Buy-outs and break-ups

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In their dreams, jumpy Wall Street underwriters may hope financial sponsors are struck by a severe attack of buyers’ remorse. Technically, if private equity buyers want to walk away from announced leveraged buy-outs, they can. Many such deals have “reverse” break-up fees, allowing the buyer to rescind its offer for an amount worth 2-3 per cent of the deal value. Some fees are as high as $1bn.

Of course, it would not be that simple. Even assuming a private equity buyer did want to back out of a deal, and had the legal right to do so, the reputational damage would be horrible. Imagine the competitive advantage it would give private equity rivals when the next auction for a hot target gets under way – and the size of break-up fee the seller would demand. Furthermore, the idea doing the rounds that nervous banks could pay the break-up fee looks like a non-starter. It is far from clear how the banks could interfere in a contract between the buyer and seller without painful legal consequences.

But the bigger problem for underwriters is that, in most cases, private equity is unlikely to want to back out. First, the economic fundamentals still look reasonable for the businesses being taken private. Second, sponsors would forgo the juicy deal fees they stand to earn from big transactions. Third, financial sponsors have been astute at offloading risk. Financing in most big deals is now committed. If the financial markets are in turmoil, that is largely the banks’ problem. True, there are shades of grey. The more conservative underwriters will have negotiated tougher financing terms, allowing them to ratchet up interest rates to higher levels if they are stuck with funding LBO debt themselves. But that is probably the extent of the banks’ downside protection.

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