Mergers and acquisitions (M&A) allow companies to increase their market share, reduce competition, expand geopolitical influence, and raise the current market price.
With about 63,000 M&A deals closed in 2021, the acceptance of M&A transactions as an effective way to boost a company’s operations is obvious. Meanwhile, the approaches to conducting M&A deals vary.
This article describes forward and reverse triangular mergers as a noteworthy way of the target company’s acquisition. As you keep reading you will find out the definitions of a forward triangular merger and a reverse triangular merger, the peculiarities of their processes, and their main advantages and disadvantages.
What is a forward triangular merger?
A forward triangular merger, or indirect merger, is when an organization purchases a target company supported by a subsidiary, which is also called a shell company. After closing a deal, the shell company takes in the target company and assumes all the target’s resources and liabilities.
Forward triangular mergers are not the same as forward mergers. In forward mergers, there are only two companies involved in the deal — an acquiring company and a target company. The latter merges into the purchasing company and ceases its existence after the deal. That’s why a forward merger is considered a direct merger.
What is a reverse triangular merger?
A reverse triangular merger differs from a forward triangular merger regarding the surviving company terms. During a reverse triangular merger, a shell company, which is a buyer’s subsidiary, merges into the target company after closing the deal. Therefore, a target firm becomes a wholly owned buyer’s subsidiary.
Note: To learn more about the difference between horizontal and vertical mergers, read our dedicated article.
The forward triangular merger process
Companies are mainly interested in a forward triangular merger when the deal is financed by at least 50% stock. In this case, the target company’s shareholders’ stock is non-taxable. If the deal is financed by more than 50% stock, the bid becomes taxable.
The process of forward triangular mergers begins with the approval of the board of directors of all companies involved. A forward triangular merger happens when a subsidiary of the buyer acquires the target company. After the deal’s completion, the target company is absorbed by the subsidiary and becomes owned solely by the acquiring company.
The reverse triangular merger steps
A reverse triangular merger occurs when an acquirer’s subsidiary disappears into the target company. For such a merger to start, a buyer forms a subsidiary with only one purpose—to purchase a target company by its means.
During reverse triangular merger steps, the target company takes on all the subsidiary’s liabilities, rights, and assets. After the deal’s completion, the subsidiary or shell company ceases to exist, and the target company continues its operation as a wholly owned buyer’s subsidiary.
If the purchaser buys at least 80% of the target company’s stock, the deal is then non-taxable.
Forward triangular merger pros and cons
Among the main advantages and disadvantages of forward triangular mergers are the following.
- Tax benefits
Often, companies choose forward triangular mergers as a way to acquire the target company with the purpose of getting tax benefits. When purchasing a company with a combination of cash and stock, the buyer can offset tax against the voting stock it uses for the acquisition and, thus, save significantly on taxes.
- Protection from liabilities
The forward triangular merger allows the acquirer to use a subsidiary as a “shield” from the target company’s liabilities. This way, the buyer becomes a fully-fledged owner of the target company’s assets, but doesn’t suffer from its liabilities.
- Easy sale
After closing the deal, the target company remains a subsidiary of the buyer, which makes it significantly easier to sell it if there’s such a need. This is much harder to do in direct mergers, as the target company becomes a fully merged entity.
- Straightforward execution
The acquisition is significantly simplified because the acquirer is the only one shareholder of the subsidiary. Since the shareholders’ permission is obligatory to start the deal, it would be much more time-consuming to get permission from numerous shareholders like in a direct merger.
- Lack of business continuity
The target company’s continued existence is impossible, since the target company ceases to exist after the merger. As a result, all the target company’s business contracts and licenses become legally void and have to be rewritten.
Reverse triangular merger pros and cons
Reverse triangular mergers bring the following advantages and disadvantages.
- Target company’s business continuity
Unlike a forward triangular merger, a reverse subsidiary merger allows an acquirer to continue the target company’s business without losing contractual arrangements and licenses. This is also the main advantage of reverse triangular mergers over forward triangular mergers.
- Protection from liabilities
If more than 80% of the buyer’s stock is used to finance the deal, then it’s qualified as tax-free and the acquiring firm meets no tax liability.
- Straighrforward execution
Since the only shareholder of the subsidiary is an acquirer, the process of getting shareholders’ permission to initiate the merger is significantly simplified.
- Possible pitfalls
Though a reverse triangular merger protects an acquirer from the target’s liabilities, it’s still possible that the parent company might face those liabilities with time.
Connection with SPACs
M&A experts and enthusiasts often compare a reverse merger vs. SPAC. This is because a reverse triangular merger underlies most of the SPAC deals.
In a SPAC transaction, a special purpose acquisition company, which is a shell company, is formed to raise capital through the IPO deal to purchase an existing company. To learn more about how a SPAC merger works, explore our dedicated article.
Forward and reverse triangular mergers are indirect mergers where a subsidiary or shell company is created to acquire the target firm.
Unlike direct mergers, indirect mergers of any form allow the acquiring company to get protection from the target company’s liabilities.
The main difference between a forward and reverse triangular merger is the “destiny” of the shell and target companies. In a forward triangular merger, the shell company absorbs the target company and the latter ceases to exist. But during the reverse triangular merger, the shell company “disappears” into the target company, and the latter becomes a fully-fledged subsidiary of the buyer.