When it comes to the wild world of corporate mergers and acquisitions, understanding the different merger options available to companies is crucial to building a successful business strategy. So what is the difference between a forward merger, a forward triangular merger, and a reverse triangular merger? Learn about the steps, benefits, and limitations of each in this article.
What Is a Forward Merger?
A forward merger, also known as a direct merger, is a deal where the buyer, or the parent company, directly merges with the target company. The target company no longer exists and the two companies act as a single entity under the buyer’s name and structure. The buyer assumes all of the target’s assets and liabilities, including contracts, licenses etc.
The main reason to implement a forward merger is that it allows the two companies in question to easily integrate both during and after the merger, and it maintains the acquiring company’s business continuity.
The downside of a forward merger is that the buyer or parent company takes on all of the target company’s liabilities. Forward mergers may also require shareholder approval or a vote from the shareholders to approve the purchase, which can drag out the process.
What Is a Forward Triangular Merger?
A forward triangular merger, also known as an indirect merger, happens when the acquiring company absorbs the target company via a subsidiary entity or a shell company. This shell company assumes all the target assets and liabilities.
Forward triangular mergers are generally less common than reverse triangular mergers — the reason they are less favorable is that the target company’s licenses and contracts can be held by third parties’ consent. For a forward triangular merger to be legal, the purpose of the business must be maintained by the acquiring company.
Steps for a Forward Triangular Merger
The benefit of this type of merger is that it protects the acquiring company from absorbing the target company’s liabilities (unlike a forward, or direct, merger). The reason that a company would want to do this is because when these mergers are financed by at least 50% stock, the target shareholders’ stock will be non-taxable. If these were financed by more than 50% cash, the bid would be taxable.
Dealing with reverse triangular merger tax is where things start to get a little complex. Unlike the relatively straight line that a forward merger takes, there are additional steps involved in a forward triangular merger. Whether it’s a taxable transaction or not, the ratio of cash and stock involved in the deal also must follow a series of regulations, including Section 368, one of the federal tax codes.
Pros and Cons of a Forward Triangular Merger
The most common benefit of the forward triangular merger is the protection it gives to the acquiring company, limiting the possible negative impacts of its involvement with the liabilities of the target company. It also allows the buyer much more leeway in the terms of the purchase of the target company, as up to 50% of the purchase price can be in either cash or other non-stock options. This can be a tax benefit, depending on other factors.
But on the downside, a forward triangular merger can cause a major disruption in the business continuity of the target firm, and all of its non-tangible assets (contracts, licenses, etc.) will have to be closely scrutinized and reassessed.
What Is a Reverse Triangular Merger?
In a reverse triangular merger, a new company is founded by the acquiring company to create a subsidiary. That subsidiary purchases the target company and absorbs it. The difference between forward and reverse triangular mergers is that in the case of the reverse triangular merger, the subsidiary has only one shareholder (the acquiring company), and the acquiring company may get control of the target’s assets and contracts — something that isn’t always the case in a forward triangular merger.
The reason you would want a reverse triangular merger is when the target company’s continued existence is needed for things such as franchising, leasing or contracts, or specific licenses that may be held and owned solely by the target. Since the buyer must meet the continuity of business enterprise rule (a taxation principle applicable to corporate mergers and acquisitions in which, to qualify as a tax-deferred reorganization, the buyer must either continue the target company’s business or use its business assets when conducting business) the acquirer must follow those guidelines.
Steps for a Reverse Triangular Merger
Unlike a forward triangular merger, in a reverse triangular merger, there is an additional step preceding the deal. This makes this type of reverse merger it far more complex than a standard forward merger. In this case, a new company is formed, which is a subsidiary of the acquiring company, and the newly created company is the legal buyer of the target company.
A reverse triangular merger can be taxable or nontaxable, depending on the structure of the acquisition. If at least 80% of the stock of the target company is acquired by the buyer, it may be considered nontaxable. In a reverse triangular merger, at least 50% of the payment is the stock of the purchasing company and that company gains all the assets (and liabilities as well) of the target company — differentiating it from a forward triangular merger.
Pros and Cons of a Reverse Triangular Merger
The benefits of reverse triangular mergers are numerous. They include…
- The ability to expedite the transaction, as the newly created company used to absorb the target company doesn’t have to deal with the issue of shareholder approval or convincing the majority of shareholders to agree to the deal.
- The ability of the acquiring company to continue contractual obligations enacted by the target company, ensuring business continuity for the target company.
- The creation of a “firewall,” shields the acquiring company from any liabilities that the target company might have outstanding, either present or future.
The cons of reverse triangular mergers include any potential legal or financial liabilities that may be lurking in the shadows of the target company, something that the newly formed company will have to contend with sooner or later. In addition, the tax regulations involved in acquiring a company via a reverse triangular merger can get extremely complex very quickly, which requires more scrutinization of the numbers and additional audits to confirm all the tax laws are being followed to the letter.
How Does A Virtual Data Room Help In These Mergers and Acquisitions?
Mergers and acquisitions happen every day, but it’s only been in the last few years that these forward mergers and reverse triangular mergers can take place with all the technological sophistication of a virtual data room.
In the past, all of the actions taken before a merger and acquisition would require travel on both sides — the buyer and the target company — and there would be a physical, brick-and-mortar data room in which all of the financial documents relevant to the operation of the businesses were contained. Strict supervision and security would be necessary and maintained to make sure that the right people had access to the right things at the right times. It was a time-consuming and expensive process that had many drawbacks.
Virtual data rooms allow for the right people to look at the right things at the right time — all from the comfort of their office, even if they’re on other sides of the world. The data is controlled, secure, tracked, and time-stamped so that there is never a question as to who saw what and when. Everything can be done electronically and there is much less expense and hassle involved. It literally makes the data room as intuitive and accessible as your smartphone or tablet, from anywhere in the world.
This article was originally published in April 2020, and updated in November 2020 with information surrounding new best practices.