Reverse Break up Fees

Financial Penalty

Payment of the agreed sum occurs immediately after the termination of the purchase agreement. When reverse break up fees are large, they act as a powerful deterrent against a buyer walking away from a deal for strategic reasons. The fee is designed to cover the transaction costs, including the millions spent on lawyers and bankers, while also providing a premium for the market uncertainty caused by the failed bid.

In some cases, the fee can be as high as seven or eight percent of the deal price. The impact on the buyer balance sheet can be severe, leading to a drop in share price and a loss of credibility in the capital markets. For a private equity firm, losing a reverse break up fee often means a direct hit to the limited partners capital, making future fundraising more difficult.

Termination Event

Defined events in the contract determine exactly which failures will lead to the forfeiture of the funds. Under the regime of reverse break up fees, the seller is not entitled to the money if the seller itself caused the deal to fail through a breach of warranty. Most disputes center on whether the buyer used its best efforts to obtain regulatory clearance.

If the buyer decides that the price of a regulatory remedy is too high, it must weigh that cost against the certain loss of the fee.

Negotiation Advantage

Sellers use the threat of a high fee to force buyers to accept more risk during the early stages of a deal. Because reverse break up fees provide a guaranteed floor for the seller losses, they allow for more aggressive pricing and higher valuations. A buyer who is confident in their ability to close the deal will offer a higher fee to signal their commitment to the seller board of directors.

This is a primary tool for differentiating between competing bids in a contested auction process.