As the credit crunch continues, many buyers may have to pay a fee for not being able to close an acquisition due to a provision called a reverse breakup fee.
What is a “reverse breakup fee?”
A reverse breakup fee is paid to the target company when the buyer backs out of acquiring the target. If the acquirer fails to close the acquisition because it can’t obtain financing, the reverse breakup fee provision is triggered. (Traditionally, acquirers insisted on including “financing out” clauses allowing them to decline to close acquisitions–without penalty–if they couldn’t obtain the necessary financing.)
What’s the reasoning behind reverse breakup fees?
Target companies believed that acquirers should share the risk that the proposed (and public) deal did not go through. These risks for target companies include:
(1) securities class action lawsuits;
(2) disruption of business operations; and
(3) the potential for an unstable set of management/employees.
Therefore, as acquisition targets gained bargaining power relative to their acquirers over the past few years, reverse breakup fees were increasingly inserted into acquisition documents to re-allocate such risks. According to Factset MergerMetrics, 76 percent of all going private deals involving U.S. target companies included a reverse breakup fee provision.
How much are typical reverse breakup fees?
Reverse breakup fees usually range between 1 to 3 percent of the acquisition price. That may seem like a nominal amount, but keep in mind 3 percent can be a massive dollar amount for private equity deals.
Do reverse breakup fees have any place in smaller acquisition deals?
While reverse breakup fees are found in private equity/leveraged buyout deals, they have a place in smaller deals. At a minimum, small targets also risk that a proposed acquisition will disrupt business operations and negatively affect management/employees (2 and 3 above). And one could argue that a smaller target would suffer more on the operations and personnel side compared to a larger company. Additionally, its inclusion could help entice smaller targets to enter into a proposed acquisition. The tradeoff is that increased language in acquisition documents may scare off the buyer or seller.