M&A Issues: Breakup Fees
Continuing our discussion of M&A Issues, we are going to talk about breakup fees today.
A breakup fee is a payment made by the buyer to the seller if the M&A transaction doesn't close.
Many M&A transactions do not include breakup fees, particularly smaller transactions. But as the value of the transaction rises and the potential disruption to the seller's business increases, it is more likely that the transaction will include a breakup fee. The negotiation of the breakup fee can be 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.
As a buyer, you want to avoid and/or limit the size of breakup fees as much as you can. And you want to be very specific about the circumstances in which you would pay them. You can and should carve out as many reasons for a deal falling apart from the breakup fee as you can.
As a seller, you want to include a breakup fee in the LOI for a bunch of reasons. First and foremost, it is a good way to make sure the buyer is serious about the transaction. It is a lot like a down payment in a contract to purchase a home. It forces the buyer to signal the seriousness of their interest.
In addition, the merger transaction can be very distracting for the seller and the seller's management team. If the selling company goes through a prolonged M&A transaction and then the deal does not close, there can be significant negative impact to the business and the breakup fee is a way to get protected from that negative impact. However, a one time cash payment is rarely the solution to the problems that result from such a situation.
When you are selling your company, ask your lawyer right up front about the appropriateness of a breakup fee. He or she will tell you whether it is typical in your kind of transaction. The smaller and quicker the transaction, the less appropriate it is.
But don't just listen to your lawyer. Decide in your gut whether the seller is serious about the deal or not. And try to anticipate how disruptive the transaction will be to your business. If you have any qualms about the seller's intentions or the disruption that will ensue, ask for a breakup fee. And if the buyer is unwilling to include one, think hard about whether you want to do the transaction.
Comments (Archived):
What else needs to go into the LOI? And I second Charlie’s question.
i wrote a post about that. about ten MBA Mondays ago
I need a review then 🙂
I haven’t been single for 7 years but I’m still paying a few breakup fees….
Fred–I’ve found very few breakup fees actually get included in LOI’s. Fundamentally, an LOI is a preliminary stage document that is generally done before due diligence is complete–in many cases before diligence even starts–and is non-binding with the exception of a very few provisions around confidentiality and, in a non-auction deal, exclusivity for a limited period.Is your experience different? People can talk a lot about including breakup fees in LOIs but it always seems like the wrong point in the process, so the entire discussion breaks down or slows to a crawl. At 50+ closed deals and literally hundreds of LOIs, breakup fees have entered into very few. The deal is too preliminary at an LOI point. No exclusivity or a shorter exclusivity period always seems like the best way to keep a buyer honest to me.To me, breakup fees are a definitive merger agreement remedy that is heavily negotiated along with rights to specific performance (i.e., causing a deal to close) to that there is an agreed up on set of remedies in the event a deal cannot close or a party refuses to close. Even when agreed upon, the credit crunch showed that many of the remedies do not work as intended even with a full merger agreement.
I disagree, Dave. I’ve been doing M&A transactions for 17+ years, and if the seller has leverage (e.g., has created a competitive environment), it should indeed include a break-up fee in the LOI. At a minimum, the break-up fee should cover seller’s expenses if the buyer walks; otherwise, the buyer basically has an option for the term of the exclusivity period.
Scott–Fair enough, it appears to be a point where reasonable minds can disagree. I’ve been doing this for the same amount of time as you and in both legal and corp dev roles. I’d be curious what % of deals you see this in the normal technology company sale environment. I’ve seen more deals slow to a crawl or stop over the LOI stage breakup fee than I have seen the breakup fees actually paid because any payment is typically contingent on diligence completion (and when deals fall apart diligence can always be to blame).From a buyer perspective, the buyer rarely knows much at the stage they are putting out an LOI in most non-auction deals because the seller wants an LOI early to understand the terms. If you are running a multi-stage auction, the dynamics can certainly change but then you would typically try to not go to exclusive and take two buyers closer to the end.
