Reverse Triangular Merger – Definition

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Reverse Triangular Merger Definition

A reverse triangular merger refers to the creation of a new firm which happens when an acquiring company creates a subsidiary firm which is then absorbed into their target company and later acquired by the acquirer. This sounds complex, but we happen to have an illustration that will help. Let us assume that Company “S” wishes to acquire a target firm “T.” Now, in a normal merger, firm “S” simply moves in with their bid and take control of “T” when the purchase is completed. However, this doesn’t exist in the reverse traditional merger. Here, Company “S” will create a subsidiary, say “C,” and “C” will be the one to purchase “T.” After this purchase is complete, “C” will be absolve into “T,” thus giving the mother firm, which in this case is “S” access to all shares in the target company. This is possible because the subsidiary is created solely for the acquisition and thus will have just one shareholder; “S.”

Just like direct mergers and forward triangular mergers, reverse mergers may be taxable or nontaxable, depending on the mode of execution and other factors as stated in Section 368 of the Internal Revenue Code, popularly known as the “Code.” In a case where such a merger is nontaxable, it is considered a restructuring for reasons related to tax.

Bottom Line: It is possible for a reverse triangular merger to qualify as a nontaxable organization if 80% of the sellers shares is merged with the voting stock of the acquirer. A limit of 20% is placed on non-stock consideration.

A Little More on What is a Reverse Triangular Merger

In this system of acquisition, the acquirer creates a subsidiary solely for the purpose of merging with the seller or the target company. Here, the subsidiary will buy the target firm (thus reducing the tax it’ll pay if it eventually gets taxed), and will merge with it. Later on, this subsidiary will liquidate, and this will make the selling entity the only surviving party of the merger. Thus, this will in turn make the target company a subsidiary of the acquirer, and its shareholders will get to have the buyer’s stocks. The reverse triangular merger is a perfect model for acquirers since the seller retains its identity and even its business contacts, thus making the acquirer benefit from existing clients.

In this sort of merger, the acquirer gains ownership rights to all sorts of assets and liabilities of the target company, and pays at least 50% of the acquisition cost with its stocks. The acquirer is required to meet a bona fide needs rule. However, if a legitimate needs arises in the fiscal year of the acquisition, a fiscal year appropriation may be obligated to be met.

Having earlier stated that the acquirer will have rights to the assets and the liabilities of the target company, as well as retain their identity and business contacts, the acquirer will be required to continue with the business of the target company or utilize a reasonable part of the assets in their operations. The acquirer may also qualify for a tax-free merger if the shareholders of the selling company hold stakes in the acquiring firm. Simply put, the acquirer must be gain approval from shareholders and directors in both firms.

Bottom Line: Reverse Triangular Merger is usually an amazing deal when the target company’s continued existence is needed for more than tax purposes like for franchising, contracts, or gaining patent rights or licenses owned exclusively by the target firm.

Important Details

    • In a reverse triangular merger, an acquirer creates a subsidiary which obtains the target company and gets absolved into it.
    • Reverse triangular mergers can be either taxable or tax-free just like other methods of acquisition
    • In a reverse triangular merger, the acquirer pays at least 50% of the cost with their stocks, and gains possession of all the assets and liabilities of the target company.

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