Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Exclusivity Fee Trap That Cost a Seller 40 Million
Transcript
- Lucas: So we've spent a lot of episodes on traps that trigger when a deal is moving forward. Today I want to talk about one that hits you when the deal falls apart. It's the exclusivity fee, and it cost one seller forty million dollars. Luna: An exclusivity fee? That's not something you hear about every day. Usually it's the buyer complaining about wasted time, not the seller writing a check. Lucas: Exactly. And that's the trap. A seller signs a ninety-day exclusivity agreement, thinking it's just a promise not to shop the company elsewhere. But buried in that term sheet is a clause that says if the deal doesn't close, even because the buyer can't get financing, the seller owes the buyer a fee. In this case, it was fifty million dollars, and the seller ended up paying forty. Luna: Wait, how does that happen? The buyer's the one who walks away, and the seller pays them? That seems backwards. Lucas: It does, but it's more common than you'd think. The logic from the buyer's side is: we're spending millions on due diligence, legal fees, and management time. We want some protection if you decide to back out and sell to someone else. That's the legitimate use. But the trap is when the fee triggers regardless of why the deal fails, including the buyer's own cold feet or financing falling through. Luna: So the seller is basically on the hook for the buyer's risk. That seems like a lopsided deal. Lucas: It is, but sellers often sign because they're flattered by the offer and they want to show good faith. They don't realize that the exclusivity fee can be as high as three to five percent of the enterprise value. For a billion-dollar company, that's fifty million dollars. Luna: And in this case, what actually happened? Why did the deal fall through? Lucas: The buyer was a private equity firm, and they'd lined up debt financing contingent on their own internal approval. About six weeks in, their investment committee got cold feet over some industry headwinds, and they pulled the offer. The seller had already turned down a competing bid from a strategic buyer because of the exclusivity agreement. So the seller was left with nothing, and then the PE firm demanded the fee. Luna: That's brutal. So the seller lost the better deal and then had to pay the buyer for the privilege of losing it. Lucas: Exactly. And the worst part is, the seller's lawyers had flagged the clause early on, but the seller wanted to keep the momentum going and didn't want to seem difficult. They figured the deal would close anyway. That's a classic mistake. Luna: So what should a seller look for? How do you avoid this? Lucas: First, the fee should only trigger if the seller walks away to take a better offer, not if the buyer backs out for any reason. Second, cap the fee at something reasonable, like one percent of enterprise value, and make it mutual. If the buyer walks, they pay the seller a fee to compensate for the time and lost opportunities. Luna: Mutual breakup fee. That makes sense. And what about the exclusivity period itself? Lucas: Keep it as short as possible. Thirty to forty-five days is usually enough for a serious buyer to do preliminary due diligence. Ninety days is a long time to take your company off the market, especially if the buyer's dragging their feet. Luna: And I assume you'd want to protect yourself with a fiduciary out, right? Like, if a better offer comes in, you can still take it. Lucas: Yeah, that's crucial. But even with a fiduciary out, the buyer will often demand a matching right or a fee if you leave. So you need to negotiate that carefully. The bottom line is: the exclusivity fee is a risk allocation tool, and sellers need to understand how it's drafted. Luna: And this is the kind of thing that can make or break an exit. I mean, forty million dollars is a lot to lose over a clause you thought was just a formality. Lucas: Totally. And it's not just the money. The seller also lost nine months of their life and had to go back to the market with a tainted deal. That's a huge opportunity cost. Luna: You know, it makes me think about how we approach our own work. We're not selling companies, but we're in the business of sharing knowledge, and we do it without any ads or sponsors, which is pretty rare these days. Lucas: Yeah, we're lucky that a small group of listeners chips in monthly through Buy Me a Coffee at buy me a coffee dot com slash fexingo. It's not a huge number, but it covers the hosting costs and keeps the whole thing running. Luna: And it means we can keep doing deep dives like this without worrying about ad reads or selling out. So if this podcast has helped you in your own deal-making, consider throwing a few bucks that way. No pressure, but it genuinely helps. Lucas: Right. And speaking of deal-making, let's get back to the exclusivity fee. Another thing to watch is the definition of 'failure to close.' Some agreements say the fee is due if the deal doesn't close by a certain date, regardless of why. That's a landmine. Luna: So you'd want to tie it to a specific event, like the buyer backing out or the seller breaching a representation. Lucas: Exactly. And you also want to make sure the fee is a liquidated damages provision, not a penalty. If it's structured as a penalty, courts are less likely to enforce it. But the buyer will draft it to look like a reasonable estimate of their costs, so you need to challenge it. Luna: I've also heard about 'reverse breakup fees' where the buyer pays if they can't get financing. That's becoming more common, right? Lucas: It is, especially in larger deals. But for mid-market deals, sellers still don't ask for it, and that's a mistake. You should always ask for a reverse breakup fee if the buyer's financing is a condition to closing. It gives them skin in the game. Luna: So what's the key takeaway for a seller listening to this? If you're about to sign an exclusivity agreement, what should you do? Lucas: First, get a lawyer who does M&A all day, every day. Second, assume the deal might fall apart, and negotiate the exclusivity fee as if it's going to trigger. Cap it, make it mutual, and tie it to specific events. And third, keep the exclusivity period short and include a fiduciary out. Luna: And if the buyer insists on a long exclusivity with a big fee, that might be a red flag. It could mean they're not serious or they're planning to lowball you later. Lucas: Right. A serious buyer will be willing to share the risk. If they're not, you have to ask yourself why. In the case of that forty million dollar loss, the buyer was a known PE firm with a reputation for playing hardball, and the seller just didn't push back. Luna: It's a tough lesson. But I think it's one that can save you a lot of money if you're in that position. Lucas: Absolutely. And if you're a buyer listening, well, be careful too. If you demand an exclusivity fee that's too aggressive, you might scare off good targets. A fair deal is better for everyone. Luna: So, next time you're at the negotiating table, remember the exclusivity fee. It's not just a formality; it's a real financial risk. Lucas: Exactly. And that's the value of these episodes. We dig into the details so you don't have to learn the hard way. Thanks for listening, and if you want to support us, you know where to find us.