The simple truth of the matter is that in most small deals, the buyer does have an option for an exclusive period of time.A seller has to induce a buyer to buy and showing a bit of leg is part of the deal. You have to know your buyer.The trick is to keep the exclusive period as short as possible and to learn as much as possible from the prospective buyer.I once sold an entire portfolio of office buildings to some REIT clowns who had put the deal into a ML red herring and then tried to give us a haircut a couple of days before the closing.On a Saturday morning at 6:00 AM before a Tuesday closing, they called all troubled and soulful as to why the “deal was not going to work unless I gave them a $6MM discount”.Their earnest money check had not yet cleared and though arguably they had signed the contract, their money was not yet at risk. They thought they were having fun jerking my chain.But I knew all about that red herring and knew that the primary use of funds was to do our deal.I called their bluff. I shot 82. By Monday morning they were ready to pay more than the original price.I made them eat shit and it felt really, really, really good. I needed about 15 years of business experience to be able to play that hand correctly but the principles were very simple — know everything you can about your buyer.You have to know your buyer.
Love this.Put another way “if you don’t understand the interests, motivations and capabilities of the buyer, you’re not going to get full value as the seller.”
the art of the re-trade.a private equity firm will snog you on the dancefloor to get you off the market and make you walk behind them when you leave the show.
Makes sense.
Love the way you always seem to manage to sum up the basic and essential issues underlying your topics and you do so succinctly and clearly Fred. A great foundation upon which for your readers to add comments and observations from their experiences which makes this such a great teaching forum.Conceptually, from a sellers standpoint, including agreement to a breakup fee in the LOI makes a great deal of sense both from the angle of establishing the buyer’s good faith in terms of seriousness and commitment to closing a deal ~ in which case, the serious buyer potentially has little effectively at stake in the long run ~ and from the angle of inevitable business disruption costs of the seller who potentially has a great deal at stake. Almost equivalent to a home or commercial RE deal with the buyer depositing earnest money upfront and then doing their due diligence before coming to the closing table.A business that becomes the subject of M&A interest may well find itself with more than one suitor thus needing a way to differentiate between looky-loos, as well as dissuading anyone intent on using this approach to another business as a strategy to compromise the seller, and those who are of serious intent.By a seller requesting, and receiving, inclusion of a break up fee in the LOI also potentially helps the seller in determining how much effort it may give to looking at any other, but perhaps ostensibly more enticing, offer from any other subsequent suitors that, if the seller was to entertain, might ultimately backfire on the seller leading to them being left at the altar with no conclusive deal closing with anyone. Conversely, the buyer, by offering to include a break up fee, is implicitly, if not explicitly, asking for exclusive consideration of their offer before any other offers may be entertained.Practically, however, this option could become a bed of thorns for either party: Just as with so many real life events and circumstances, every M&A situation will have different elemental details to be taken into consideration even though overall principles of bringing any such deal to fruition are much the same. For example; “how much should a break up fee be?” and “under what circumstances does it get triggered?” can become a very time and cost consuming and distracting exercise in and of itself: An exercise with possibly little advantage to either party – except the lawyers – essentially because it must be based upon mostly subjective issues rather than upon definitively objective data at this stage of the game.Hence while including a break up fee might be very welcome component of an LOI offer from a suitor for the seller, it could also be counter productive, having the effect of turning away an otherwise viable acquirer: I really like your last comment Fred, about not just listening to your lawyer but also trusting your gut: Always very sanguine advice and a great conclusion.
I have seen many times where entrepreneurs go with their ‘gut’ in deciding the level of seriousness of a buyer and have been flat wrong. Both in mistaking a serious buyer for a tire-kicker and in mistaking a tire-kicker for a serious buyer. Few entrepreneurs have had the deal experience necessary to tune their gut reactions on important deal-related issues.
true. this is one place where a VC can really help an entrepreneur
thats why board composition MUST include expertise in these affairs.
“…don’t just listen to your lawyer. Decide in your gut…”Priceless advice and so true for many situations where lawyers are involved.
yup. lawyers are great but you have to do what is right in your gut at times.
