A reverse termination fee is also known as a reverse breakup fee. It refers to the amount of money paid to the target company after the acquirer backs out of the deal or the transaction fails to complete. Usually, the reverse termination fee is included in the acquisition agreement, and it can be triggered when the acquirer is unable to obtain the required financing to close the transaction. The purpose of the reverse termination fee is to compensate the target for its time and effort in facilitating the transaction.
Reverse termination fee vs. termination fee
A reverse termination fee is the opposite of a termination fee, which is the fee paid by the target entity to the acquirer if the transaction fails to sail through. The latter compensates the acquirer for the effort, time, and costs incurred to close the deal.
On the other hand, an acquirer has to pay a reverse termination fee to the target when the transaction fails to go through due to the acquirer’s shortcomings. Both types of fees compensate either party for their contribution toward facilitating the transaction.
Reasons for a reverse termination fee
Most target companies give preference to merger or acquisition bids that provide a reverse termination fee. Target companies believe that the acquiring entity should share in the risks that they face when the proposed deal fails to get finalized. Some of these risks include:
Securities class action
Since most merger and acquisition deals are usually made public, the target company’s security prices may fluctuate as investors become uncertain about the effects of the deal. Security class actions are lawsuits that may be filed by the company’s investors who suffered a loss due to violations of the securities laws. Such violations may include the fraudulent reporting of the company’s financial data.
The lawsuits allow individual investors who have been affected by misrepresentation to file a single legal action rather than individual lawsuits. If the court is satisfied that the investors suffered economic injury due to fraudulent reporting of the company’s data, it may award settlements worth millions of dollars.
After an M&A deal fails to go through, the target company may experience disruptions to its business operations due to their initial expectations not being realized. Also, the failure to obtain financing from the acquirer may cripple certain departments of the target company that expected to benefit from the deal. The effect of the business disruption is a decline in revenues and profits, and the target will want to be compensated for such expected losses using the reverse termination fee.
Potential exit of executives
The failure of a proposed public deal to go through may bring about instability and the possible exit of key executives and employees. It may be due to disagreements among the management team who had high expectations of growing the business with the support of a more financially-stable acquirer.
Causative events for a reverse termination fee
The main reason for the termination of a purchase agreement between a target and an acquirer is when the latter fails to obtain financing for the transaction by a specific date. The termination provision of the purchase agreement should specify the party that will terminate the agreement under various circumstances.
The acquirer will not want the target company to have the right to terminate the purchase agreement under several circumstances. These circumstances include:
The target entity led to the financing failure. The target entity may hinder the provision of capital to finance the transaction when they fail to cooperate with the buyer’s effort to access financing from the lending institution.
The target did not meet all the conditions that are outlined in the purchase agreement in favor of the acquirer.
Similarly, the target will object to the acquirer’s intentions to terminate the transaction under several circumstances. These circumstances include:
The acquirer willfully causes the financing failure and does not use all available avenues to force the lender to honor the lending agreement.
The acquirer did not seek other alternative channels of obtaining finance after the failure of the first financing option.
Amount of the reverse termination fee
The size of the amount payable as a reverse termination fee depends on the size of the entire deal value that the two parties initially agreed upon. The fee typically ranges between 1% to 3% of the deal value, and the figure may vary from one deal to another. While the fee may appear negligible, the apparently small percentage may yield millions of dollars in settlements when the deal value stretches into billions of dollars. The target and the acquirer should agree on the size of the reverse termination fee from the onset of the purchase agreement.
The target company may use the amount of the reverse termination fee to determine the possibility of the deal going through and risks associated with the deal. For example, when the acquirer agrees to a high percentage of a reverse termination fee, it indicates that the acquirer is serious about seeing the deal through to its final stages. On the contrary, a lower percentage indicates that there is a high probability that the deal with not go through, and the acquirer wants to save money in case of a failed transaction.
Real-life example of a reverse termination fee
In February 2018, semiconductor company Broadcom Inc. offered an $8 billion reverse breakup fee to telecoms equipment manufacturer Qualcomm if the acquisition failed to win regulatory approval. Broadcom gave up on the offer after Qualcomm’s board of directors rejected its initial $82 per share takeover bid on the basis that the offer undervalued the company.
The $8 billion breakup free represented about 6.6% of the total deal value, which amounted to $121 billion in equity value. Such a high percentage indicated that Broadcom was committed to completing the acquisition of Qualcomm’s entire business.
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