Quick facts
- What it is: a payment owed if the target terminates to take a better offer
- Typical size: a low single-digit percentage of equity value
- Legal test: within a range of reasonableness, judged with the whole deal
- Reverse version: payable by the buyer if the buyer fails to close
- Purpose: compensate a bidder, not to foreclose competing bids
A break-up fee, also called a termination fee, is money the target pays the buyer if the deal falls apart for specified reasons, most commonly because the target accepted a better offer from someone else.
It is compensation for a bidder who spent money and lost. It is also, if set too high, a way to stop anyone else from bidding, which is why courts look at it.
In plain English
Bidding for a company is expensive. Advisers, lawyers, financing commitments, and months of management time, all spent on something that might evaporate if a rival appears at the last moment.
A break-up fee makes the first bidder whole. The problem is that the same fee raises the price for the second bidder, who must now beat the offer and cover the fee. Set it high enough and there is no second bidder, which suits the first one perfectly.
What a real negotiation looks like
In re Toys "R" Us, Inc. records the bargaining directly. In its proposed merger agreement, the KKR group "asked for a termination fee of 4% of the implied equity value of the transaction to be paid if the Company terminated to accept another deal, as opposed to the 3% offered by the company in its proposed draft." The company's negotiators then "bargained the termination fee down to 3.75% the next day," while also reducing the expenses the buyer sought in the event of a failed shareholder vote.1
Three percent, four percent, settled at 3.75%. That is the actual range these negotiations occupy, and it explains why break-up fees are quoted as percentages of equity value rather than round numbers.
How courts assess them
There is no fixed ceiling. Delaware applies a standard rather than a rule: courts "will not substitute their business judgment for that of the directors, but will determine if the directors' decision was, on balance, within a range of reasonableness."1
That assessment is contextual. A fee is not judged alone but alongside the rest of the deal protections, the strength of the price, and how likely another bidder actually was. In Toys "R" Us the board knew the only other bid was $1.50 per share lower, worth some $350 million less,1 which made a competing offer improbable and the fee correspondingly less obstructive.
The underlying principle traces to Revlon, where the court accepted that lock-ups and related agreements "are permitted under Delaware law where their adoption is untainted by director interest or other breaches of fiduciary duty," while holding that Revlon's own arrangements failed that standard.2
The distinction is consistent across both cases. A protection that compensates a bidder is legitimate. A protection that forecloses the auction is not.
The reverse break-up fee
The mirror image, payable by the buyer to the target if the buyer fails to close. It is common where the risk of non-completion sits on the buyer's side: financing that might not materialise, or antitrust clearance that might not arrive.
For a seller this matters more than the headline price. A buyer who cannot complete leaves the target damaged, with customers unsettled, staff departed and months lost. The reverse fee prices that risk, and its size tells you how confident the buyer really is.
Related protections
Break-up fees rarely appear alone. They sit alongside no-shop clauses limiting the target's ability to solicit other offers, matching rights letting the buyer top any rival bid, and sometimes a go-shop provision permitting a defined period of active solicitation.
Courts assess the package. A modest fee combined with a strict no-shop and unlimited matching rights can be more restrictive than a larger fee standing alone.
Where the protections are adopted defensively rather than as part of an agreed sale, the older Unocal question also applies: whether the board had reasonable grounds to perceive a threat, and whether its response was "reasonable in relation to the threat posed."3
What this means for a founder
Break-up fees appear in private acquisitions too, usually smaller and often framed as expense reimbursement.
The questions worth asking are the same ones a court asks. What triggers the fee, and does it cover situations where the buyer simply changed their mind? Is it reciprocal, so that a buyer who fails to close owes you something? Is it capped at documented expenses, or is it a percentage that exceeds what the buyer actually spent?
And the practical one: if a better offer arrived next month, what would it have to be worth for your shareholders to still be better off after paying this fee? If you cannot answer that quickly, the number is too high.
Related reading
- Go-Shop Provision covers the clause that reopens the auction after signing
- Material Adverse Change Clause covers the buyer's other route out
- Crown Jewel Defense covers the lock-up structures these fees replaced
- White Knight covers the competing bidder a fee makes more expensive