Ask the Advisor - Q: Should I Consider Offering a Prospective Buyer a Break Fee?

A: When a business seller isn’t quite ready to commit to an M&A transaction but still wants to keep its prospective buyer interested, it can offer a break fee (also called a breakup fee). If the seller doesn’t go ahead with the deal, the buyer is reimbursed for its time and deal-related expenses.

It doesn’t make sense from a financial perspective to offer break fees to multiple prospects. But if there’s a good offer you’re concerned about losing, a break fee can be a strong enticement for the buyer to stick around.

In the seller’s court

A seller might have to pay a break fee if, for example, it backs out of a provisional agreement to sell to one buyer to go with a different one. (Reverse break fees, on the other hand, are paid by buyers that breach deal agreements or that can’t consummate transactions due to insufficient financing.)

Break fee amounts, and the conditions under which they’re paid, generally are worked out early in deal negotiations. Fees range between 1% to 3% of the deal’s value, usually depending on the buyer’s negotiation tactics and the seller’s interest in keeping the buyer on board. If you’re particularly worried that a buyer may look elsewhere, you might want to offer a higher fee.

Strategic advantages

Break fees act as insurance for buyers concerned about the risk of an M&A deal. Some break fee agreements require a seller to pay a buyer if the buyer discovers information during due diligence that diminishes the company’s value — or if there are other factors that endanger the transaction.

At the same time, you can use break fees to your advantage. These fees have the potential to discourage other buyers from making offers. But they also can help you realize a higher purchase price if you stipulate that subsequent offers include the amount of the break fee you’ve already offered. Only serious contenders will consider paying more to stay in the game.

Depending on circumstances

When does offering to pay a break fee make sense? It depends on the state of the M&A market, industry conditions and the details of your deal. So talk with your advisors to determine whether it’s likely to work to your advantage to offer a break fee or other enticements to a potential buyer.

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