Companies acquire, or merge with, other companies for a variety of reasons, namely: to create economies of scale/scope and cost/revenue synergies, to acquire promising technology or other intellectual property or intangibles, to capture more market share, to diversify a business portfolio, or to create tax benefits (such as acquiring net operating losses to carry forward into future years), among other reasons. Merger structure plays in important role in considering a merger for your company. The structure types and advantages/disadvantages are explained below.
Also known as a forward merger, a direct merger involves the target company (the “Target”) merging directly into the acquiring company (the “Buyer”). In this type of merger, the Target ceases to exist post-closing and the two companies become a single entity under the Buyer’s name and structure.
- This is the simplest of the merger structures.
- A merger would be structured as a direct or forward merger typically for tax reasons. A direct or forward merger is usually treated as an asset acquisition (for tax purposes), followed by a liquidation of the Target. In an asset acquisition, the Buyer gets a step-up in basis on the assets of the Target equal to the purchase price, which essentially means that, in addition to the larger depreciation deductions available, any future sale of the Target’s assets would result in a smaller tax liability (taxable gain).
There are a few disadvantages to the direct/forward merger structure:
- This type of transaction may be subject to “double taxation.” First, the transaction is taxed at the corporate level and then again at the shareholder level.
- The Buyer is generally not shielded from the liabilities of the Target.
- Generally, the Buyer must obtain third-party consents to avoid breaching the Target’s contracts that contain anti-assignment provisions.
Forward Triangular Merger
In a forward triangular merger, the Buyer creates a merger subsidiary (or uses an existing subsidiary) to acquire the Target. The Target then merges into the Buyer’s merger subsidiary and the Target ceases to exist as a separate entity.
- This is also treated as an asset acquisition for tax purposes where the Buyer (or the Buyer’s merger subsidiary) receives a step-up in basis on the assets of the Target, resulting in the same tax advantages described in 1a above.
- The Buyer is partially shielded from the liabilities of the Target as they are contained within the merger subsidiary.
- Similar to the direct merger disadvantages described above, this type of merger may be subject to double taxation.
- The Buyer may also need to obtain third-party consents to assume the contracts of the Target.
Reverse Triangle Merger
In a reverse triangular merger, the Buyer creates a merger subsidiary and the merger subsidiary merges with and into the Target. The Target assumes all of the merger subsidiary’s assets and liabilities, the merger subsidiary ceases to exist as a separate entity, and the Target becomes a wholly-owned subsidiary of the Buyer.
- This is treated as a stock acquisition for tax purposes and therefore results in only one level of taxation – at the shareholder level.
- With the reverse triangular structure, there is generally no need to obtain third-party consents to avoid breaching anti-assignment provisions in the Target’s contracts because the Target entity survives (may not be the case, however, in California as the law is unclear on whether this structure effects an assignment by law). Also, if the contracts contain change-of-control provisions, the Buyer may still need third-party consents.
- The Buyer is partially shielded from the liabilities of the Target as they are contained within the Target as a subsidiary of the Buyer.
- Because the Buyer retains the Target entity, brand recognition is preserved.
The Buyer does not receive the step-up in basis on the Target’s assets.
Generally, Buyers prefer forward mergers or forward triangular mergers because they receive a step-up in basis in the Target’s assets. On the contrary, Sellers (or the Target shareholders) generally prefer reverse triangular mergers because the transaction is taxed only once (the transaction is treated purely as the selling stockholders selling their stock in exchange for the merger consideration, a single taxable gain or loss).
The attorneys at Wilson Bradshaw can advise you as to the proper transaction structure for your merger/acquisition. They can also walk you through all the necessary steps of the transaction, including negotiating the merger agreement, performing the proper due diligence, and handling all other aspects of the transaction.
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