropriation if a legitimate need arises in the fiscal year for which the appropriation is directed.

Reverse triangular mergers are attractive when the seller needs to continue to exist for reasons other than tax benefits, such as rights related to franchises, leases or contracts, or specific licenses that may be held and owned by the seller alone.

Because the acquirer must meet business continuity rules, the entity must continue the target’s business or use a substantial portion of the target’s business assets.

The acquirer must also meet the continuity of interest rules, which means that the merger can take place on a tax-free basis if shareholders of the acquired company hold equity interests in the acquiring company. In addition, the acquirer must be approved by the boards of both parties.

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