This article is part of our ongoing series exploring key tax considerations across the biotech lifecycle—from funding through exit.
The need for financing in the biotech industry typically results in a biotech pursuing access to the public markets. One option for IPO is the reverse merger, which can provide a faster route to public-company status while limiting adverse tax effects.
At a high level, a reverse merger involves a private company combining with a publicly traded entity – often a failed legacy biopharmaceutical company – to create a new public vehicle. For biotech companies, that structure can offer quicker access to liquidity as the failed biopharmaceutical is already SEC registered. While the transaction may appear efficient from a capital markets and transaction cost perspective, the tax analysis is not straightforward.
Why Reverse Mergers Attract Attention
One reason reverse mergers remain attractive is that, in some cases, they can be structured to qualify as tax-free reorganizations under section 368. If the requirements are met, shareholders may be able to exchange stock without immediate recognition of gain, preserving value at a stage when capital efficiency matters.
Where Tax Risk Can Emerge
The opportunity, however, is closely tied to the structure of the transaction.
Furthermore, these transactions can also create the illusion that they are tax advantaged due to the failed biopharmaceuticals existing tax attributes. Public companies may carry net operating losses that, if preserved and unlimited, could provide a future tax shield once the combined company begins generating revenue. However, section 382 and more specifically, section 382(c) can limit or entirely disallow the tax benefits due to historical public company churn or in an instance where there is no continuity of business at the failed biopharmaceutical company. In practice, that means a tax attribute that appears valuable on its face may be far more limited than expected if the transaction and the tax law is not fully understood.
Companies also need to consider how the transaction may affect QSBS treatment. While certain tax attributes may survive a reorganization, continued QSBS qualification after a reverse merger depends heavily on the facts and structure of the deal. That question can be especially important for early investors who are counting on long-term capital gains exclusion as part of the return profile.
Why Structure is Only Part of the Equation
Even when a reverse merger offers a viable tax path, it still needs to work operationally and strategically. Ownership dilution, governance structure, public-company readiness, and market perception can all influence whether the transaction creates long-term value. In other words, tax efficiency alone does not make a reverse merger the right answer.
For that reason, the most effective evaluations do not treat tax as a standalone workstream. The structure needs to support the company’s broader capital strategy, leadership objectives, and readiness for life as a public entity.
How We Help
WilliamsMarston advises biotech companies through IPO readiness and transaction structuring, helping leadership teams evaluate whether a reverse merger aligns with their capital strategy and long-term objectives. If you are assessing your pathway to the public markets, we would welcome a conversation to evaluate the tax and structural considerations specific to your business.
