As the number of M&A deals has increased over the last several months, so it seems has the amount buyers are agreeing to pay for the right to walk away from those deals. Before the recent economic downturn, reverse termination fees were generally around three percent of the purchase price. Now, the trend is for buyers and sellers to agree to reverse termination fees of five to twelve percent of the deal’s value. For example, in May, Silver Lake Technology Management, L.L.C. and Warburg Pincus LLC agreed to a reverse termination fee of 6.7% of the purchase price in their acquisition of Interactive Data Corporation, and Thomas H. Lee Partners, L.P. has agreed recently to reverse termination fees of 5.0% and 6.0%, respectively, of target’s equity value in its deals to acquire CKE Restaurants, Inc. and inVentiv Health, Inc. Last month, Irving Place Capital agreed to a reverse termination fee of 12.5% of the purchase price in its acquisition agreement for Thermadyne Holdings Corporation.
Some buyers are also agreeing to two-tier fee structures where the buyer agrees to pay a lower percentage of target’s equity value if it is unable to obtain financing and a much higher percentage of target’s equity value for its right to walk away for any other reason. For example, Cerberus agreed to pay 10% of target’s equity value if it was unable to obtain financing for its acquisition of DynCorp International, Inc. and then 29.8% of target’s equity value for a “willful breach” of the agreement. Similarly, GTCR agreed to pay 12.6% of target’s equity value if it was unable to obtain financing for its acquisition of Protection One, Inc. and then 31.6% of target’s equity value for a “willful breach” of the agreement.
Why the shift? Sellers are asking for higher termination fees because they remain concerned about buyers’ willingness to walk away from a transaction upon a failure to obtain financing on acceptable terms, deterioration of the business or for some other reason. The credit crisis spawned a rash of broken deals in which the traditional reverse termination fee was not high enough to prevent a buyer from leaving the deal on the table. Moreover, while reverse termination fees before the credit crisis were often tied to fees payable by sellers that exercised a fiduciary out, fees purporting to lock up buyers are not subject to the same fiduciary limitations imposed on these kind of seller fees.
Buyers, on the other hand, are now more willing to agree to higher termination fees because (i) they are more confident they will be able to get the financing necessary to close the deal and (ii) they are being forced to compete with other buyers for attractive targets. On the private equity front, private equity buyers have money to spend (with estimated cumulative private equity fundraising overhang at over $400 billion according to the Alliance of Merger & Acquisition Advisors and PitchBook Data, Inc.) and are often agreeing to higher reverse termination fees to compete with strategic buyers who often don’t require acquisition financing to complete a deal.