Termination fee (break-up fee)

A termination fee, or break-up fee, is a payment specified in a merger agreement that one party must make to the other if the deal is called off for certain reasons. The standard fee is paid by the target to the buyer; a reverse termination fee is paid by the buyer to the target.

How it works

A target typically owes the fee if its board changes its recommendation or terminates the agreement to accept a superior proposal, or if it signs another deal within a set period after a failed vote. These fees commonly run about 2% to 4% of the deal's equity value; courts look skeptically at fees large enough to deter rival bidders. A lower fee often applies to bidders who emerge during a go-shop period.

A reverse termination fee protects the target if the buyer cannot close, most often because of failed financing or antitrust rejection. In private equity deals, it may be the target's main remedy. In large strategic deals with heavy regulatory risk, reverse fees can be substantially larger than the target's fee.

Why it matters for traders

Fees shape behavior. A large target fee raises the cost for any competing bidder, making a topping bid less likely. A large reverse fee signals the buyer is confident about regulatory approval, or at least willing to pay to show it. For arbitrage traders, a reverse fee also provides partial compensation to the target if a deal breaks, softening the downside. Both fees are disclosed in the 8-K announcing the deal and detailed in the merger agreement.

Example

Hypothetical Northwind Health (NWHL) agrees to acquire Contoso Diagnostics (CTDX) for $4 billion. The agreement sets a $140 million termination fee (3.5%) payable by CTDX and a $300 million reverse termination fee payable by NWHL if antitrust approval is not obtained. A rival later offers $4.4 billion; to make its bid work, it must cover the $140 million fee CTDX owes NWHL, so the rival's effective cost is $4.54 billion.

FAQ

Who pays a break-up fee?

Usually the target, if it walks away for a better deal. A reverse termination fee is paid by the buyer, typically if financing or regulatory approval fails.

How big is a typical termination fee?

Often around 2% to 4% of the deal's equity value, though it varies with the deal and any go-shop terms.