Reverse triangular mergers: strategy, benefits, and challenges

Many studies conclude that between 70% and 90% of mergers and acquisitions fail. It was true for many decades. However, times have changed for the better. Today’s businesses, especially frequent acquirers, report up to 70% merger success rates.

Companies learn from past mistakes, have unprecedented capabilities in data analytics, and use beneficial merger structures, like reverse triangular mergers. This article explores the rationale, benefits, and challenges behind reverse triangular mergers. Keep reading to learn the following:

1. What is a reverse triangular merger?
2. Steps of reverse triangular mergers
3. Examples of real-world reverse mergers
4. Challenges and best practices for reverse triangular mergers

Understanding reverse triangular mergers

A reverse triangular merger occurs when an acquiring company creates a subsidiary that merges with and into the target company.

A reverse triangular merger follows the general M&A timeline. However, the target company becomes the surviving entity and a subsidiary of the acquiring company. Let’s explain the reverse triangular merger process step by step:

1. An acquiring company forms a subsidiary or shell company (merger sub). It’s specifically formed as a merger tool. It often has little to no operations and is easy to merge with and into the target company.
2. The subsidiary acquires the target entity. The purchasing company infuses capital into the subsidiary, which, in turn, purchases the target company’s assets. It’s typically a full asset acquisition. The target’s shareholders receive voting stock in the merger sub in the exchange for the target company’s stock.
3. The target company becomes a subsidiary of the acquiring company. The merger subsidiary company gets absorbed by the target company. The acquired target company resumes its operations as the subsidiary of the acquiring firm and maintains ongoing regulatory compliance.

Strategic rationale and benefits of reverse triangular mergers

Reverse subsidiary merger has several benefits:

1. Easy approval. A merger sub doesn’t technically need shareholder approval to acquire targets as the true acquirer is its only shareholder. 
2. Business continuity. This merger structure doesn’t affect the target’s business assets and operations. A target company’s business retains independence and existing business contracts and licenses. 
3. Strategic flexibility. A reverse triangular merger doesn’t require an acquiring entity to make a target company its operating unit. An acquirer can maintain a comfortable integration pace and respond to market dynamics more strategically without disrupting the target’s operations. This merger structure also enables partial business consolidation.
4. Potential tax benefits. Companies can reduce tax load in various scenarios. An acquirer assumes the target company’s tax attributes. Also, deal parties may lower built-in taxes or capital gains taxes for the target company’s shareholders based on how they form deal cost structures (shares, cash, equity).
5. Space for M&A tactics. Reverse mergers protect acquiring companies from seller liabilities. Such transactions also open possibilities for more complex deal structures, such as two-step mergers, to address various deal issues.

3 examples of reverse triangular mergers

Let’s explore how a triangular reverse merger works in real-world deals:

1. Google and DoubleClick
2. Dell and EMC
3. Salesforce and Slack

Google and DoubleClick

Google acquired DoubleClick, an advertising software company, for $3.1 billion in April 2007. Let’s explore this acquisition in detail.

Acquisition rationale

Google aimed to improve its online advertising technology and market presence. DoubleClick was among the strongest market players, offering advertising on The Wall Street Journal, Nasdaq, America Online, and other high-traffic websites.

Parties involved

The merger agreement was between the following parties: 1. Buyer: Google Inc. (Now it’s Google LLC, a subsidiary of Alphabet Inc.) 2. Merger Sub: Whopper Acquisition Corp., a wholly-owned subsidiary of Google Inc. 3. Target: Click Holding Corp., the parent company of DoubleClick Inc.

Merger details

Whopper Acquisition Corp. merged into Click Holding Corp. and ceased to exist. Click Holding Corp. became the surviving entity and a wholly-owned subsidiary of Google Inc. Thus, the target company remains independent. There are a few more provisions from the merger agreement: – Bylaws. Click Holding Corp. inherited the bylaws of Whopper Acquisition Corp. – Board. The board directors of Whopper Acquisition Corp. replaced the directors of Click Holding Corp. – C-suite. The officers of Click Holding Corp. remained on duty. – Shares. Google Inc. acquired 100% of Click Holding Corp.’s shares (which held 100% shares of DoubleClick) through Whopper Acquisition Corp.

