Reverse Merger

A reverse merger (sometimes called a "reverse triangular merger" in its most common form) is a merger structure in which the target entity survives the merger and the acquirer's subsidiary is the disappearing entity. The end result resembles a stock purchase: the target's equity is exchanged for the buyer's consideration and the target becomes a wholly-owned subsidiary of the buyer, but the merger structure provides specific tax, contractual, and regulatory advantages.

Reverse triangular merger structure

The buyer forms a wholly-owned merger subsidiary ("MergerCo"). MergerCo merges with and into the target, with the target as the surviving entity. The target's shareholders receive the merger consideration; their target shares are cancelled; MergerCo's shares (held by the buyer) are converted into the target's surviving equity. The result: target is now a wholly-owned subsidiary of the buyer.

Why use the structure

Continuity of contracts. The target survives and keeps its own contracts, so a clause that restricts only assignment may not be triggered (depending on contract language and governing law). A clause triggered by a change of control or by a merger of the target usually still applies.

Tax treatment. A reverse triangular merger can qualify as a reorganization under IRC § 368(a)(1)(A) and § 368(a)(2)(E) if, among other requirements, target shareholders exchange stock constituting control (80 percent, § 368(c)) for buyer voting stock and the target afterward holds substantially all of its and MergerCo's properties. A merger paid solely in buyer voting stock may instead qualify under § 368(a)(1)(B). In a qualifying reorganization, target shareholders recognize no gain on buyer stock received but recognize gain up to the cash and other property received (§§ 354(a)(1), 356(a)(1)).

Regulatory and licensing. Where a license or permit cannot be assigned, a reverse merger leaves it with the same entity. Many licenses still require notice or approval on a change of ownership or control, so the structure does not avoid those terms.

Forward merger distinguished

A "forward triangular merger" uses the same triangular structure but has the target merge into MergerCo (so MergerCo survives, target disappears). Tax and contract considerations differ. A forward triangular merger is tested under IRC § 368(a)(2)(D), and the target's contracts pass to MergerCo. Texas law vests the target's property in the survivor without any transfer or assignment having occurred (§ 10.008(a)(2)), but a contract that restricts assignment by operation of law or by merger may still be triggered, depending on its language and governing law.

Companion article: Selling Your Business in Texas