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- Break-up fee is a contractual provision in M&A that obliges one party to pay.
- It serves to compensate the buyer for invested resources and opportunity costs.
- Typical triggers include the acceptance of a higher offer and rejection by the Management Board.
- The amount is usually set as a percentage of the transaction value, typically 1% to 5%.
- Courts examine the appropriateness of the fee and whether it violates competition law.
- Break-up fees offer both advantages and disadvantages for buyers and sellers.
- Trends show an increasing use and complexity of fee structures in various markets.
A break-up fee, also known as a termination fee, is a contractual provision in mergers and acquisitions (M&A) that requires a party to pay a fixed sum if it terminates the transaction under certain circumstances. Typically, this fee is paid by the seller (target company) to the potential buyer if the transaction does not materialize due to specific reasons defined in the contract.
Main purpose and functions:
1. compensation: Compensates the buyer for time, resources and opportunity costs invested in the transaction.
2. liability: Increases the seller’s liability towards the transaction.
3. deterrence: prevents competing bidders from intervening in ongoing negotiations.
4. price signal: Can serve as an indicator of the value of the company.
Typical triggers for break-up fees:
– Acceptance of a higher offer from another bidder
– Rejection of the transaction by the seller’s board of directors or shareholders
– Material breach of representations and warranties
– Failure to obtain necessary regulatory approvals (in some cases)
Structure and height:
– Usually defined as a percentage of the transaction value
– Typical range: 1% to 5% of the transaction value
– Can be defined as a fixed or graduated amount
– Sometimes linked to specific milestones or points in time in the transaction process
Legal and regulatory aspects:
1. reasonableness: courts examine whether the amount of the fee is reasonable and not excessively dissuasive.
2. fiduciary duties: Must be consistent with the board’s duties to shareholders.
3. competition law: must not act as an unlawful restriction of competition.
4. stock exchange rules: Special rules may apply to listed companies.
Advantages and disadvantages for the buyer:
Advantages:
– Protection against financial losses if the transaction fails
– Increased negotiating security
– Possible deterrence of competing bidders
Disadvantages:
– May be perceived as aggressive and put a strain on negotiations
– May not be sufficient to cover actual costs
– May lead to inflated bids to justify the fee
Advantages and disadvantages for the seller:
Advantages:
– Can signal the seriousness of the buyer
– Possibility to negotiate better conditions
– Can be used as leverage against other bidders
Disadvantages:
– Restriction of flexibility with alternative offers
– Potential financial burden if the transaction does not materialize
– Possible negative perception by shareholders
Negotiation strategies:
1. reciprocity: agreement of mutual break-up fees
2. staggering: adjustment of the amount to different scenarios or points in time
3. limitation: setting an upper limit for the fee
4. exceptions: Definition of specific circumstances under which no fee is due
5. escalation mechanisms: gradual increase of the fee in the course of the process
Industry-specific considerations:
– Technology: Often higher fees due to volatile market conditions and intense competition
– Regulated industries: Special consideration of regulatory approval processes
– Public sector: Possible restrictions or special requirements
Alternatives and related concepts:
– Reverse break-up fee: Fee payable by the buyer to the seller
– Topping fee: Fee for the right to outbid a competing offer
– Lock-up agreements: agreements to secure key assets
– No-shop clauses: Prohibition of active search for alternative offers
Trends and developments:
– Increasing use in different transaction types and markets
– Greater differentiation and complexity of fee structures
– Increased attention from regulatory authorities and shareholder representatives
– Integration into more comprehensive deal protection mechanisms
Conclusion:
Break-up fees are an important instrument in M&A transactions that harbor both opportunities and risks. Their effective use requires careful consideration of the legal, financial and strategic implications. While they can provide protection and incentives, they must be considered in the context of the overall transaction and market conditions. A balanced and well-structured break-up fee can help to align the interests of all parties and stabilize the transaction process.
