Reverse triangular merger peculiarities and benefits

In the tradition of globally recognized companies such as Amazon and Whole Foods, reverse triangular mergers have become a key aspect of corporate strategy, driving businesses toward new levels of success and innovation. 

Join us as we explore reverse triangular mergers, covering their procedures, best practices, and advantages and disadvantages.

What is a reverse triangular merger?

A reverse triangular merger occurs when an acquiring company creates a subsidiary or shell company to buy a target company. Afterward, the target company absorbs the subsidiary.

👁️‍🗨️forward vs reverse triangular merger

A forward triangular merger occurs when the buying company merges with the target company, making the latter disappear. Then, they operate together as a single business entity under the buyer’s name and structure.

A reverse triangular merger occurs when a shell company merges with the target, which then becomes a subsidiary of the buyer.

Additional resources: Forward and reverse triangular mergers 

Source: https://www.paranetlegal.com/types-of-mergers/ 

Next, we invite you to explore the procedure of a reverse triangular merger, including the involved parties and documents.

What is the reverse triangular merger process?

The process varies depending on jurisdictional differences, negotiation dynamics, and regulatory requirements. Here, we provide a basic transaction framework. But before diving in, let’s review the key parties and documents involved in a reverse triangular merger.

Parties involved:

• Acquirer — the company initiating the merger process
• Target company — the entity being acquired in the merger
• Subsidiary — a business entity established by the acquirer to facilitate the merger
• Legal and financial advisors — professionals providing guidance and expertise throughout the process.

Note: Besides the main parties, other stakeholders may also play a role depending on the circumstances. These include shareholders, government regulatory agencies, creditors and lenders, and independent committees.

Documents:

• The merger agreement outlines the terms and conditions of the merger.
• Articles of incorporation establish the framework for the newly formed entity.
• Regulatory filings are required for regulatory approvals.
• Valuation reports detail the valuation of involved entities.
• Shareholder agreements address the rights and obligations of shareholders post-merger.

Note: Depending on the complexity and circumstances of the merger, additional documents may be involved. Some examples include confidentiality agreements, employment contracts, asset purchase arrangements, and intellectual property assignments.

The main reverse triangular merger steps are as follows:

Preparation and due diligence	The acquiring company conducts due diligence on the target company to assess its financial, legal, and operational status. Legal and financial advisors may be engaged to assist in evaluating the transaction’s feasibility and potential risks.
Formation of subsidiary	The acquiring company forms a new subsidiary specifically to acquire the target company. This subsidiary will serve as the acquiring entity in the merger.
Agreement and negotiation	Negotiations occur between the acquiring company and the target company regarding the merger terms, including the purchase price, allocation of assets and liabilities, and other transaction details.
Approval and documentation	The boards of directors of both the acquiring and target companies approve the agreement. Legal documentation, such as the agreement itself and required regulatory filings, is prepared and signed.
Notice to shareholders and regulatory filings	The target company’s shareholders are informed about the merger and vote on the transaction if required by law. Depending on the size, nature, and jurisdictions involved in the transaction, regulatory filings, including antitrust notifications, may be necessary.
Merger execution	The acquiring company’s subsidiary merges with the target company, leaving the subsidiary as the surviving entity and the target becoming a wholly-owned subsidiary of the acquiring company.
Integration and post-merger activities	The parties combine the acquired company’s operations, systems, and personnel with those of the acquiring one. Post-merger activities may involve rebranding, restructuring, and implementing synergies to realize the strategic objectives of the merger.
Compliance and reporting	The combined company must comply with all legal and regulatory requirements, including ongoing reporting and financial disclosures. Any remaining post-merger adjustments are completed as necessary.

The procedure may seem bulky and time-consuming. However, some effective practices we provide below increase the chances of success. Scroll down to explore a real-life reverse triangular merger example.

An example of a successful reverse triangular merger

On June 15, 2017, Amazon.com, Inc. entered into a merger to acquire Whole Foods Market, Inc. for $42.00 per share in cash, leading to a total purchase price of $13.7 billion. According to the agreement, Amazon agreed to acquire Whole Foods through its indirect subsidiary, Walnut Merger Sub (the special-purpose vehicle), with Whole Foods remaining a subsidiary of Amazon.

Source: https://www.forbes.com/sites/bonanzachalaban/2018/07/10/will-whole-foods-benefit-from-the-amazon-effect/ 

The successful merger between Whole Foods and Amazon resulted in multiple benefits, including the following:

• Amazon gained a foothold in brick-and-mortar retail, especially in groceries, through Whole Foods’ extensive store network.
• Whole Foods’ offerings, such as organic foods, complemented Amazon’s existing product lines, broadening its appeal.
• Amazon’s logistics expertise enhanced Whole Foods’ supply chain efficiency and delivery capabilities.

Overall, the merger created synergies, driving growth and value for both companies and their stakeholders. Next, we outline some best practices to help ensure deal success.

Best practices for reverse triangular mergers

Following the recommendations and tips below ensures a seamless and successful transaction despite the procedure’s complexity.

1. Conduct thorough due diligence

Comprehensive due diligence on the target company’s financial, legal, and regulatory standing effectively uncovers potential risks. As a result, financial discrepancies, hidden liabilities, or ongoing or potential litigation are identified and addressed early on.

✔️Practical tips:

• Create a comprehensive checklist of financial, legal, and regulatory aspects to review.
• Employ advanced due diligence online solutions to simplify data gathering and analysis.
• Prioritize transparency and open communication with the target company to gather relevant information effectively.

