What Does Reverse Termination Fee Mean?
A reverse termination fee is a certain amount of money that an acquiring entity pays a target entity when the deal is not completed. The objective of this fee is to give some measure of confidence in the other party that the deal will be completed, and also to compensate the target entity for the time, effort and expenses incurred towards the deal. In fact, willingness to provide a reverse termination fee can be a crucial factor in the target organization's acceptance of a bid.
Divestopedia Explains Reverse Termination Fee
A reverse termination fee is the opposing side to a termination fee, in which the target entity pays a certain amount of money to the acquirer if the deal does not go through. Both terms are essential parts of merger agreements as they give the acquirer and the target organization fair compensation for their efforts when the deal does not get completed by either party.
A reverse termination fee comes with additional conditions that include inability to raise the funds needed to close the deal, breaches to the agreement accepted by the acquirer and failure to get financing or regulatory approval, if applicable. In such cases, the acquirer has to pay the stipulated reverse termination fee to the target entity.
In most cases, the size of the reverse termination fee depends on the size of the deal as the former is an agreed percentage of the entire deal value. These fees are negotiated beforehand by both parties so that they are an integral part of both public and private mergers. The fee also gives an idea to the target entity about the possible risks associated with the deal. It also gives them the probability of the deal not going through based on the negotiations and agreements entered by both parties pertaining to reverse termination fees. When the acquiring company agrees to a high percentage, it indicates that the deal is more likely to go through; but, if not, the acquirer may agree to a lower percentage. While these are not hard rules, it is common sense for acquirers to save their money in the case of a failed deal. The same idea is applicable to target entities and termination fees as well.
Reverse termination fees are difficult to negotiate in middle-market transactions. It is usually understood that there is risk in undertaking the acquisition of a mid-market business and, therefore, payment of a termination fee to either the buyer or seller is rarely seen.