Intralinks recently published the findings of a long-term, global study into abandoned acquisitions – deals that are announced but which subsequently fail to complete. Together with the M&A Research Centre at Cass Business School, London, we investigated more than 78,500 M&A deals announced over the past 25 years to identify the significant predictors of failed deals, and the strategies that acquirers and targets can employ to increase the likelihood of successful deal completion. We also interviewed 40 global M&A professionals, and incorporated their insights into our report. I’ll also highlight some of their comments in this post.
My first blog post on our study, Abandoned Acquisitions: Why do some deals fail to complete?, gave an overview of its key findings. In this second, and subsequent posts, I’ll take a deeper dive into the most significant predictors of deal failure. If you want more details about the methodology and data sample behind our study, please download the full report here.
In this post, I’ll discuss the subject of break fees, also known as termination fees, which were found to be the most significant factor affecting deal failure involving publicly listed M&A targets and the fourth most significant factor involving private M&A targets.
Public M&A targets
Our analysis revealed that, for public M&A targets, target termination fees (i.e., a fee payable by the target to the acquirer if the deal fails to complete) reduced the average probability of deal failure by almost 12%, compared to deals where no target termination fee had been agreed. As the chart below shows, in every M&A cycle over the past 25 years, public M&A target deals with target termination fees have significantly lower deal failure rates than deals without such fees. Over the entire period of the study, the average failure rate for deals for public targets where the target agreed to pay a termination fee was 4.7%, compared to 13.4% for deals where no such fees were payable – almost three times as high. In contrast, our study found that reverse break fees, (also known as acquirer termination fees, i.e., a fee payable by the acquirer to the target if the deal fails to complete) had no significant impact on deal failure involving public M&A targets.
There may be several explanations for this finding. One is that break fees make target companies think more carefully about agreeing to an acquisition. “If there are termination fees, the parties will be much more cautious when entering into the agreement,” says a corporate development director of a US private company.
Another explanation is that break fees help to align the interests of target and acquirer in ensuring successful deal completion. “These fees are effective because they provide an incentive to both parties to move forward and complete the deal,” says a senior vice president of a US public company.
Another commonly cited reason for break fees was to increase the hurdle for rival bids for the target. “We use break fees when we’re concerned about securing exclusivity,” says the chief investment officer of a European private equity firm.
Public companies, with a public shareholder base and activist investors who may wish to maximize short-term shareholder returns, are usually under an obligation to consider serious approaches from acquirers. An acquirer who makes the best agreed offer for a public target may therefore feel entitled to demand a break fee if the deal does not complete.
Nevertheless, not everyone is convinced that break fees are such an important factor in ensuring that an agreed deal proceeds to completion – rival bidders may simply be asked to meet the target’s termination fee costs, for example. Indeed, some executives believe that insisting on this sort of term can be counter-productive. “It would surprise me if they had any real impact,” says a senior vice president of a US public company. “Where they are effective, I think they are effective for the wrong reasons. Deals should rise and fall based on strategic reasons only.”
Those not convinced by the merits of break fees also point out that their prohibition in the UK does not appear to have had a material impact on deal failure rates. Since September 2011, target termination fees and all other forms of deal protection which impose obligations on a target in the UK are subject to a general prohibition under the UK Takeover Code. “M&A in the UK is handled with care and professionalism and termination fees are not an essential part of deal success,” says a senior director of corporate M&A of a Swiss public company.
However, the majority view of our interviewees can be summed up by the head of corporate development of a US public company: “Target termination fees reduce the chances of deal failure. Due to the break fee, a target company is more committed to, and serious about, closing the deal.”
Private M&A targets
For private M&A targets, our study found the opposite effect of break fees compared to public targets: whereas acquirer termination fees didn’t affect outcomes for deals involving public targets, they reduced private target deal failure by 2%, making them the fourth most significant factor influencing private target deal failure rates. In contrast to the findings involving public targets, our study found that target termination fees for private targets had no significant impact on deal failure.
One explanation for the contrasting findings regarding break fees for public vs. private M&A targets may be the following: unlike public companies, private companies are under no obligation to consider an acquirer’s interest. Private companies have no public shareholder base or activist investors who may relish a bid, or even a bidding war, for the target. Private companies do not have to consider the shareholder value implications of an acquirer’s bid.
For a private company, the decision to engage with an acquirer is usually entirely voluntary and may involve months of work and distraction for the target’s management and employees to accommodate the acquirer’s due diligence process and negotiations that may, or may not, eventually result in a firm offer. Therefore, a private target company may wish to ensure that an acquirer is effectively incentivized to complete an agreed deal, and that the acquirer is forced to share the pain and pay a penalty if it decides to walk away.
“Leveraging termination fees is a good idea for both the parties. Therefore, in an M&A transaction, both the parties must be aware of the risk involved, and manage the deal by structuring it appropriately with the help of termination fees,” says the managing director of a Hong Kong private company.
To find out more about the predictors of deal failure, and the strategies acquirers and targets can use to avoid the deal failure trap, download Abandoned Acquisitions: Why do some deals fail to complete?