Deals fall apart

A broken deal leaves all manner of messes in its wake: punitive break fees, reputational damage, protracted lawsuits and bitter accusations.
Recent months have seen several of the private equity industry’s largest leveraged buyout agreements crumble, and sorting out who owes what to whom is never simple. Mega-buyouts in particular rack up hefty expenses, pulling in lawyers, accountants and consultants to scrutinise the target company and work out the terms of an acquisition. When the deal fails to close, all those expenditures are for naught. It is important that there be clear language in place regarding who pays for what.
Private equity general partners typically arrange for the target company to pay for transactional costs associated with the deal if it falls apart, say Richard Becker, a partner at Hogan & Hartson and co-head of the firm’s private equity practice. Before the deal closes, his clients typically enter into letters of intent that include binding language putting the target company on the hook for transaction fees whether or not the deal goes through.
“It’s sort of priced into the deal, particularly if the deal works,” Becker says. “The target company works it into their models, in terms of how much cash they’re actually getting.”
It is possible, Becker says, for a target company to be such a hot commodity that it is able to refuse that type of provision (although this looks increasingly unlikely in today’s market). In that case, most partnership agreements are structured so that the management company picks up the transaction fee cost, and then charges the remainder of the fees associated with a broken deal, including the break fee, to the fund.
“The deal costs are sort of baked into [the GP’s] management fee and that’s why they’re so motivated to pass those costs along to the target company,” Becker says. “If they get beyond a certain threshold I would imagine the fund would pick it up, but I’ve never really seen it get into that sort of dramatic situation.”
Target companies understandably don’t want to be on the hook for an unlimited amount of fees, so the letter of understanding will often include explicit fee caps. For a venture deal, this could be anywhere from $35,000 to $45,000, Becker says, while a leveraged buyout could have a cap of a couple hundred thousand dollars.
The basic arrangement of who pays for what is generally accepted by all parties, Becker says, and is unlikely to be changed much by current economic conditions. Instead, parties should try to clamp down on costs so that less is spent to begin with.
“It’s obviously going to be an area of a lot of intense interest with the economy turning down and private equity activity turning down; but I think what you’re just going to see is a lot more tentativeness both from target companies and from funds about how much is being spent and what it’s being spent on, rather than trying to shift the burden as to who pays what cost,” he says.
Some service providers are also willing to cut their fees if the deal falls apart, although this isn’t a universal practice, he says. The key to getting a break on fees is to have developed a longstanding relationship with your service providers.
“Depending upon the quality of the relationship between the fund and the service provider, you can usually work something out. The bigger the client, the more business they give you, obviously the more motivated the service provider is to be accommodating.”