Break Up Fee (M&A) - Explained
What is a Break Up Fee?
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Table of ContentsWhat is a Breakup Fee?How does a Breakup Fee Work?How Breakup Fee Provisions Are UsedAcademic Research on Breakup Fee
What is a Breakup Fee?
A breakup fee is sometimes called a termination fee, this is a fee (penalty) used in takeover agreements, otherwise known as mergers and acquisitions. A breakup fee is paid by a seller to the buyer when he backs out of the agreement to sell to the buyer. In the context of mergers and acquisitions, the target company is the seller while the acquiring company is the buyer. If the target company backs out of the deal as states in the merger deal, such a company would pay a fee to the acquiring company for terminating the deal.
How does a Breakup Fee Work?
A breakup fee is calculated as a percentage of the original value of the deal, it is often between 1% to 3% of the original value. This fee compensates the prospective buyer for the time and resources wasted in securing a deal with the seller. Generally, either of the party in a takeover agreement that decides not to pursue the deal pays the breakup fee, however, in reality, target companies back out often which is why a breakup fee is paid by the seller. Although breakup fees are often used in the context of penalty, they also serve as a motivation for sellers to do their part in a takeover agreement. Nevertheless, if the seller decides to terminate the deal, a breakup fee must be paid.
How Breakup Fee Provisions Are Used
In a merger and acquisition, provisions for breakup fees are contained in the preliminary agreements or letter of intent. This provision stipulates that a seller will pay a fee to the buyer if he rescinds the agreement to sell to the buyer. Initially, breakup fees were used in public takeover agreements, but its usage has been extended to construction projects, an agreement between companies, and a public offering. There are certain conditions or events that trigger the use of the provision of breakup fees, such events include;
- A seller choosing another buyer different from the initial buyer named in the letter of intent or preliminary agreement.
- A seller backing out of the agreement to sell to a buyer.
- A buyer noticing a defect not earlier disclosed.
- Lack of interest by the seller to fulfill their part of the takeover agreement.
Academic Research on Breakup Fee
- Is There One Best Way to Sell aCompany? Auctions Versus Negotiations and Controlled Sales1, Boone, A. L., & Mulherin, J. H. (2009). Is There One Best Way to Sell a Company? Auctions Versus Negotiations and Controlled Sales 1.Journal of Applied Corporate Finance,21(3), 28-37. For managements and boards that have decided that the valuemaximizing choice is to sell their companies, the board must then address another important question: what is the best way to sell the company? Should they use a wideranging auction that seeks to attract the largest number of bidders, exclusive negotiation with a single bidder, or a controlled sale with a limited group of potential buyers?
- Audit market structure,feesand choice following the Andersenbreak-up: Evidence from the UK, Abidin, S., Beattie, V. A., & Goodacre, A. (2008). Audit market structure, fees and choice following the Andersen break-up: Evidence from the UK.Fees and Choice following the Andersen Break-up: Evidence from the UK (January 1, 2008). This paper presents evidence on audit market concentration and auditor fee levels in the UK market in the crucial period of structural change following the PricewaterhouseCoopers' (PwC) merger and encompassing Andersen's demise (1998-2003). Given the current interest in auditor choice, analysis is also undertaken at the individual audit firm level and by industry sector. There is evidence of significant upward pressure on audit fees since 2001 but only for smaller auditees. Audit fee income for top tier auditors (Big 5/4) did not change significantly while the number of auditees fell significantly, consistent with a move towards larger, less risky, clients. Andersen's demise markedly reduced the level of inequality among the top tier firms but PwC retained its position as a 'dominant firm'. On switching to the new auditor, former Andersen clients experienced audit fee rises broadly in line with inflation, with no evidence of fee premia or discounting. They also reported significantly lower NAS fees, consistent with audit firms and auditees responding to public concerns about perceptions of auditor independence. There is no general evidence of knowledge spillover effects or cross-subsidisation of the audit fee by NAS. The combined findings provide no evidence to indicate that recent structural changes have resulted in anticompetitive pricing; the key concern remains the lack of audit firm choice.
- -border acquisition abandonment and completion: The effect of institutional differences and organizational learning in the internationalbusinessservice industry, 1981 , Dikova, D., Sahib, P. R., & Van Witteloostuijn, A. (2010). Cross-border acquisition abandonment and completion: The effect of institutional differences and organizational learning in the international business service industry, 19812001.Journal of International Business Studies,41(2), 223-245. Based on the concepts of North's (1990) political economy of national institutions and economic behavior, we investigate how formal and informal institutional features influence the likelihood that a cross-border acquisition deal will be completed, as well as the time taken for its completion after announcement. Additionally, we study how past experience with completed acquisition deals moderates the effects of institutional differences. We focus on a relatively new context the pre-completion stage of acquisition processes. We test our hypotheses using data from 2389 announced cross-border acquisition deals in the international business service industry (19812001). We find that differences in national formal and informal institutions explain part of the variation in the likelihood that an announced cross-border acquisition deal will be completed, as well as the duration of the deal-making. In addition, organizational learning moderates the effects of institutional distance: past experience with completed cross-border acquisition deals increases the likelihood of a subsequent deal completion in institutionally closer environments, but shortens the deal duration in institutionally distant environments.
- Termination Feesin a'Bright Line'Jurisdiction, Clarkson, P., Law Chapple, L., & Christensen, B. (2006). Termination Fees in a'Bright Line'Jurisdiction.Available at SSRN 948583. We seek to statistically inform the debate over whether the Australian Takeovers Panel's bright line policy toward break fees is appropriate. The sample data we employ consist of 313 takeover bids from the period January 2002 through June 2006 where the target was an ASX listed public company. Of these, 85 involved a break fee arrangement whereas 228 did not. Consistent with U.S. results, we find that break fee usage and toeholds are used as substitutes, and that break fees are generally granted by larger target companies, those with higher book-to-market ratios, and in friendly deals. However, with regards to the effect of break fee usage on the competitive bidding process, we find the extent of post-bid competition to be unrelated to break fee usage and the rate of bid success to be lower for bids involving the use of break fees. Thus, in contrast with the predictions of agency theory, U.S. findings, and conventional wisdom, break fees appear to be neither anti-competitive nor coercive within the Australian context.
- Network neutrality: A survey of the economic literature, Schuett, F. (2010). Network neutrality: A survey of the economic literature. This paper reviews the small but growing economic literature on network neutrality. It considers a number of possible departures from network neutrality, in particular termination fees, second-degree price discrimination, and vertical foreclosure.