Benefits

– Less extensive shareholder impact. Google didn’t need approval for the target stock purchase from its shareholders, as it didn’t undergo structural changes. Only the acquired company needed to obtain shareholder approval. – Operational continuity. DoubleClick retained existing contracts and operations. The target company’s continued existence allowed Google to avoid service disruptions during integration.

Dell and EMC

In 2016, Dell Inc., a tech giant, acquired EMC Corporation, a software, storage systems, and network supplier, for $67 billion. Let’s see how this reverse triangular merger example worked.

Acquisition rationale

Dell aimed to complement its computer offerings with software, networking solutions, data analytics, and data storage systems of EMC Corporation.

Parties involved

The merger agreement was between the following parties: 1. Buyer: Denali Holding Inc., an acquiring parent company (rebranded as Dell Technologies in 2016). 2. Merger Sub: Universal Acquisition Co., a wholly-owned subsidiary of Denali Holding Inc. 3. Target: EMC Corporation.

Merger details

Universal Acquisition Co. merged into EMC Corporation and ceased to exist. EMC Corporation became the surviving entity and the subsidiary of Denali Holding Inc. and a sister company of Dell Inc. Here are a few more details from the merger agreement: – Bylaws. EMC Corporation’s bylaws were amended to reflect the merger. – Board. Directors of Universal Acquisition Co. became the directors of EMC Corporation. – C-suite. Executives of EMC Corporation remained unchanged. – Shares. Denali Holding Inc. acquired 100% of EMC Corporation’s shares through Universal Acquisition Co.

Benefits

– Strategic flexibility. Dell could integrate or sell parts of EMC without a complex corporate restructuring. Thus, Dell later sold 81% of equity ownership in VMware, a wholly-owned EMC subsidiary. – Smooth integration. Dell integrated core technologies, customer bases, and applications of EMC at a comfortable pace and maintained operational efficiency. It also chose to leave some business functions of EMC independent.

Salesforce and Slack

Sometimes, reverse triangular mergers evolve into “double-dummy” ones. This deal structure retains the principle of a reverse triangular merger. The difference is that it has two merger subs and provides more tactical options.

Salesforce’s acquisition of Slack in December 2020 ($27.7 billion) represents a “double-dummy” two-step merger. Let’s take a closer look at this deal.

Acquisition rationale

Salesforce acquired Slack’s remote messaging technology to strengthen its position in the sales market and benefit from the surge in remote jobs during the COVID-19 pandemic.

Parties involved

1. Buyer: Salesforce.com inc. 2. Merger Sub1: Skyline Strategies I Inc. 3. Merger Sub2: Skyline Strategies II LLC. 4. Target: Slack Technologies Inc.

Merger details

Salesforce and Slack described a clever plan in the merger agreement: – The first merger. Skyline Strategies I Inc. (Merger Sub1) merges with and into Slack Technologies. Slack becomes the surviving corporation. – The second merger. If Slack doesn’t execute a supplemental indenture to the Convertible Notes Indenture, the second merger will occur in two variations, described as the alternative transaction structure: ➟ Slack merges with and into Skyline Strategies LLC (Merger Sub2) and ceases to exist. Skyline Strategies LLC becomes the surviving LLC and subsidiary of Salesforce. It is a forward triangular merger. ➟ Slack merges directly with and into Salesforce and becomes its operating unit.

