Despite being relatively rare, the
continued presence of reverse break fees in deals underlines
the seller-friendly conditions in the market currently. It was
expected this kind of deal protection would decrease following
the ban of break fees in the UK in 2011 though this has not
As the M&A market becomes more
competitive, reverse break fees – where the buyer has
to pay the seller a fee for not going through with the deal or
breaching its covenants - could become more common on the
bidder side as an additional incentive to help sellers over the
line to exclusivity.
Carl Bradshaw, M&A partner at Kirkland & Ellis,
said that he has seen an increased incidence of reverse break
fees because of the strong seller-favourable conditions,
driving tougher terms around deal certainty.
"A general trend of increased merger
control complexity to deals has also prompted them to be
considered more often, sometimes in exchange for reducing
'hell-or-high-water’ purchaser covenants to divest
existing businesses," he said.
Break fees were banned in the UK seven
years ago because they were blamed for deterring additional
offers as targets were more likely to focus on reaching a deal
with first bidders. However many market participants have
claimed since then that the ban could damage competition in
takeovers and result in poorer deals for target shareholders.
This could lead to fewer competing bids for companies and less
value for bidders.
"Competition is becoming
more challenging, putting more pressure on buyers to
allocate more risk onto themselves"
Of course, the ban on break fees cannot be
used as the sole reason for the extraordinary high valuations
currently but it could nonetheless exacerbate the situation.
Without the presence of break fees, their counterpart for
buyers were expected to become less prevalent because the
seller is reluctant to accept them in a deal without having the
equivalent term in their favour. But due to the current
competitiveness of the market, they could be seen in an
increasing number of transactions.
A partner at a global private equity firm
said reverse break fees remain a very small portion of overall
deals – about one in 10 – but they are
starting to gain traction.
"Competition for deals is becoming more
challenging and is putting more pressure on buyers to
accommodate the seller and allocate more risk onto themselves,"
Again, this only goes to underline the
dominance of sellers in the market – in that they are
able to call the shots and dictate more favourable terms into
deals. This does not look likely to change soon. With private
equity expected to better last year’s record year
($621 billion raised), terms are likely to become even more
seller-friendly. To get sellers comfortable with execution
risk, Chinese buyers have even been resorting to cash deposits
or letters of credit upon signing the deal. The European and US
sectors could see more seller-friendly terms soon.
Reverse break fees are becoming
more common due to the intense competition in the M&A
sector and this is expected to increase for this
The use of reverse break fees was
expected to decline after the UK ban on break fees in 2011,
but they have remained static. With the influx of regulation
this year, this is also expected to boost them;
The UK Government’s
plans to increase their merger intervention powers could also
see an increase in their usage.
But reverse break fees also play an
important role in overcoming regulatory hurdles. Herbert Smith
Mark Bardell said that they are becoming more common now
because there are more hurdles for businesses to navigate. For
certain sectors subject to more stringent regulation like
aerospace or pharmaceuticals for instance, reverse break fees
are more common as targets look for greater assurance.
The UK government’s robust
powers to intervene in mergers on national security grounds may
potentially result in an increase in deal protection, including
various types of risk-associated fees. It proposed lowering the
threshold where ministers can scrutinise business investment to
£1 million ($1.42 million approximately) in October.
Previously, ministers could only intervene in mergers involving
companies who had a UK turnover of over £70 million or
where the share of UK supply increases to 25% or over. This
broadens the scope of investigation hugely. The UK plans to
implement a more extensive regime for screening transactions
for national security issues in the long term that will further
increase the scope for intervention.
According to Koregate Capital managing
partner Edward Belsey, the expectation was that reverse break
fees would fall away but that hasn’t been the
case. Unlike corporates, deals involving private equity firms
are extremely unlikely to include a reverse break fee. They are
most common in larger deals with a tender process and often
where there is more competition for buyers. Belsey anticipates
that they will continue to appear in these deals for the
"The trend will be driven by the market
and I don’t see them falling away," he said. With
more regulation on the horizon, the prospect of them falling
away becomes even less likely.
Ashurst M&A partner
Tom Mercer said that deals are currently subject to a lot
of regulatory scrutiny, particularly cross-border deals. The
influx of regulation after the financial crisis has boosted the
likelihood of targets looking for more assurances. Their
inclusion depends largely on the identity of the bidder, but
the target will have to justify why a reverse break fee is
"If the acquirer is a private entity there
is unlikely to be any regulatory issues relating to their use
– but by the same token it is generally accepted that
private equity will not pay a reverse break fee," said
But for corporates it is likely that there
will be an increase in their use in spite of the ban on break
fees, showing just how dominant sellers are in the market
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