One plus one is three: this equation is the special alchemy behind a reverse triangular merger or acquisition. The primary purpose of purchasing a company is to create shareholder value that exceeds the sum of two companies. The reasoning behind mergers and acquisitions is that two merged companies are valued more than two separate ones. Strong entities will want to buy other entities to increase competitiveness and cost-efficiency.

Target companies, on the other hand, will agree to be bought when they are certain they cannot survive on their own. Another added bonus would be that they can now reach a greater market. There are various types of mergers when viewed from the perspective of business structures. However, we are only going to discuss the reverse triangular merger in details.

What Is a Reverse Triangular Merger?

It is a merger in which a subsidiary of the acquiring company carries out the acquisition.

In this type of acquisition, the acquiring entity forms a subsidiary which purchases the target company. The subsidiary subsequently owns the target company. This merger is easy to accomplish since the subsidiary has only one shareholder, the acquiring company.

The subsidiary of the acquiring entity may have control of the target’s contracts and nontransferable assets. After the merger, the shareholders of the target company receive equity in the acquiring company. This is referred to as a reverse triangular acquisition since three parties are part of it:

  • the target company.
  • the acquiring company.
  • the purchasing subsidiary of the acquiring company.

Who Uses a Reverse Triangular Merger?

This type of merger is very common in mergers between public traded companies and private corporations. The private company normally has strong prospects and wants to raise funds by purchasing a publicly-listed subsidiary company, normally an entity with limited business assets. The private corporation reverse merges into the publicly traded company, and together they become a public company with tradable shares.

How to Create a Reverse Triangular Merger?

As discussed earlier, this merger requires the buying entity to form a subsidiary that will merge into the selling corporation. Once the merger is successful, the selling entity then liquidates, and the stock of the purchasing company is issued to the seller’s shareholders.

Payment is made in 50% of the stock of the buying entity which also gains all assets and liabilities of the selling entity. If a legal need arises, an appropriation may be crucial since the buying entity must meet the bona fide needs rule.

To meet the continuity of business enterprise rule, the acquirer must continue the business of the target company or otherwise use a significant part of the target entity’s asset in a company. The buying company should also meet the continuity of interest rule implying that the merger may be made on a tax-free basis in case the stockholders of the sold company hold an equity share in the buying company. Furthermore, the buying entity must receive approval by the board of directors of both companies.

illustration fish triangular merger

Reorganization after a Reverse Triangular Merger

When the transaction is completed, the buying company holds a significant part of the selling entity. Former shareholders of the target entity get an amount of voting stock of the buying entity and an amount of stock of the target entity which is 80% of control.

In some cases, the buying company gets at least 80% control in fair market value of the target’s assets for voting stock. Then, the company can still use property or money to purchase the target company.

Ways in Which a Good Reverse Triangular Merger Can Help Your Business

This kind of merger offers a lot of benefits to business owners compared to mergers like forward triangular merger and statutory merger. This is because the selling entity has only one principal shareholder which is the buying company. Here’s how at reverse triangular acquisition can help your business:

Continuation of Contracts

After the merger is complete, the contract between the subsidiary company and the target company remains between the two parties.

Many clauses in contracts that prevent assignment of a contract without the written consent of the subsidiary are inapplicable since the transaction does not involve the transfer of the contractual right from one company to another. Therefore this type of merger is preferred when the acquiring company wants to protect the value of contractual rights faster and with a high degree of certainty. Unlike in a reverse triangular acquisition, third parties may withhold approval of the assignment of contract to the buying entity in the case of a direct merger and a forward triangular merger.

Fewer Liabilities

In a reverse triangular acquisition, the subsidiary of the acquiring entity buys the selling company. This way, the acquirer maintains a strategic distance from the selling entity and any liabilities that may follow. The buying entity will not expose itself to the target entity’s liabilities since only the subsidiary of the buying company merges with the target entity.

Selling the Company Is Possible

Sometimes, the selling entity may realize that it made a mistake purchasing a firm. In this situation, it is easy to sell the acquired entity, which is a subsidiary of the acquirer. It is easy to sell a subsidiary rather than sell a section of a fully integrated company.

Quicker Execution

For merger transactions to occur, the buying company needs to get the approval of the shareholders of the selling company. In a reverse triangular acquisition, the number of stockholders is reduced implying that it will take less time to get approval. This translates to a faster transaction.

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A reverse triangular merger is the best case scenario among the types of mergers. It is fast to execute, has fewer liabilities and companies can separate when the need arises. You can opt for this merger if you (the seller) wants continued existence for purposes other than tax benefits.

If you have additional knowledge on this type of merger, please let us know your thoughts in the comment section below.

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