What is a merger?

Takeaway: A merger is an acquisition structure that involves combining the startup with another entity. Mergers typically only require consent from a majority of the target company’s stockholders to approve the deal.

If you're considering exiting your startup, a merger might be one of the strategies to explore. A merger refers to a transaction where two companies combine to form a single entity. In this context, the selling startup would merge with another company (or a subsidiary of the larger company). The startup’s stockholders receive cash, shares of the surviving entity (or its parent), or a combination of both in return for their shares of the startup. This post will provide an overview of selling a startup through a merger.

Mergers are structured as either direct or indirect. Direct mergers are typically set up as forward mergers in which the startup merges into the buyer. Indirect mergers are usually set up as either forward triangular mergers or reverse triangular mergers and are used by buyers to shield themselves from the startup’s liabilities. In indirect mergers, the buyer will form a subsidiary that merges with the startup so that, after the transaction, the buyer will own the merged subsidiary.

Mergers are similar to stock sales in that the buyer takes on all of the assets, liabilities, contracts, and obligations of the startup. As a result, thorough due diligence is necessary in a merger.

Buyers often prefer mergers because approving a merger under state law often requires only a majority of the startup’s stock. The startup’s corporate documents likely have additional consent requirements (often including a preferred stock vote) and may have a drag-along right that can be used to get additional consent.

Mergers structured as reverse triangular mergers often do not trigger anti-assigment clauses in commercial agreements, which can eliminate the need to seek lots of third-party consents and speed up the process.

From a tax perspective, forward mergers and forward triangular mergers are typically treated the same as asset acquisitions (i.e., generally better for buyer and worse for seller) and reverse triangular mergers and generally treated as stock acquisitions (i.e., generally worse for buyers and better for sellers).

Selling a startup through a merger can be a beneficial exit strategy that presents an opportunity for the startup's stockholders to benefit from the combined entity's future growth. However, it comes with its complexities and challenges, making it crucial to carefully consider whether it's the right path for your startup and to seek professional advice throughout the process.