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Negotiating Reverse and Forward Triangular Mergers

OVERVIEW

(1) What is a forward/reverse triangular merger?(2) Legal steps to follow(3) Anti-assignment clauses(4) Benefits of triangular mergers(5) Forward vs. reverse

FORWARD TRIANGULAR MERGER

• Target Company Shareholders receive merger consideration consisting of at least 50% Acquiring Company stock

• Target Company merges into Acquisition Subsidiary with Acquisition Subsidiary being the surviving corporation

Acquiring Company Shareholders

Acquiring Company

Acquisition Subsidiary

Target Company Shareholders

Target Company

Acquisition Subsidiary (post-

merger)Merger

Merger Consideration

Acquiring Company Shareholders

Acquiring Company

Before After

REVERSE TRIANGULAR MERGER

• Target Company Shareholders receive merger consideration consisting of at least 80% voting stock of Acquiring Company

• Acquisition Subsidiary merges into Target Company with Target Company being the surviving corporation

Acquiring Company Shareholders

Acquiring Company

Acquisition Subsidiary

Target Company Shareholders

Target Company

Target Company (post-merger)

Merger

Merger Consideration

Acquiring Company Shareholders

Acquiring Company

Before After

LEGAL STEPS

• Form Acquisition Subsidiary– Capitalize Acquisition Subsidiary with merger

consideration• Agreement and plan of merger• Board of Directors approvals– Acquisition Subsidiary– Acquiring Company– Target Company

• Target Company shareholder vote

ANTI-ASSIGNMENT CLAUSES

• Beware “anti-assignment” provisions in Target Company’s contracts– Look for anti-assignment or anti-transfer provisions– Are there any IP license grants to Target Company that will

require consent for transfer?• Consider the state law merger statute

– Generally, forward triangular mergers trigger anti-assignment provisions, but reverse triangular mergers do not

– Exception: Under California law, reverse triangular mergers may trigger anti-assignment clauses

• Review any “change of control” provisions in Target Company’s contracts

WHY ADOPT A TRIANGULAR MERGER?

• Acquiring Company remains separate from Target Company liabilities– However, Acquisition Subsidiary needs to assume

“substantially all” of Target Company’s business and therefore it cannot leave behind the liabilities

• No approval from Acquiring Company shareholders– There is a shareholder vote of Acquisition Subsidiary,

however Acquiring Company is usually the sole shareholder of Acquisition Subsidiary

FORWARD VS. REVERSE

• Forward triangular mergers– More likely to trigger anti-assignment provisions in Target

Company’s contracts– Will need a new Taxpayer Identification Number (TIN) and

therefore new payroll– However, only 50% of the merger consideration needs to be stock

of the Acquiring Company• Stock does not need to be voting stock

• Reverse triangular mergers– Less likely to trigger anti-assignment provisions in Target

Company’s contracts– Retain TIN and continue existing payroll– 80% of the merger consideration needs to be voting stock of the

Acquiring Company

FORWARD VS. REVERSE

• Failure to satisfy the respective stock consideration requirements results in a “busted” merger– Reverse triangular mergers are riskier due to the 80% voting stock

requirement• Busted forward triangular merger = reclassification as an

asset sale followed by a liquidation – Two levels of tax

• Busted reverse triangular merger = reclassification as a stock sale– One level of tax

• Therefore the forward triangular merger is the safest option, but with the highest penalty (two levels of tax vs. one level of tax) should the merger fail

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