Bid protections come out of the sale proceeds, so a topping bid is worth far less to creditors than its headline suggests.
The minimum overbid is the stalking horse price plus the break-up fee, plus the capped expense reimbursement, plus the minimum bid increment. On an illustrative $200 million stalking horse bid with a 3 per cent fee, $1.5 million of expenses and a $1.0 million increment, the first topping bid must be at least $208.5 million, yet it leaves the estate only $1.0 million better off, because $7.5 million goes straight back to the stalking horse.
Worked in full in The Distressed Debt Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
In a Section 363 sale the debtor usually signs an asset purchase agreement with a first bidder, the stalking horse, and asks the bankruptcy court to approve bidding procedures around it. The stalking horse sets the floor and does the diligence that makes the auction possible. In return it asks for bid protections: a break-up fee and an expense reimbursement, usually payable if it is outbid and the alternative sale closes, and a minimum increment that any rival must clear. Break-up fees are often in the region of 2 to 4 per cent of the purchase price, with expense reimbursement on top, and minimum increments vary from case to case; all are set in the bidding procedures the court approves. Those protections are paid out of the sale proceeds, which means out of the creditors' recovery. The question for a distressed investor holding unsecured claims is how much of the topping bid actually reaches the waterfall.
| Input | Value |
|---|---|
| Stalking horse bid | 200.0 |
| Break-up fee, % of the bid | 3.0% |
| Expense reimbursement cap | 1.5 |
| Minimum bid increment | 1.0 |
| Secured debt, paid first from proceeds | 150.0 |
| Administrative and wind-down costs | 10.0 |
| General unsecured claims | 100.0 |
The structure is deliberately simple: one asset, one secured class paid in full, one unsecured pool taking what is left. Real cases add priority claims and disputes over what the liens cover, but the arithmetic of the protections does not change.
Break-up fee = 3.0% × 200.0 = 6.0; protections = 6.0 + 1.5 = 7.5
Minimum overbid = 200.0 + 7.5 + 1.0 = 208.5, 4.25% above the stalking horse bid
Net to the estate if the minimum overbid wins = 208.5 − 7.5 = 201.0
Unsecured pool = net proceeds − 150.0 secured − 10.0 admin
Excel: =SH*(1+Fee)+Expenses+Increment for the minimum overbid, and =MAX(0,MIN(Gross-Protections-Secured-Admin,GUC))/GUC for the unsecured recovery
| Outcome | Gross price | Protections paid | Net to estate | Unsecured recovery |
|---|---|---|---|---|
| Stalking horse wins, no auction | 200.0 | 0.0 | 200.0 | 40.0 |
| Rival wins at the minimum overbid | 208.5 | 7.5 | 201.0 | 41.0 |
| Auction runs to 220.0 | 220.0 | 7.5 | 212.5 | 52.5 |
A headline 4.25 per cent topping bid is worth 1.0 cent to the unsecured class. The protections are a one-off cost, though: once they are paid, every further dollar of competitive bidding goes to the estate. The auction that runs to $220.0 million raises the gross price by $20.0 million and the unsecured recovery by 12.5 cents, a net uplift of $12.5 million. That is why creditors' committees fight over the size of the protections at the bidding procedures hearing rather than at the auction: after approval, the cost is fixed and only the competition is variable.
Suppose a rival buyer would pay up to $205.0 million. Without protections it could bid and force the price up. With them, it cannot submit a qualifying bid below $208.5 million, so it stays out, and the asset sells to the stalking horse at $200.0 million. The protections create a zone of 8.5 in which a higher value exists but cannot be captured; in this case up to $5.0 million, 5.0 cents of unsecured recovery, is left on the table. A topping bid only improves on the stalking horse outcome above $207.5 million gross, and only buys the unsecured class 5 cents more at $212.5 million.
| Break-up fee | Protections | Minimum overbid | Dead zone | Gross bid for +5 cents |
|---|---|---|---|---|
| 1% | 3.5 | 204.5 | 4.5 | 208.5 |
| 2% | 5.5 | 206.5 | 6.5 | 210.5 |
| 3% | 7.5 | 208.5 | 8.5 | 212.5 |
| 4% | 9.5 | 210.5 | 10.5 | 214.5 |
The minimum overbid always nets the estate exactly one increment more than the stalking horse bid, whatever the fee: 41.0 cents in every row. What the fee changes is the width of the dead zone and the gross price a rival must reach before creditors see a real improvement. Each percentage point of fee on a $200.0 million bid is 2.0 cents of unsecured recovery when a topping bid wins at any given price, and a wider band in which no rival can bid at all.
Reading the topping bid as the sale price in the recovery model. Plug $208.5 million into the waterfall without deducting the protections and the unsecured class shows 48.5 cents instead of 41.0, an overstatement of 7.5 cents that is entirely the stalking horse's fee and expenses. The second mistake is to treat the protections as a pure cost. Without a stalking horse there may be no floor at all, and a floor of $200.0 million against a liquidation value well below it is worth more to creditors than the $7.5 million it may cost. The test is whether the fee is plausibly the price of getting a credible first bid, which is broadly what the court is asked to weigh.
The book's recovery model drives the waterfall off a few visible assumptions, and the free workbooks for the book's cases build that waterfall by live formula. For how a recovery turns into a return over time, see what an 80-cent recovery is actually worth.
Minimum overbid = stalking horse bid + break-up fee + expense reimbursement + increment. Here $200.0 million becomes $208.5 million, the estate gains only $1.0 million from it, and rivals valuing the asset between $200.0 and $208.5 million are shut out. Model the protections as a deduction from any topping bid, and judge them by the dead zone they create.
The estate, out of the proceeds of the winning bid, so it reduces what reaches creditors. In the illustrative case a rival who wins at the $208.5 million minimum overbid triggers $7.5 million of fee and expenses, leaving $201.0 million: the unsecured class recovers 41.0 cents instead of the 48.5 a model that ignores the protections would show.
The band between the stalking horse bid and the minimum overbid, in which a rival cannot submit a qualifying bid. With a $200.0 million bid and $7.5 million of protections plus a $1.0 million increment, a buyer valuing the asset at $205.0 million is shut out, and up to $5.0 million, 5.0 cents of unsecured recovery, is left uncaptured.
On a $200.0 million bid, each extra percentage point of fee costs the unsecured class 2.0 cents of recovery when a rival wins at a given price, and widens the dead zone by $2.0 million. Moving from a 1% to a 4% fee raises the minimum overbid from $204.5 million to $210.5 million, while the estate still nets only one increment more than the stalking horse bid.
This article is one calculation from The Distressed Debt Investor. 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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