In the few years before the credit crisis, financial buyers often arranged to buy businesses in deals that required a termination fee to be paid by the sponsor if the shell-company buyer refused to consummate the transaction. These reverse termination fees evolved out of seller demands for sponsors to eliminate traditional financing conditions and add more "skin-in-the-game." Typically, the fee was payable by the buyer whether or not the failure to close was due to financing failure. The price of this "option" was typically the same as the breakup fee paid by a seller following a successful topping bid (about 2% to 4% of the equity value). When the credit markets tightened, financial buyers demonstrated a willingness to exercise that option. With the return of significant financial sponsor activity since the fourth quarter of 2009, sellers and financial buyers have had to adapt. As a result, reverse termination fees as a percent of equity value are now much larger than they were before the credit crisis but they are still frequently less than sponsor equity commitments.
Below is a link to a brief video interview by The Deal of Phillip R. Mills, a partner in Davis Polk's Mergers and Acquisitions Group, in which Mr. Mills discusses how reverse termination fees have increased in size since the financial crisis, the different types of present-day reverse termination fees, and the adaptability of private equity buyers in today's changed environment.
Click here to access the video interview from The Deal.