A break up fee is the other side of the mirror from a “no shop” provision. Regardless of which side you are on, they draw an almost perfect balance.Why?Because they accrue to the benefit of the other party.Buying something and you don’t want the seller to just troll your offer around? Insist on a confidentiality provision, a no shop provision and a liquidated damages provision in the event either are breached.Selling something and don’t want to provide a free look? Insist on earnest money and a break up fee. A break up fee is just a liquidated damages provision.The other thing to understand is that a break up fee or a no shop liquidated damages fee — as exclusive remedies — may be cheap insurance as it quantifies the downside and avoids lengthy litigation.One last thought, in certain instances it may be advisable to actually make someone deposit the break up fee or the no shop liquidated damages with a third party subject to specific escrow instructions in much the same way that the earnest money in a real estate transaction is held by a title company.An alternative is a letter of credit with clear and precise funding instructions.I have used all of these mechanisms and when done on the front end, they prevent a lot of pissing and moaning on the tail end.Even seemingly symbolic amounts of money are useful as they make the buyer or seller rise to a moral standard. Most people will do what they commit to do if it is in writing. Most people who negotiate like hell on these kind of things are not going to do what they say they are going to do. It is a good pre-nup test.
“The other thing to understand is that a break up fee or a no shop liquidated damages fee — as exclusive remedies — may be cheap insurance as it quantifies the downside and avoids lengthy litigation.”That is good advice. In addition to MBA Mondays, we could have Legal Tuesdays (I know that doesn’t ring right)Maybe because of the full employment act for lawyers or because its scary/hard, I find many people don’t want to put the “and then what” which is the remedy for breach in contracts.”I want five nines in my ServiceLevelAgreement”. Ok, that is less than six minutes a year…if we don’t hit what is the remedy? I want five nines!! or what??
How about Attorney Tuesdays?
Sounds like a good idea to me.What is the bag limit on attorneys up your way? And do you have to discriminate between does and bucks or can you shoot them all?I think Attorney Tuesdays might be a good idea but let’s make damn sure we know whether we are using shotguns or rifles.I may not understand the concept fully. That happens sometimes.
LOL.
You do not have to use plugs in your shotguns with lawyers.Driving is considered good form.Does or Bucks it doesn’t matter, you don’t even need a tag. 🙂
will require a guest post
What would be interesting is how to work with lawyers. I am going to write about that.As much as people would like it you never are going to get legal advice. It doesn’t make sense, why would a lawyer want to give out their work for free and worse when somebody takes it out of context why would they want to feel responsible.
Aside from the breakup fee issue, an important but often over-looked way to gauge seriousness is for the seller to have a serious, granular, candid conversation with their key contact at the buyer. You need to understand what the buyer’s process is, where the buyer is in their process, when deadlines will be hit in the process and who your champions/sponsors are at the buyer. Every regular buyer has a process, and irregular buyer’s will need to create one, so you can gain insight and it will help you gauge how much effort to put in. Push hard on what is the buyers close rate in situations analogous to yours, understanding the close rate will vary depending on types of deals. It should be high in one to one or one to few situations, but will understandably be lower in auctions by definition.Buyers really vary on the amount of buy-in and approval needed to put out an LOI. Some are very rigorous with significant approvals needed to put one out, some thrown them around like popcorn. The deals that I’ve seen which wasted the most time from sellers were deals where the buyer was out of alignment. For example, corp dev was charged with finding “a company that does X”, they find seller who does x, seller spends a lot of time in diligence but it turns out that buyer’s business management never bought into buying seller and didn’t even know about it when an LOI was signed.If you do not have at least one person at the buyer who will be candid with you on process and their level of engagement, then question their seriousness hard regardless of where you end up on asking for a breakup fee in the LOI.
The most important element of an LOI is the recognition that it simply settles the large stroke business terms, it does not allow a buyer to start dating your secretary. LOIs are typically not binding.The LOI is only a prelude to a binding Asset Purchase Agreement.There may be a bit of heavy petting going on while negotiating the LOI but nobody gets any info until it is subject to all of the protections of a binding contract.[Side note: schedule all of the due diligence materials as an exhibit to the APA and deliver them at signing. Make the other side sign for them and attest that they have got everything they are going to get. If the deal does not make, get them back in the same condition. This saves time and starts the clock ticking. Only give anybody a finite time period to conduct DD even if you know it may have to be extended. Impose deadlines because you can always subsequently relax them.]You will know how serious the buyer or seller is really going to be by who signs the actual document. If Jimmie down in the mail room — a stud no doubt but not necessarily the go to guy on the deal front — signs it, then forget about it.If the CEO signs the deal and you have lunch with the Chairman of the Board and the the CEO and the CFO and a bit of gaiety, some bubbly, play the name game and a good steak — then they are serious.Find out if the guy on the other side of the deal has ever done a deal before, whether his word is good and why he wants to do the deal.Then sit back and get weekly reports on exactly where the deal is. Call the other guy and make it a point to ensure that you and he think the deal is in the same damn place.Always know who the lawyers are working on the deal. If they are paying for Sullivan Cromwell, it is likely not a head fake.