Benefits

– Business continuity. The merger would have been reverse triangular If Slack had delivered a supplemental indenture. The two parties would have enjoyed better business continuity and smoother integration. – Tax benefits. The second merger into the merger sub2 would provide significant tax benefits to Salesforce, Slack, and their shareholders. This merger would be a tax-free reorganization under the Internal Revenue Code Section 368, deferring capital gain taxes for Slack’s shareholders. – Space for tactical maneuvers. The second direct merger into Salesforce was a plan to eliminate post-deal complications from Slack’s inability to amend the Convertible Notes Indenture.

Outcome

Salesforce and Slack opted for the direct merger into Salesforce. Slack became an operational unit of Salesforce.

2 primary challenges and risks of reverse triangular mergers

Reverse triangular mergers imply several challenges:

1. High complexity
2. Regulatory constraints

High complexity

Reverse triangular mergers have more structural intricacies, and additional risks must be considered during due diligence. Based on our experience, there are the risks associated with the high complexity of reverse mergers:

• Regulatory scrutiny. It may require additional filings associated with shell companies, such as the SEC Form S-4. The SEC may initiate investigations if it finds any suspicious statements.
• Liability concerns. While reverse mergers offer limited liability protection, an acquiring company may still assume the target company’s liabilities (Salesforce and Slack example). These concerns may require additional diligence and preparation.
• Higher costs. M&A transaction costs are typically between 1% and 4% of the deal value. Reverse mergers may be in the higher percentile range. Such acquisitions require more accounting and advisory costs.

Regulatory constraints

A reverse triangular merger involves several regulatory compliance obstacles:

• A track record. Merger subs formed by public companies may need to show good standing and have a clean track record. It’s also necessary for the seller-initiated due diligence as it assumes the merger sub’s liabilities.
• Regulatory filings. Merger subs may also prepare filings according to federal, state, and local regulations.

3 best practices for managing a reverse triangular merger

Businesses adopt the following practices to make reverse triangular mergers as simple and efficient as possible:

1. Conduct integrated due diligence.
2. Avoid multiple advisors.
3. Use M&A technology to fuel mergers.

Conduct integrated due diligence

Many successful acquirers use integrated due diligence to investigate interdependencies between functional areas and capture a broader picture of the deal. In a reverse acquisition strategy, it’s advisable to emphasize the following aspects as part of integrated due diligence.

Avoid multiple advisors

Harvard Business Review estimates that M&A participants spend nearly $40 billion on M&A advisors each year. Many companies hire multiple advisors, especially during IPOs — up to 16 investment banks per deal valued over $1 billion.

While that may be beneficial for IPOs, HBR research on 10,000 mergers and acquisitions shows that one advisor per M&A deal is much better. Here is why:

• Conflicting opinions. Contradictory advice from multiple advisors drags decision-making. 
• Data leaks. Backchanneling leads to sensitive data leaks that destroy deals unless dedicated M&A software solutions are involved.
• Bad compromise. Middle-ground solutions tend to be less effective.

Use M&A technology to fuel mergers

Dedicated M&A solutions can unlock over $70 million in deal value for buyers and sellers due to time savings, more efficient deal coordination, and enhanced security. For instance, M&A technology accelerates contract review speed by 20%. 

Our observations show that a virtual data room for M&A is especially effective for complex deal structures like reverse triangular mergers:

• Fast due diligence. Built-in file redaction, automatic file conversions, smart document labels, auto-indexing, and full-text search simplify due diligence reviews.
• Effective team coordination. User roles and M&A workflows align teams on deal objectives and merger agreements.
• Clear communications. Customizable Q&A workflows with auto-forwarding and user activity notifications create clear reporting lines adaptable to various M&A goals.
• High deal security. VDR-contained communications, role-based permissions, and system-wide encryption prevent data leakage.

The bottom line

• The target company survives and retains business continuity in a reverse triangular merger. This deal structure makes less rushed and disruptive integrations than direct mergers.
• Such mergers are more structurally complex and involve higher advisory and accounting costs.
• It’s advisable to use virtual data rooms, hire fewer advisors, and emphasize integrated due diligence for the best results in reverse triangular mergers.

Category

Mergers and acquisitions