What is a Subsidiary Merger?
A subsidiary merger is a type of merger that occurs when the acquiring company uses its subsidiary company to acquire a target company. The acquirer may create a subsidiary company or use one of its existing subsidiary companies to execute the merger and acquisition transaction. In a subsidiary merger, the acquired company is merged with the subsidiary of the acquirer rather than merging directly with the acquiring company in a regular M&A deal.
Following the deal, the target company then becomes a wholly owned subsidiary of the acquiring company, with the buyer as the sole shareholder. It means that the acquirer exerts total control over the entity, potentially gaining control also of the latter’s non-transferrable assets and contracts. The main purpose of a subsidiary merger is to protect the buyer from the liabilities of the target company.
Types of Subsidiary Merger
The following are the two main types of subsidiary mergers:
1. Forward Triangular Merger
A forward triangular merger is an indirect merger where a subsidiary of the purchasing company completes the acquisition on behalf of its parent company. The subsidiary company acquires all the assets and liabilities of the target company. The acquired company then becomes a fully owned subsidiary of the purchasing entity. After the acquisition, the target company liquidates, and the buyer becomes the sole shareholder of the combined entity.
Pros and Cons of a Forward Triangular Merger
One of the reasons why buyers prefer a forward triangular merger is that it gives them more flexibility in terms of purchasing the stock of the target company. Buyers can use a combination of both cash and stock. Half of the consideration used to pay the target company’s shareholders must be at least 50% stock of the acquirer. If the consideration for the transaction was 100% cash, it would make the transaction taxable.
On the downside, forward triangular mergers are less preferred than reverse triangular mergers due to access to the target company’s licenses and authorizations. The properties will need to be reassessed, and some third parties may withhold consent to the target company’s contracts, licenses, and authorizations. The acquiring entity may incur additional costs in order to be granted consent to the rights of the licenses and assignment of contracts.
2. Reverse Triangular Merger
A reverse triangular merger shares a lot of similarities with a forward triangular merger; however, they differ in the party that is liquidated. In a forward triangular merger, the target company is liquidated, whereas, in a reverse triangular merger, the subsidiary created by the purchasing entity is liquidated.
A reverse triangular subsidiary merger occurs when an acquiring entity uses its subsidiary to acquire another company. After the acquisition, the subsidiary is absorbed into the acquired company, and the buyer becomes the only shareholder. The acquired company becomes a wholly owned subsidiary of the acquiring entity, and the buyer acquires all the assets and liabilities of the acquired company.
Pros and Cons of Reverse Triangular Merger
A reverse triangular merger retains the selling entity and liquidates the shell company created for the purpose of executing the acquisition. The acquired entity continues its regular operations as a subsidiary of the buyer, and the acquiring entity will not need to sign new contracts, licenses, and authorizations. It makes the reverse triangular merger more preferred compared to the forward triangular merger.
For the merger transaction to be tax-free, the acquiring entity must use its stock to acquire 80% of the target company’s stock. Cash and other non-stock consideration must not exceed 20% of the total consideration paid if the buyer wants to enjoy a tax-free acquisition transaction. The transaction will be taxed if it does not meet the rule, but the acquirer must use its stock as at least 50% of the consideration paid for the transaction.
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