Break Up Fee (M&A) - Explained
What is a Break Up Fee?
Written by J. Mance Gordon
Updated at April 20th, 2024
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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.