Reverse breakup fee

What Is Reverse Breakup Fee?

A reverse breakup fee is a contractual provision within a merger agreement that obligates the acquirer to pay a specified amount to the target company if the deal fails to close under certain predefined circumstances. This type of fee falls under the broader financial category of Mergers and acquisitions (M&A) and serves as a form of protection for the seller. Unlike a traditional breakup fee paid by the seller, a reverse breakup fee shifts the financial burden to the buyer, providing the target company with compensation for the time, resources, and potential lost opportunities incurred during the failed acquisition process.¹⁷

History and Origin

The concept of breakup fees initially emerged to protect buyers from sellers backing out of deals. However, as M&A transactions grew in complexity and regulatory scrutiny intensified, especially concerning antitrust issues, sellers began to demand reciprocal protection. The rise of reverse breakup fees reflects this evolution, becoming a more common feature in merger agreements to address risks primarily associated with the buyer's inability to close the deal.¹⁶

Historically, these fees have become particularly relevant in transactions where securing regulatory approval or financing is a significant hurdle. For instance, the increased focus by antitrust authorities on large strategic combinations has made reverse breakup fees a critical component in allocating regulatory risk between merging parties.¹⁵ Legal insights from firms like Skadden, Arps, Slate, Meagher & Flom LLP highlight the trend of regulatory reverse termination fees becoming the "new normal" in M&A.¹⁴

Key Takeaways

A reverse breakup fee is a payment made by the acquiring company to the target company if a merger or acquisition fails to close due to specific reasons attributable to the buyer.
These fees provide financial protection to the target company for the time, effort, and resources expended during a failed deal.
Common triggers for a reverse breakup fee include the acquirer's inability to secure financing or failure to obtain necessary regulatory approvals.
Reverse breakup fees enhance deal certainty for the seller and demonstrate the buyer's commitment to the transaction.
The amount of the fee is typically negotiated and outlined in the merger agreement, often representing a percentage of the total transaction value.¹³

Interpreting the Reverse Breakup Fee

A reverse breakup fee is typically interpreted as a measure of the acquirer's commitment and a form of risk mitigation for the target company. A higher reverse breakup fee can signal the buyer's strong intent to complete the transaction, as it represents a significant financial penalty if they fail to do so. Conversely, a lower fee might suggest less commitment or a greater perceived risk on the buyer's part.

The specific circumstances that trigger the payment of a reverse breakup fee are crucial for its interpretation. These conditions are meticulously detailed in the merger agreement and often relate to regulatory hurdles or financing failures. For instance, if an acquirer agrees to a substantial reverse breakup fee tied to antitrust issues, it indicates their willingness to undertake significant efforts to obtain regulatory approval, potentially even considering divestitures.¹²

Hypothetical Example

Consider "Tech Innovations Inc." (the acquirer) proposing to acquire "Creative Software Solutions" (the target) for $5 billion. During their due diligence, both parties negotiate a merger agreement that includes a reverse breakup fee of $250 million. This fee would be payable by Tech Innovations Inc. to Creative Software Solutions if the deal fails to close due to Tech Innovations Inc.'s inability to secure the necessary financing or if it cannot obtain crucial regulatory approval within a specified timeframe.

Suppose after several months, the Federal Trade Commission (FTC) expresses significant antitrust concerns, indicating they will block the deal unless Tech Innovations Inc. divests a substantial portion of its existing business. Tech Innovations Inc. determines that the required divestiture would undermine the strategic rationale for the acquisition and decides to terminate the agreement. In this scenario, because the termination was due to Tech Innovations Inc.'s failure to overcome a regulatory hurdle (a condition often stipulated for reverse breakup fee payment), Tech Innovations Inc. would then pay Creative Software Solutions the $250 million reverse breakup fee. This compensates Creative Software Solutions for the disruption, legal fees, and the opportunity cost of being off the market during the failed acquisition attempt.

Practical Applications

Reverse breakup fees are a vital tool in modern Mergers and acquisitions (M&A), especially in large and complex transactions.

