What Is a Breakup Fee?

A breakup fee, also known as a termination fee, is a cost that happens if the seller backs out of a deal during a takeover or merger and acquisition agreements. It gives compensation to the potential purchaser for the time and resources they used to create the deal.

Breakup fees are usually between 1 and 3 percent of the deal's total value. In Delaware, courts regularly find breakup fees between 3 and 4 percent acceptable.

Where Do You Include a Breakup Fee?

Breakup fee talks are an important part of the letter of intent (LOI) negotiation, and there are cases where merger deals have not happened because both parties could not agree on a breakup fee.

Why Is a Breakup Fee Important?

Mergers and acquisitions don't always include breakup fees — especially smaller deals — but as the value of the deal increases and the possible disruption to the seller's business grows, you'll want to make sure the exchange includes a breakup fee.

If a company ends up not selling to the original purchaser and sells to someone with a better offer, the original purchaser needs to make sure they have their time and resources protected. Sometimes a breakup fee will keep other companies from bidding because they know they'll have to bid a price that covers the breakup fee.

Reasons to Consider Using a Breakup Fee

Breakup fees help the buyer cover any of the expenses that added up during planning, negotiating, and investigating the deal if it falls apart. It also protects the buyer if the seller receives a higher offer.

Sometimes, breakup fees keep the seller from seeking other offers, because they know that if the deal falls apart, then they'll need to pay the seller.

Breaking Down Breakup Value

If a company is not performing well, or the stock hasn't reached the level of full value that investors believed that it would, those investors may ask for the company to be split apart. Once this is done the proceeds are returned to investors either as cash, stock in spun-off companies, or a combination of the two.

Investors can also ask for the breakup value of a well-performing company to either determine the floor of the stock or a potential entry point for prospective buyers. To calculate this accurately, detailed information on the revenue, earnings, and cash flows for each distinct operating unit of the company is required. With this information, a relative valuation can be derived for the different segments as a spun off stock.

Reverse Breakup Fees

Reverse breakup fees are payments from the buyer to the seller if a deal is not completed as a result of actions by the buyer. The upsides of including this type of fee in the purchase agreement or LOI are that it reduces and quantifies the buyer's liability, eliminates the need for litigation, and limits the seller's options of seeking other forms of repayment at a future date.

Reverse breakup fees are a good way to make sure that the buyer is serious about the deal. Merger deals are distracting for sellers and their management teams. If the deal doesn't close, the seller's business may be negatively affected. The breakup fee is a way to protect yourself from negative effects.

It's important to consider the following when creating a reverse breakup fee agreement:

  • The trigger event underlying the payment of the reverse breakup fee. What will trigger the fee's payment? The contract should clearly include the trigger event.
  • The interaction between the fee and other solutions. Buyers and sellers should consider what other solutions for payment there are aside from the fee.
  • The fee amount. You will need to decide what the exact amount of a reverse breakup fee will be should a financing failure happen.
  • Guarantees. You may want to ask that either the parent company of the buyer or its sponsor guarantee a reverse breakup fee.

Sample Clauses for Breakup Fees

The following are some clauses about breakup fees that you may want to include in your LOI:

  • No shop or no solicit. This clause protects the fund while negotiating the deal. This clause protects the buyer after both parties have signed the contract. A contract with a public company is at risk because it could need a shareholder vote, there could be a counter bid, or an insider of the company could begin to solicit other bidders to gain a financial advantage.
  • Fiduciary out. The fiduciary out means that if the seller does something specified in the agreement, then they do not need to pay the breakup fee. This means that someone only needs to pay the breakup fee if someone else outbids the first buyer. As a buyer, you want to make sure this is not part of the LOI.

Breakup Fees in European Countries

  • France. Under French law, a breakup fee provisions' classification depends on their classification and how they're qualified.

Breakup fee provisions involving listed companies raise specific issues, especially involving the amount of the fees. It is usually lower than 2 percent.

  • The United Kingdom. Without the panel's consent, the seller may not enter into any other deals with the buyer during an offer period or when considering an offer.

 If a competing buyer announces that they intend to make an offer, this is allowed if the fee is no higher than 1 percent of the value of the first buyer.

Frequently Asked Questions

  • Where do you find breakup fee provisions?

You can use breakup fee provisions in letters of intent, preliminary agreements, and option agreements.

  • When does the breakup fee need to be paid?

The fee is usually linked to the triggering event. The first contracts should include the exact time that the breakup fee is due.

  • What is the sum-of-parts value?

The sum-of-parts value of a publicly traded company comes from analyzing each business segment of a company separately.You want to find this value when large cap stocks are likely to operate in a few different markets or industries. A breakup value analysis will be brought done by investors if the market cap of the stock is less than the breakup value for a certain period of time.

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