In light of the time and expense involved in planning and negotiating a transaction, it is not surprising that acquirers look to protective lock-up devices — such as termination fees — to deter competing bids.
A recent study by Houlihan Lokey sheds some light on the use of lock-up devices in the past few years by summarizing key termination fee metrics for M&A transactions involving U.S public target companies between 2008 and 2012, and by analyzing termination fees as a percentage of both transaction and enterprise value.
The study reveals that although termination fees as a percentage of transaction value ranged from 1.0% to 10.9% from 2008 to 2012, both the mean and median termination fee values were steady, in each case falling within the 3.2% to 3.5% range. In 2012, both the mean and median termination fee as a percentage of the transaction value was 3.5%.
In 2008 and 2010, the median termination fees as a percentage of enterprise value were equivalent to the observed median using transaction values (3.3%). However, due to the inclusion of debt, enterprise values were typically greater than the corresponding transaction values, resulting in the observed median termination fees based on enterprise value to be slightly lower than those observed using transaction values.
Interestingly, the study revealed that neither the form of consideration nor the type of acquisition appears to correlate strongly with termination fee size. Transactions with “go-shop” provisions, however, were typically structured to contain bifurcated termination fee provisions, where the termination fee payable would be considerably lower during the go-shop period.
In addition to the “forward” break-up termination fees described above, the Houlihan study also considered the prevalence of “reverse” breakup fees, which fees are payable to the target if the deal does not close, typically due to the unavailability of “committed” financing. The incidence of reverse breakup fees has climed quickly in the aftermath of the financial turbulence of 2008, with the median reverse breakup fees as a percentage of transaction value increasing from 3.5% in 2008 to 4.7% in 2009, and the median reverse breakup fees as a percentage of enterprise value increasing from 3.2% in 2008 to 4.1% in 2009. The size of reverse breakup fees remained at these elevated levels in 2012 (5.0% of transaction value and 4.7% of enterprise value), although the negotiation of two-tier fees has become increasingly common, with a lower fee payable if a closing does not occur due to a financing failure as opposed to a willful failure.
When considering forward and reverse termination fees, it is noteworthy that such fees serve different functions and should be distinguished accordingly. Forward termination fees have the potential to interfere with the duty of a sellers’ board to secure the highest possible purchase price insofar as high termination fees have the potential to effectively forclose a competitive bidding process. Although there is no bright-line test for determining an acceptable termination fee, U.S. courts have expressed concern that termination fees in excess of 3% of the purchase price may be unreasonable, depending on the circumstances. By contrast, reverse termination fees neither deter competitive bids nor increase the cost of a bidding contest and, as such, pose no such concerns.