Regulatory Risk Allocation: They are increasingly used to allocate the risk of failing to obtain regulatory approval, particularly from antitrust authorities. For example, when Adobe abandoned its planned $20 billion acquisition of Figma in 2023 due to regulatory hurdles in the UK and EU, Adobe was required to pay Figma a $1 billion termination fee.¹¹ This highlights how significant these fees can be when deals collapse due to competition concerns.
Financing Risk Mitigation: In deals involving substantial private equity involvement or leveraged buyout structures, the acquirer's ability to secure adequate financing is critical. A reverse breakup fee protects the seller if the buyer's financing falls through.
Demonstrating Commitment: The inclusion of a large reverse breakup fee can signal the seriousness of an acquirer's bid, enhancing deal certainty for the target company and its shareholders.
Major Deals Examples: In the proposed acquisition of Activision Blizzard by Microsoft, the merger agreement included a tiered reverse termination fee, starting at $3 billion and potentially rising to $4.5 billion, payable by Microsoft under specific circumstances related to regulatory failures.¹⁰,⁹ This substantial fee underscores the importance of such provisions in high-stakes transactions. Details of such fees are often publicly disclosed in regulatory filings.⁸

Limitations and Criticisms

While reverse breakup fees offer important protection for target companies, they are not without limitations or criticisms.

One primary criticism revolves around the adequacy of the fee itself. If the fee is too low, it may not sufficiently compensate the target company for the extensive time, effort, and resources—including management distraction and potential integration risk—expended during a failed deal. A low fee might also not fully deter an acquirer from walking away if market conditions change significantly or if they simply become less committed.

Another limitation is that reverse breakup fees are typically triggered only by specific, predefined events outlined in the merger agreement, such as a failure to secure financing or obtain regulatory approval. If the deal collapses for reasons not explicitly covered by the contractual obligations for the reverse breakup fee, the target company may be left without compensation. The negotiation of these specific triggers and the amount of the fee is often a contentious point in dealmaking.

Fr⁷om a corporate governance perspective, some critics argue that overly large reverse breakup fees could potentially incentivize an acquirer to pursue a risky deal, knowing that the "cost of walking away" is capped by the fee, rather than facing uncapped liability for damages. However, this is balanced by the fact that regulatory bodies scrutinize such clauses. Legal and academic discussions, such as those published by the Harvard Law School Forum on Corporate Governance, often delve into the nuances of how these fees affect deal dynamics and risk allocation.

##⁶ Reverse Breakup Fee vs. Termination Fee

The terms "reverse breakup fee" and "termination fee" are often discussed together in the context of Mergers and acquisitions, but they represent distinct concepts primarily differentiated by which party pays the fee and under what circumstances.

A termination fee (or traditional breakup fee) is a payment made by the target company to the acquirer. This fee is typically triggered if the target company terminates the merger agreement to accept a superior offer from another bidder (a "fiduciary out") or if its shareholders fail to approve the deal. The purpose of a termination fee is to compensate the initial buyer for their investment in the due diligence process and to deter the seller from soliciting or accepting competing bids after an agreement has been reached.

Conversely, a reverse breakup fee is paid by the acquirer to the target company. This fee is activated when the buyer is unable to complete the transaction due to specific reasons on their side. Common triggers for a reverse breakup fee include the acquirer's failure to secure necessary financing for the deal or its inability to obtain crucial regulatory approval (e.g., antitrust clearance). Essentially, the reverse breakup fee acts as compensation for the target company for being "taken off the market" and expending resources on a deal that ultimately fell apart due to the buyer's shortcomings.

##⁵ FAQs

Why is a reverse breakup fee used in M&A deals?

A reverse breakup fee is primarily used to protect the target company in a Mergers and acquisitions deal. It compensates the seller for the time, effort, and resources they invested in the transaction if the buyer fails to close the deal due to reasons like inability to secure financing or regulatory hurdles. It ⁴also signals the acquirer's commitment.

What are common triggers for a reverse breakup fee?

The most common triggers for a reverse breakup fee include the acquirer's failure to obtain the necessary financing to complete the acquisition, or the inability to secure required regulatory approval from government bodies, such as antitrust authorities. These specific conditions are outlined in the merger agreement.

##³# How is the amount of a reverse breakup fee determined?
The amount of a reverse breakup fee is determined through negotiation between the acquirer and the target company during the drafting of the merger agreement. It is often set as a fixed dollar amount or a percentage of the total deal value, typically ranging from 2% to 10% depending on the deal's size, complexity, and specific risks involved, particularly regulatory risk.

##²# Does a reverse breakup fee guarantee the deal will close?
No, a reverse breakup fee does not guarantee that a deal will close. It serves as a form of compensation to the target company if the deal fails for specific reasons attributable to the buyer. It does, however, provide a level of financial protection and can encourage the buyer to put forth maximum effort to overcome obstacles, especially regulatory ones, due to the financial penalty for failure.¹