Those are all great indicators of seriousness, JLM. I just have to add one more – watch for a lack of serious objection questions.Like a sale that is bound to go nowhere fast, if potential buyers don’t have a handful of tough questions that could sink the deal if not properly asked, it’s a good indicator that they aren’t really that serious.Maybe they’re trying it on for size, maybe they’re getting a look at who you are, but no M&A deal is so perfect that there aren’t objection questions, even on the part of the pursuing party.
Great post… can you also write about Indemnification in M&A transactions?
i don’t think i am qualified to do that
Sorry, I should have been more specific with my question. Should the VC participate in the indemnification or is the indemnificaiton solely responsibility of the founders?
I can give you a first hand insight — they never ever work. You are trying to collect a debt of honor from someone who has usually demonstrated they have no honor.I have acquired that insight based upon being a full tuition non-scholarship student.The better approach is a “hold back” provision wherein a fund is held for such contingencies for a period of 12 months after closing.But beware, it cuts both ways.If one does the best DD possible, some of these horribles can be evaporated.
Sorry, I should have been more specific with my question. Should the VC participate in the indemnification or is the indemnificaiton solely responsibility of the founders?
to use JLM’s words “if you go to the pay window, you share in theliabilities associated with that”
***Anyone starting a company would do well to immerse themselves in these posts and the comments. Its all free advice and guidance from top quality contributors.That said – we just went through a lengthy process that ended unsuccessfully and has had a material adverse effect on the company. The purchaser was one of the worlds largest in our category – as such it was impossible to impose a break up arrangement. Whats more we were restricted by confidentiality provisions (they even insisted on 3 of us in management signing personal provisions) and had a terms sheet from 2 PE firms that we had to walk away from.At the end of the process we re-visited with the PE firms who showed far less interest. the convertible notes then imposed a re-cap and wiped out the majority of the equity for us founders.It can be very tricky navigating these issues – be sure to have a great lawyer – and a strong board that can bring influence.
ugh. i am really sorry to hear this mark.
hey if everything in life were a success – there wouldn’t be much to talk about right!
“Antitrust is a Bitch.”- The words of one VC when asked about the breakdown of negotiations over Google’s proposed purchase of Groupon.One issue that might be added to this post is that the “seriousness” of the buyer is no longer the only issue a seller needs to worry about. A seller also needs to carefully review the regulatory hurdles for the transaction – if they are steep, a company needs some assurances that the buyer will actually try to overcome any resistance along the way. When your buyer has a dominant share of some market (even if it’s not YOUR market), regulators in Europe and the US are getting involved with increasing frequency. You should make sure that your lawyers spend some time analyzing the deal from this perspective.
Yeah. That was last week’s MBA Mondays post
Doh! Not sure how I missed that one…but, yes, you already nailed it 🙂
It is worth noting that the Takeover Panel in the UK is looking to banish all break fees and deal protections on the grounds that they unfairly empower the buyer and punish a bid target.Needless to say the private equity and VC community are up in arms about it – because they rely on break fees to cover the cost of locking in financing in case the target walks away.http://www.efinancialnews.c…
If seller: “The maximum the buyer will accept”If buyer: “The minimum the seller will accept”
I know I’ve written this before but it still cracks me up.If you’re AdMob, apparently you just subtract $50MM from the $750MM Google has offered you and make that the breakup fee.I still can’t believe Google signed it, but they apparently wanted to steal AdMob from Steve Jobs so very badly…
You’d likely generally start asking for 3-5% of deal value, which would be the upper end of the boundaries for large, public deals for Delaware corporate law reasons. But at an LOI stage, realistically you’d be looking for good faith type money would cover your out of pocket costs.The problem will be that the buyer will then likely ask the seller for the same or something similar, since typically the buyer’s out of pocket costs in diligence far outstrip the seller’s and deals fall apart just as often for seller issues/problems as buyer reluctance.If you don’t think the buyer is serious, don’t go exclusive or go exclusive for a short time to make sure they engage.
was the breakup fee disclosed publicly?
Heavily rumored and Eric Schmidt declined to deny it on more than one occasion, I read.