Reverse Triangular Merger

A reverse triangular merger is an acquisition structure where the buyer creates a new subsidiary, called a merger sub, and that subsidiary merges into the target company. After the deal closes, the merger sub disappears and the target company survives as a wholly owned subsidiary of the acquirer. The target's legal identity remains intact, its contracts stay in place, and the acquirer gains full ownership without dismantling the business it just purchased.

Think of it like buying a company and sliding a holding company above it, while the original business keeps running under its own name below.

How the Structure Is Built

The process follows a specific sequence. First, the acquiring company incorporates a new shell subsidiary, usually called Merger Sub or Acquisition Corp. Second, the target company's shareholders vote to approve the merger. Third, Merger Sub merges into the target, and in exchange for their shares, the target's shareholders receive cash, stock in the acquirer, or a combination of both. Fourth, Merger Sub ceases to exist. The target company continues operating as the acquirer's wholly owned subsidiary.

One practical advantage of this structure is that only the target's shareholders typically need to approve the deal. Because the acquirer owns 100 percent of Merger Sub, it can approve Merger Sub's side of the transaction through a simple board resolution without a shareholder vote. This matters when the acquiring company has a large, dispersed shareholder base that would slow down the deal.

Why Acquirers Choose This Structure

The reverse triangular merger is one of the most common acquisition structures in U.S. corporate law. Its advantages flow from a single feature: the target company survives. When Amazon acquired One Medical in 2023 for $3.9 billion, it used a reverse triangular merger so that One Medical could continue operating as a separate subsidiary without disrupting its patient relationships, contracts, and clinical operations.

Several factors make this structure attractive:

• Contract continuity: The target retains its contracts, licenses, and permits because no transfer occurred. Change of control clauses can still trigger consent requirements, but the risk is lower than in a direct asset purchase.
• Limited liability: The acquirer holds the target as a subsidiary. The acquirer's assets are not directly exposed to the target's pre-closing liabilities.
• Brand and regulatory preservation: Industries like pharmaceuticals, healthcare, and defense often hold licenses tied to the entity's legal identity. A reverse triangular merger keeps those licenses in place without requiring reapplication.
• Minority shareholder management: The structure allows the acquirer to squeeze out minority holders through a statutory merger process more efficiently than a straight stock purchase.

Tax Treatment Under Section 368

The tax implications of a reverse triangular merger depend on how the deal is financed. Under Section 368(a) of the Internal Revenue Code, a reverse triangular merger can qualify as a tax-free reorganization if two tests are satisfied.

The continuity of interest test requires that at least 80 percent of the total consideration paid to target shareholders consists of acquirer stock, not cash. The continuity of business enterprise test requires the surviving entity to continue operating a significant part of the target's business after closing.

If both tests are met, target shareholders do not recognize taxable gain at the time of the merger. They receive acquirer stock and defer any gain until they eventually sell those shares. If the deal is primarily cash, the merger is taxable, and shareholders recognize gain immediately.

Reverse Triangular vs. Forward Triangular Merger

The table shows that the key difference comes down to which entity survives. If you want to preserve the target's identity and operations, the reverse triangular merger is the right choice. If full integration is the goal and the target's standalone identity is not valuable, a forward triangular merger may be simpler.

Connection to SPAC Transactions

The reverse triangular merger is the dominant structure underlying most Special Purpose Acquisition Company deals. When a SPAC takes a private company public, the SPAC creates a Merger Sub that merges into the private company. The private company survives as the public entity, having effectively acquired the SPAC's public listing. The rise of SPAC transactions in 2020 and 2021 brought the reverse triangular merger structure to mainstream attention.

What to Watch Before Closing

Before relying on the reverse triangular merger to preserve contracts, review the target's key agreements for change of control provisions. These clauses trigger consent requirements based on the change of ownership, not the transfer of an asset. A reverse triangular merger changes who owns the target, even though the target's name and legal entity remain unchanged. In practice, this means some contracts will still require third-party consent despite the structure's design to minimize that burden.

Sources:

• https://ventures.wyrick.com/blog/mechanics-and-advantages-of-reverse-triangular-mergers
• https://dealroom.net/faq/guide-to-forward-and-reverse-triangular-mergers
• https://dealert.ai/blog/p/reverse-triangular-merger-explained-structure-tax-advantages-and-strategic-uses-in-ma/
• https://www.versaillesgroup.com/m-and-a-blog/reverse-triangular-mergers/

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