One fee, four bases, and the band of rival bids it quietly removes from the auction.
A merger break fee is calculated as a percentage of the target's equity value at the offer price, then read per share, against enterprise value and against the premium. On an illustrative 10,000 million offer, a 3.0 per cent fee is 300 million, 1.20 a share, 2.40 per cent of enterprise value and 15 per cent of the premium. Its real effect is on a rival: with a 2 per cent overbid, a topping bidder must value the target at 42.00 a share, 5.0 per cent above the 40.00 offer, instead of 2.0 per cent without the fee.
Worked in full in Mergers and Acquisitions by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A break fee, or termination fee, is what the target pays the first buyer if the target's board walks away, usually to accept a better offer. It compensates the buyer for its costs and the deal it lost, and it discourages an interloper. Whether it is reasonable depends on what base it is measured against, and each base gives a different picture of the same number.
| Input | Value |
|---|---|
| Diluted shares, million | 250.0 |
| Offer price per share | 40.00 |
| Undisturbed share price | 32.00 |
| Net debt | 2,500 |
| Break fee, % of equity value | 3.0% |
| Minimum overbid a rival needs to win | 2% |
| Reverse break fee payable by the buyer | 5% |
Break fee = offer price × diluted shares × fee percentage
In Excel: =Offer*Shares*FeePct, here =40*250*3% = 300 million.
| Base | Base amount | Fee on that base |
|---|---|---|
| Equity value at the offer | 10,000 | 3.0% |
| Enterprise value, adding 2,500 of net debt | 12,500 | 2.40% |
| Premium paid, 8.00 a share over 32.00 | 2,000 | 15% |
| Per share | 40.00 | 1.20 a share |
Equity value is the usual base, because it is what the target's shareholders are being paid. Measured on enterprise value the fee looks smaller; measured against the 25 per cent premium it is a large slice of the value the shareholders gain from the deal. A fee drafted as 3.0 per cent of enterprise value would be 375 million, 1.50 a share, 25 per cent more than the same rate on equity.
Markets differ. In US practice target termination fees are commonly discussed as a few per cent of equity value, and courts look at their size against the deal. Under the UK Takeover Code, target-paid break fees are generally prohibited, with limited exceptions. The percentages here are illustrative.
If a rival wins, the target pays the fee to the first buyer, and the rival ends up owning a company 300 million poorer. So the rival must be able to pay the offer, plus its overbid, plus the fee per share.
Rival's minimum value per share = offer + overbid + fee ÷ shares
40.00 + 0.80 + 1.20 = 42.00, or 10,500 million for the company, 5.0 per cent above the offer. Without the fee the hurdle is 40.80, 2.0 per cent above.
The fee therefore adds three points to the gap a rival must find in synergies or conviction. Any rival that values the target between 40.80 and 42.00 a share would have topped the offer without a fee and will not with one. That band, 300 million across the whole company, is exactly the fee.
| Fee | Amount | Per share | % of EV | % of premium | Rival hurdle | Above offer |
|---|---|---|---|---|---|---|
| 1% | 100 | 0.40 | 0.80% | 5.0% | 41.20 | 3.0% |
| 2% | 200 | 0.80 | 1.60% | 10.0% | 41.60 | 4.0% |
| 3% | 300 | 1.20 | 2.40% | 15.0% | 42.00 | 5.0% |
| 4% | 400 | 1.60 | 3.20% | 20.0% | 42.40 | 6.0% |
Each point of fee adds one point to the rival's hurdle, because the fee is a percentage of the same equity value the rival must beat. Matching rights for the first buyer push the hurdle higher still: the rival must expect to bid more than once.
The mirror image is paid by the buyer if the deal fails for reasons on its side, most often a refusal of merger clearance or a failure of financing. At 5 per cent of equity value it is 500 million, 2.00 a share. If the target's board puts the chance of a regulatory block at 20 per cent, the reverse fee is worth 100 million to its shareholders in expectation, 0.40 a share, which is compensation for months of a business run under interim covenants while its share price is tied to the offer.
Size a break fee on equity value at the offer, then read it per share and against the premium: 3.0 per cent here is 300 million, 1.20 a share and 15 per cent of the premium, and it moves a rival's hurdle from 2.0 to 5.0 per cent above the offer. The premium itself is worked in how to calculate a control premium, and the seven different prices of one deal in the free workbooks for Mergers and Acquisitions.
Usually on equity value at the offer price, which is what the target's shareholders receive. The base matters: 3.0 per cent of a 10,000 million equity value is 300 million, while 3.0 per cent of the 12,500 million enterprise value would be 375 million, 25 per cent more for the same quoted rate.
The rival inherits the cost, because the target pays the fee out of its own value. With a 40.00 offer, a 2 per cent overbid and a 1.20 per share fee, a rival needs to value the target at 42.00 a share to top profitably, 5.0 per cent above the offer, against 40.80 without a fee.
A fee the buyer pays the target if the deal fails on the buyer's side, typically a refusal of regulatory clearance or a financing failure. At an illustrative 5 per cent of a 10,000 million equity value it is 500 million, 2.00 a share; at a 20 per cent chance of a regulatory block it is worth 100 million in expectation.
This article is one calculation from Mergers and Acquisitions. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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