Costcutter, the largest independent food retailer in the UK and Ireland, is planning to merge with supplier and fellow shop group Nisa-Today's.
The two hope the tie-up will boost their competitive edge
The two hope the tie-up will enable them to rival the purchasing power and distribution clout of big supermarket rivals as well as lead to cost cuts.
The plan, which will lead to a new company being formed, must be approved by a shareholder vote set for July.
Icelandic bank Kaupthing is thought to be behind the deal.
Kaupthing is best known as one of the major backers of Icelandic investment firm Baugur, which owns a range of UK High Street names including frozen food chain Iceland, toy store Hamleys and the Oasis fashion shops.
The bank is thought to have become a shareholder in Costcutter following a recent refinancing.
Reports claimed the two companies have been discussing a tie-up for the past nine months.
Smaller retailers have suffered in recent years amid increasing competition from supermarket giants.
The UK's big four - Tesco, Sainsbury's, Asda and Morrisons - now control almost 75% of the UK grocery market, a development which has prompted the Office of Fair Trading to investigate their dominance of the sector.
Founded in 1986, Costcutter has a franchise operation of 1,200 UK stores, 65 stores in the Republic of Ireland and a further 52 in Poland.
The York-based group is also a member of the Nisa-Today's buying group.
Nisa-Today's, which is based in Scunthorpe, operates like a co-operative, using the collective buying power of the group of members to negotiate deals with suppliers.
It has almost 1,000 retail members running 5,000 shops and more than 300 wholesale members running 350 depots.
It has 960 retail members who have 5,000 stores while its 330 wholesale members run some 350 depots.