Though recent months have seen an encouraging increase in private equity deal volume, there are signs that sellers are still wary. The “reverse termination fees” that buyers pay sellers if they choose to walk away from a deal are rising.
Typically, buyers agree to pay from 2 percent to 5 percent of the value of the deal if they walk away from a deal after the merger agreement has been signed.
In 2009, when the credit crisis first showed signs of easing, Apax agreed to a 100 percent reverse termination fee for its $570 million acquisition of Bankrate.com, which owns a network of financial-focused websites.
Then in April 2010, Cerberus agreed to pay a 20 percent reverse termination fee to acquire DynCorp, and GTCR Golder Rauner agreeing to an 18 percent reverse termination fee to buy Protection One.
“I think it’s safe to say that there is definitely an increase occurring from the 3 percent fee, which was in line with the standard termination fee for sellers,” said James Kelly, a partner at law firm Nixon Peabody.
The range of acceptable termination fees for sellers was set by the Delaware Chancery Court, which sought to keep the fees low so that they wouldn’t discourage sellers’ boards from upholding their fiduciary duty to find the best offer. The idea, Kelly said, was that a high termination fee could potentially scare away other bidders. Reverse termination fees, when they first appeared, generally mirrored the standard termination fees. But there is no reason why this should be the case, Kelly said.
“The parties set the number so low that it ended up creating more optionality than there was to begin with,” Kelly said. “It kind of backfired in terms of what it was originally meant to do. Since the crisis, it’s definitely been going up.”
Some of the private equity firms who are being made to agree to high reverse termination fees may simply be facing the consequences of their actions during the crisis. In December 2007, Cerberus paid a scant 2.5 percent reverse termination fee to walk away from a deal with United Rentals – an action that may have made DynCorp more hesitant to agree a deal with Cerberus.
But the general improvement in the credit markets in recent months also means that it’s less risky for private equity buyers to agree to such high reverse termination fees.
“A buyer may be more comfortable signing onto a higher reverse termination fee, because they’re more comfortable that the financing is going to be there to get the deal done,” Kelly said.
It’s also interesting to note that although sellers are demanding higher reverse termination fees, there haven’t been many changes recently in the language of the “material adverse change” (MAC) clauses in acquisition agreements, Kelly said. MAC clauses give buyers a way out of a deal without having to pay the break-up fee, if some metric of the financial health of the target has declined beneath a previously agreed level.
“There has been increased specificity in the MAC clauses, but not very much,” Kelly said. “You would think in the wake of the crisis that there would be a lot more specificity, but there isn’t.”
In 2007 and 2008, many private equity firms were able to wriggle out of leveraged buyout agreements without paying any reverse termination fee, by asserting in court that the seller’s financial condition had materially declined. Given that private equity firms have proven themselves to be so adept at legal arguments, it would seem that sellers might be concerned with negotiating narrower metrics for proving that a material adverse change has occurred, rather than simply demanding higher reverse termination fees, Kelly said.
“In my view the game is still the same; it’s just that the stakes are going up,” Kelly said. “Now instead of fighting over three percent of the deal’s value, you’re fighting over 20 percent.”