Source: https://www.efinancialmodels.com/knowledge-base/due-diligence/due-diligence-101/mastering-the-art-of-due-diligence/ 

2. Engage professional advisors

Legal and financial professionals guarantee compliance with all regulatory requirements. They help draft and negotiate the merger agreement and other related documents to make all aspects of the deal legally sound and beneficial.

✔️Practical tips:

• Choose advisors with extensive experience in mergers and acquisitions.
• Promote a collaborative relationship with advisors to leverage their insights and recommendations effectively.
• Regularly update advisors on developments or changes in the process to ensure alignment and timely advice.

3. Secure financing

The parent company must ensure the subsidiary has enough funds to acquire the target company and verify that the purchase price is fair and reasonable. Financial advisors can establish an accurate valuation.

✔️Practical tips:

• Conduct a detailed financial analysis to determine the subsidiary’s funding needs and assess the parent company’s capacity to provide financing.
• Engage with financial institutions or investors to secure favorable terms and conditions.
• Consider potential risks and uncertainties that may impact financing arrangements and develop contingency plans accordingly.

4. Maintain regulatory compliance

Adherence to all relevant regulatory requirements at both state and federal levels is crucial to avoid legal complications and potential penalties. Filing the required documents with regulatory authorities, such as the SEC and state regulators, helps gain official approval for the merger to legitimize the transaction and avoid legal roadblocks.

✔️Practical tips:

• Establish a dedicated compliance team or committee responsible for monitoring regulatory requirements throughout the merger process.
• Implement robust compliance protocols and procedures to ensure adherence to all applicable laws and regulations.
• Regularly review and update compliance documentation, policies, and procedures to reflect changes in regulatory requirements.

Source: https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/fix-them-first-executing-regulation-driven-separations 

5. Consider tax implications

Assessing the tax implications of a merger helps companies understand the financial impact on their tax obligations, comply with laws, minimize liabilities, and maximize benefits.

✔️Practical tips:

• Collaborate closely with tax advisors and legal experts to conduct a thorough analysis of the tax implications associated with the deal.
• Consider various tax strategies and structures to optimize tax efficiency and minimize potential liabilities.
• Stay informed about changes in tax laws and regulations that may impact the merger’s tax implications.

6. Obtain shareholder approval

Securing shareholder approval ensures a merger’s smooth progression and minimizes the risk of legal or procedural obstacles.

✔️Practical tips:

• Communicate transparently with shareholders about the rationale, benefits, and risks of the proposed merger.
• Provide shareholders with sufficient information and opportunities for feedback or questions to facilitate informed decision-making.
• Comply with all legal requirements and procedures for obtaining shareholder approval, including holding meetings, voting, and disclosure requirements.

Pros of reverse triangular mergers

Typically, the transaction offers the following advantages:

• Easy sale. After the deal is closed, the target company remains a subsidiary of the buyer. This makes it much easier to sell if the need arises. In direct mergers, however, it becomes more difficult because the target company becomes a fully merged entity.
• Limited liability protection. The acquiring entity can protect itself from the target company’s liabilities by owning it as a subsidiary, thereby shielding the parent company from direct exposure to risks and liabilities.
• Target company’s business continuity. A reverse subsidiary merger enables an acquiring company to maintain the target’s business, contracts, and licenses. It is the primary benefit of reverse triangular mergers compared to forward triangular ones.
• Tax efficiency. During a reverse triangular merger, the subsidiary takes on the tax attributes of the target company. It allows the acquiring company to take advantage of the target company’s tax attributes, including net operating losses. As a result, the acquiring company may realize substantial tax savings. 

In the long run, successful mergers improve operational stability, enhance financial performance through synergies, and establish a strategic position for sustained competitiveness and market leadership.

Cons of reverse triangular mergers

The parties may face the following disadvantages: 

• Potential shareholder dissent. Although shareholder approval from the target company may not be required, shareholders may still disagree or express dissatisfaction with the merger. It can result in legal challenges or negative publicity.

✔️Solution: Companies engaging in reverse triangular mergers can communicate extensively with stakeholders and implement strategies to address shareholder concerns and reduce disagreement.

• Increased transaction costs. Reverse triangular mergers can incur higher transaction costs than other merger structures due to the complexity of the legal and financial arrangements involved, including creating a subsidiary entity.

✔️Solution: To manage transaction expenses, businesses should implement strict cost-control measures and negotiate advantageous terms with legal and financial advisors.

• Regulatory scrutiny. Authorities may subject reverse triangular mergers to increased scrutiny, especially in sectors with heightened oversight or antitrust concerns.

✔️Solution: It’s crucial to proactively engage with regulatory authorities and seek legal counsel. This way, you ensure compliance with all relevant laws and regulations.

Reverse triangular merger tax treatment

As direct and forward triangular mergers face similar tax issues, reverse triangular mergers can be taxable or nontaxable, depending on their execution and other intricate factors outlined in Section 368 of the Internal Revenue Code. If nontaxable, a reverse triangular merger is categorized as a reorganization for tax purposes. 

A reverse triangular merger may meet the criteria for a tax-free reorganization if 80% of the target company’s stock is obtained using the buyer’s voting stock, and non-stock consideration doesn’t exceed 20% of the total.

Source: https://www.leoberwick.com/reverse-cash-mergers-reverse-triangular-mergers/ 

Tax benefits of a reverse triangular merger

Reverse triangular mergers allow the subsidiary to gain the target company’s tax attributes. It enables the acquiring company to take advantage of the target company’s tax position, including credits and net operating losses.