In the world of mergers and acquisitions (M&A), a breakup fee—also known as a termination fee—is a financial penalty agreed upon in advance. It is paid by the target company (the one being acquired) to the initial bidder if the deal falls through because the target accepts a competing offer from another buyer. The purpose of this fee is to compensate the original bidder for the time, resources, and opportunity costs they invested during the negotiation and due diligence process.
Why Do Breakup Fees Exist?
When companies enter into a merger agreement, the acquiring firm typically spends significant time and money investigating the target company. This includes legal fees, financial analysis, regulatory review, and management discussions. If the target company then walks away to accept a better offer, the initial bidder is left empty-handed—despite having invested heavily in the process. A breakup fee helps mitigate that risk.
It also discourages the target company from backing out of the deal too easily. At the same time, it can ensure a competitive bidding process remains fair, allowing for better offers while still respecting the initial bidder’s effort.
How Big Is a Breakup Fee?
Breakup fees usually range from 1% to 4% of the total deal value. The exact amount depends on the size and complexity of the transaction. If the fee is too high, it might be challenged in court for being excessive or for unfairly preventing other bids.
Real-World Examples
One notable example occurred in the battle for EMC Corporation in 2016. Dell acquired EMC for $67 billion, and the merger agreement included a $2.5 billion breakup fee—one of the largest ever seen. This protected Dell in case EMC decided to accept a higher offer from another suitor, which, in the end, did not happen.
Another example is the failed merger between Pfizer and Allergan in 2016. Although the deal collapsed due to changes in U.S. tax rules, not a competing offer, it still involved a breakup fee of $150 million. The fee here reflected a mutual agreement about the cost of walking away from the transaction.
In 2020, LVMH’s attempt to acquire Tiffany & Co. faced complications due to COVID-19 and legal disputes. Eventually, the two companies renegotiated terms, and while a breakup fee was initially part of the original agreement, the parties restructured the deal rather than trigger the penalty.
Conclusion
A breakup fee is a common and important tool in M&A transactions. It protects the interests of the acquiring company while still allowing room for better offers. Understanding this concept is crucial for anyone studying corporate finance, deal structuring, or corporate law, as it highlights the balance between competition, commitment, and fairness in large-scale business deals.