As a mergers and acquisitions intermediary who has facilitated transactions in the technology sector for over twenty-five years, I have been watching the potential acquisition by Adobe of Figma with interest for over a year.  The potential $20 billion dollar deal recently fell apart due to regulatory issues in the United Kingdom and European Union.  One element of the negotiations between the parties was the first 10 figure ($1 Billion Dollar) breakup fee I am aware of ever occurring (https://fortune.com/2023/12/18/adobe-figma-breakup-european-regulators-merger/) in a failed transaction.

This situation generated a robust discussion at IBA about when and why is a breakup fee justified in a potential transaction.  At a main street or middle market level of transactions, the breakup fee might be described as the loss of all or part of an earnest money deposit by a buyer or financial damages assessed on the seller for not negotiating in good faith.  IBA is unique in the Pacific Northwest in that based on the size of the firm and the areas of specialization of members of our team, we annually facilitate transactions with values of six, seven, and eight figures providing us with direct market recognizance on a broad spectrum of deal sizes and industry sectors (https://ibainc.com/industries-served/).  As a firm, we take as much pride in facilitating the sale of a community beloved eating establishment as a merger between privately held companies or the acquisition of a privately held company by a publicly traded one.

What is the purpose/value of a breakup fee or earnest money deposit in a business sale transaction letter of intent?

This negotiated element potentially benefits both sides of a transaction in a variety of ways.

1. It has been IBA’s preference in negotiating the sale of privately held companies and family businesses for almost five decades as a sell side broker to obtain a financial deposit from potential buyers when agreement is reached on a letter of intent.  The reason we consistently seek placement of a deposit into a neutral third party escrow account (https://ibainc.com/blog/jen-post/understanding-what-a-truly-neutral-closing-agent-looks-like-in-your-transaction/) is that the movement of capital conveys a mental & emotional commitment to a transaction by a buyer that does not occur without that activity. Business buyers are savvy negotiators.  Many will attempt to take a business off the market and enter a period of exclusive negotiations with a quick, seller pleasing letter of intent in terms of preliminary price and terms, only later to “take another bite at the apple” through a secondary negotiation when a seller is emotionally & mentally committed to the transaction and no direct competition exists for the acquisition of a business.  The obtainment of a deposit from the buyer helps vet out the lookers from the buyers and mitigates the likelihood a potential acquirer has multiple deals under LOI and is in the process of selecting their preferred one from the group without much thought of the implications of backing out to the seller.
2. A breakup fee benefits both parties as it can create a tangible cost associated with walking away from the negotiating table when progress has a confrontational or complicated component. This frequently occurs in the legal domain. For example, I facilitated the sale of a manufacturing company, Lancs Industries (https://ibainc.com/blog/david-garfield/the-story-of-graham-barbara-hollingworth-lancs-industries/) that fabricated products out of lead to mitigate nuclear radiation exposure.  The negotiations in that transaction related to the representations, warranties, and indemnification clauses in the stock purchase agreement associated with potential trailing liability responsibility for employees and warranty claims from customers were sophisticated and detailed.  Multiple times the parties were inclined to walk away from the transaction. The deposit in place kept them at the table and with superior dealmaking M&A facilitation and legal counsel solutions were found that satisfied the parties and the transaction closed.
3. Potential contractual financial damages for the seller for not negotiating in good faith benefit the buyer in a letter of intent. It is not uncommon for a business owner to reach agreement in a competitive M&A environment with one buyer and to have the unsuccessful acquisition partners remain in contact with the business broker and/or try to replace the first position party by increasing their offer or sweetening deal terms.  Damages for exiting a deal for an attractive “bird in the bush” can help a business buyer keep the seller focused on the task at hand when a siren’s song has them inclined to go see what is potentially behind door number 2.   In addition, when a buyer has an earnest money deposit in place, in transactions employing best practices legally, that amount should be refunded before a sale is completed to an alternative buyer.
4. Both parties accrue substantial costs in pursuit of a completed transaction. Expense generating professionals ranging from attorneys to accountants to appraisers and environmental assessors will not refund their cost, if a deal fails. Sometimes life happens resulting in a party being forced to walk away from a deal.  One time, I had a buyer’s spouse enter a mental hospital because of the fear created by the risk of entrepreneurship versus the security of the highly compensated executive salary in place to fund their lifestyle and retirement.  A highly qualified, financially strong buyer exited that potential transaction out of fear for their marriage, the impact on their children, and the mental stability of a spouse they loved.  In this situation, the seller was justified in their request to be reimbursed for the expenses generated with trying to complete a transaction with that party.
5. A business and a seller can be financially damaged by a failed deal. The confidential nature of the information that a business is being sold can be protected for only so long.  At a point in a transaction, key employees, customers, and vendors (e.g., the landlord) often need to be brought into the loop of knowledge about the contemplated transaction.  If a transaction fails after that has occurred, the value of the business and rapport of ownership with important parties related to the success of the company can be impacted.  It is reasonable, if damage occurs or has the potential to occur for the buyer to help mitigate the cost of that damage, if they do not complete the transaction after starting invasive engagement with elements of the business.

IBA since 1975 has professionally facilitated over 4300 transactions in Washington, Oregon, Idaho, and Alaska.  Confidentiality about the sales has been traditionally protected until the parties involved in the deal wanted to make public disclosure about the transition of ownership. IBA sells 80 – 90% of its sell side engagements annually with a significant majority selling within 10% of their initial asking price and only going into escrow one time completing a sale to that selected buyer. The key to this success is IBA’s market leading knowledge, experience, and skill as a business brokerage firm.  It also is reliant on our ability to employ best practices.  If you are considering the sale of a business in 2024, we would welcome the opportunity to learn about your exit strategy objectives and provide an overview of our representation services.   Another attribute of IBA is we do not collect a penny from our clients until we have successfully completed our assigned business sale project.  How many salespeople do you know that are willing to put their money where their mouth is in 2024?   We remain committed to the same customer centric, paid on performance practices that have been in place at IBA since before America’s bicentennial celebration in 1976.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.