What is a Breakup Fee?
A Breakup Fee, also referred to as a termination fee, is a penalty that is paid in mergers and acquisitions transactions if the seller backs out of the deal. The fee serves to compensate the purchaser for the time and resources spent in negotiating the deal. Buyers ask for a breakup fee if the seller is given an option to receive other bids from other potential buyers. Some buyers use the breakup fee to limit the number of competing bids, since new bids must cover the cost of the breakup in the final transaction. The average breakup fee ranges from 1% to 3% of the deal’s total value.
How the Breakup Fee Provision is Used
A breakup fee provision is included in the letter of intent or preliminary agreements in an M&A deal. They are common in public takeovers, especially once the shareholders of a company get the final word on whether a transaction will go to the final phase or not. Since the company’s board owes a duty of care to shareholders, their aim is to get the best possible deal even if it means supporting a higher bid other than the one they already received. Therefore, the breakup fee seeks to protect buyers for the time, resources, and expenses that they have incurred in pursuing the transaction. Breakup fees are, however, not common in mid-market transactions for privately-held businesses since a breakup provision would deter potential buyers from bidding in a controlled auction.
Due to the growing competition in public M&A deals where the transactions are made public, more purchasers require a breakup fee to protect themselves. The breakup fee provision is added to the letter of intent during the early stages of the bidding process. The fee helps buyers cover any of the expenses incurred during planning, negotiating, and investigating the deal. Both parties to an M&A deal must agree on the events that can trigger a breakup fee.
Events that Trigger a Breakup Fee
Some of the events that may trigger the breakup fee provision include the following:
- Company’s board of directors changes their mind.
- Shareholders fail to approve the deal.
- The seller chooses a competing bidder.
- Seller opts to open the deal to the public rather than just negotiating with the buyer named in the preliminary agreement.
- A previously undisclosed defect is discovered in the target company.
Sample Breakup Fee Clauses
A breakup clause included in the letter of intent or preliminary agreement may take the following forms:
A no-shop clause protects the buyer after the buyer and the seller have signed a contract for the purchase of the business. It hinders the seller from soliciting additional bids from third parties while they are negotiating a deal with the original bidder. However, a no-shop clause with a public company faces the risk of being overruled by shareholders since the latter reserve the right to vote on the final decision. Also, if there are unsolicited bids that are higher than the current bid, the seller may decide to choose the higher bid.
A fiduciary clause is inserted by the seller into the letter of intent and it protects the seller from paying the breakup fee if they do something that has been specified in the agreement. Buyers should check for the presence of such a clause in the agreement since it would limit how they engage with the seller.
Reverse breakup fee
While buyers protect themselves from an M&A deal with a breakup fee, sellers protect themselves with a reverse termination fee. A reverse termination fee refers to a payment made by the buyer to the seller if the transaction is not completed due to the actions of the buyer. Sellers use this fee to make sure that they transact with buyers who are committed to the negotiations. A reverse breakup fee may be triggered by the following:
- The inability of the buyer to secure financing for the transaction.
- Failure to get buyer shareholder approval.
- Failure to complete the transaction by a certain date.
- Opposition from regulatory bodies.
Notable Examples of Breakup Fees
In the recent past, there were a few instances where mergers or acquisitions failed to work out and the target companies were required to pay a breakup or a reverse termination fee. Examples of the failed deals include:
AT&T’s failed purchase of T-Mobile USA
In 2011, the planned merger between AT&T and T-Mobile USA was opposed by the US Department of Justice and the US telecommunications regulator. Since the two parties initially agreed to a breakup fee provision, Deutsche Telkom received a breakup fee from AT&T. The fee included $3 billion in cash payments, $1 billion to $3 billion in wireless spectrum and a long-term agreement to allow UMTS roaming within the US for T-Mobile USA.
Microsoft’s acquisition of LinkedIn
During the negotiations for the acquisition of LinkedIn by Microsoft in 2016, the two parties agreed to a no-shop provision with a breakup fee of $725 million if LinkedIn solicited a third-party buyer during the negotiations. LinkedIn received an unsolicited bid from Salesforce, Microsoft’s biggest competitor. Microsoft was forced to raise its bid since LinkedIn did not solicit for bids but received an open offer from a third party. If LinkedIn had solicited and accepted the offer from Salesforce, it would’ve paid Microsoft $725 million as a termination fee.
Failed merger of Staples and Office Depot
In early 2015, office supplies retailers Staples and Office Depot announced their $6.3-billion merger agreement. The merger was, however, opposed by the Federal Trade Commission (FTC). The opposition was reinforced by the U.S. District Court for the District of Columbia ruling that granted the FTC’s preliminary injunction that blocked the merger. As a result, Staples was required to pay Office Depot a $250 million breakup fee.
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