DealLawyers.com Blog

There are always a lot of issues to keep in mind when negotiating termination fees, including most prominently the size of the fee, whether it is calculated by reference to enterprise or equity value, and the circumstances that will give rise to an obligation to pay the fee. This Debevoise article reviews current market practice surrounding termination fees and reverse termination fees. This excerpt addresses some things to keep in mind when negotiating the size of the fee:

Equity value is the typical metric, though there may be circumstances that warrant looking at enterprise value too. Relating the size of the break-up fee to equity value is the most common approach. However, the Delaware Court of Chancery in Lear and later in Cogent acknowledged that relating the fee to enterprise value could also be appropriate for transactions with highly leveraged targets, because most such acquisitions require the buyer to pay for the company’s equity and refinance all of its debt.

The typical size of termination fees is in the 2.0% – 3.5% range. Generally speaking, the most common range for termination fees is between 2.0% and 3.5% of equity value though negotiations may result in a termination fee outside of this range. In Houlihan Lokey’s most recent termination fee study, the smallest termination fee observed was 0.2% and the largest was 6.0%.6 The Delaware Court of Chancery has mentioned, while declining to decide the issue of whether a termination fee was coercive, that a 6.3% termination fee “seems to stretch the definition of range of reasonableness.” The average termination fee for deals announced in 2024 was 2.4% of equity value, slightly down from 2.5%, 2.7% and 2.9% in 2023, 2022 and 2021, respectively.

But, there is no bright-line test for reasonableness. Delaware courts have been clear that a purely formal, mechanical view based on percentage is not sufficient and there is no percentage that is per se acceptable. The reasonableness of the size of the termination fee will necessarily be informed by the specific deal dynamics. A target company board should take the same approach when assessing a termination fee proposal from a buyer.

The article notes that the reasonableness of a particular fee needs to be assessed holistically based on the facts and circumstances surrounding the deal, including the negotiating history, the parties’ relative negotiating strength, and the economic effect of other deal protection features, such as expense reimbursement obligations.

– John Jenkins