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What is a reverse triangular merger?
A reverse triangular merger is a way to structure an acquisition or reverse merger: the buyer forms a subsidiary that merges into the target company, the target survives as a wholly owned subsidiary of the buyer, and the target's shareholders receive the buyer's shares. It is the most common structure for a reverse merger with a public shell, because the operating company keeps its contracts, licenses and legal identity.
Joel Arberman, Meraki Partners. Based on 17 companies taken public: 11 by direct listing, 4 by reverse merger and 2 by IPO.
How does it work step by step?
- The public company (the buyer) forms a new subsidiary.
- The subsidiary merges into the private operating company.
- The private company survives and becomes a wholly owned subsidiary of the public company.
- The private company's shareholders exchange their shares for shares of the public company, usually a majority of it.
Why use this structure?
Because the operating company survives intact, its contracts, permits, licenses and bank relationships usually don't need to be reassigned. The public company's existing liabilities also stay at the parent level rather than merging into the business.
Can it be tax-free?
It can qualify as a tax-free reorganization if the buyer acquires control of the target, at least 80%, in exchange for its voting stock and other requirements are met. Tax counsel should confirm the structure for each deal.
What is a forward triangular merger?
It is the mirror image. The buyer still forms a subsidiary, but the target company merges into the subsidiary and disappears. The subsidiary survives, owns the target's business, and the target's shareholders receive the buyer's shares (and sometimes cash). A forward triangular merger can qualify as a tax-free reorganization under Section 368(a)(2)(D) of the Internal Revenue Code if the subsidiary acquires substantially all of the target's assets and the other requirements are met, including that enough of the payment is in the buyer's stock and that no stock of the subsidiary itself is used.
What is the difference between a forward and a reverse triangular merger?
| Forward triangular merger | Reverse triangular merger | |
|---|---|---|
| Who merges into whom | The target merges into the buyer's subsidiary | The buyer's subsidiary merges into the target |
| Who survives | The subsidiary; the target ceases to exist | The target, as a wholly owned subsidiary of the buyer |
| Contracts and licenses | Pass to the subsidiary by merger, but contracts that prohibit assignment or require consent on a merger can be triggered | Stay with the target, which keeps its legal identity, so consents are needed less often |
| Tax-free rule | Section 368(a)(2)(D): the subsidiary must acquire substantially all of the target's assets | Section 368(a)(2)(E): the target's shareholders must give up stock amounting to at least 80% control of the target in exchange for the buyer's voting stock, and afterwards the target must hold substantially all of its own and the subsidiary's assets |
| Flexibility on cash | More: the payment can include more cash, within the continuity-of-interest limits | Less: at least 80% control must be acquired for voting stock |
| Common use | Acquisitions where the buyer wants the business in a fresh entity or needs to pay more cash | Most reverse mergers with a public shell, and many acquisitions |
Both structures keep the target's liabilities inside a subsidiary rather than at the parent, and both need tax counsel to confirm the details for the specific deal. The names describe the direction of the merger, not whether the deal is a "reverse merger" in the going-public sense.
Which one is used in a reverse merger with a public shell?
Almost always the reverse triangular structure. The public shell forms a subsidiary, the subsidiary merges into the private operating company, and the operating company becomes the shell's subsidiary with its contracts, permits and bank accounts intact. Its owners exchange all of their shares for shares of the shell, usually a large majority of it, so the 80% control test, which looks at how much of the target is exchanged for voting stock, is normally met. Compare the route itself with an IPO in reverse merger vs IPO.
What has to be filed after closing?
If the public company was a shell, it must file a Super 8-K within four business days, with the same information a company would provide in a Form 10, including audited financial statements of the operating business.
Is a reverse merger the right route?
Only when speed truly matters. A decent shell typically costs about $300,000, and the all-in cost is often $400,000 to $600,000 plus the equity the shell's shareholders keep. See reverse merger costs.
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