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Deal Protection in Mergers & Acquisitions

Mergers and acquisitions are the bread and butter of investment banking. However, plenty of mergers and acquisitions fall through for various reasons. As such, the acquiring firm will want to employ strategies that ensure that they can consummate the transaction.

Deal protection exists because acquiring companies want to be secure from events that might lead to a deal falling apart. Or if it a deal does end up failing, the companies like to be compensated for the effort that was put in into the deal.

Because management and ownership are separated, a board of directors might agree to a deal before shareholders hold a formal vote. In that case, what happens when a third party steps in with a better offer? Deal protections come in to make it harder for any third parties considering a bid.

Termination Rights

A target company usually has the right to terminate the original merger agreement if it receives a superior proposal and the board wants to accept the new deal. However, buyers would want to make it harder or more expensive for the target to switch.

The no-shop (“no-talk”, “non-solicitation”)

Once the merger agreement is signed, target has to stop considering competing bids.

The Fiduciary Out

If the board receives an unsolicited superior proposal from a third party, then by not considering that proposal the board would be breaking its fiduciary duty to the shareholders. Sometimes an event might cause the board to realize that the target company is worth much more than what it was believed to be worth at signing. This is often referred to as finding gold in the backyard. On these occasions, the board would also be breaking its fiduciary duty to let the proposal proceed. The fiduciary out provision allows directors to freely provide information to the competing bidder.

Termination Fees (break-up fees)

Charge levied when one party fails to consummate a merger can happen if the target is unsuccessful in getting shareholder approval or because it agreed to a competing offer. The fee should be close to an estimate of costs realized by the bidder as a result of termination. Often criticized for being a tool used to force shareholders and directors to accept the deal.

Reverse Breakup Fees

If the acquiring company fails to close the transaction, usually because it can’t obtain the necessary financing, it has to pay a penalty to the target. The fees serve as an insurance from disruption of operations, loss of key employees and potential lawsuits for when the target is in play.

Topping rights

Original bidder wants to know exactly what is going on in the negotiations with a competing bidder. Before the seller can terminate the initial agreement with the original bidder, he is given several days to renegotiate, and usually has to increase its offer by a prespecified amount to keep board support.

Go-Shop Clause

In some cases the transacting parties can’t reach an agreement on price. The buyer might offer the seller to take some time (usually 30 days) after signing the merger agreement to announce the proposed deal publicly and wait for competing bids. If the target does receive one, the break up fee would be reduced and some of the other deal protection provisions wouldn’t apply. If they don’t end up finding a better deal, then the seller would accept the buyer’s price, and the buyer would keep all the provisions.

Right to Match/Matching Right

If the board of directors of the seller wants to either terminate the agreement or change the recommendation for it, the buyer has the right to improve its offer before the decision is made. It’s usually important for situations when the seller receives a superior proposal from a third party during the go-shop period. The buyer can also negotiate a right to improve its offer if the target board has a right to change its recommendation because of an intervening event (gold in the backyard). In this case, the right is not to “match” an offer, but to make enough changes to the agreement so as to avoid the need for the board to change its recommendation.

Shareholder Lock-up

The buyer can enter into an agreement to lock-up target’s shareholders, preventing them from selling their shares to anyone except for that buyer. Soft lock-ups allow shareholders to sell if they receive a superior offer. Hard lock-ups are unconditional.

Often buyers like to have the target company’s board support to make the process of acquiring easier. Working closely with the board would give the buyer access to more confidential information, and the board knows well all the details of the business and best ways to run it. Having their support also makes it easier to get the shareholder support.

However, not every takeover is friendly, and shareholders often want to have some kind of protection from possible transfer of shares to undesirable or unknown companies/individuals. At the same time, in case of an attractive offer, the shareholders willing to cash out would want liquidity. To help reach a compromise between non-selling and selling shareholders the shareholder agreement – an arrangement among shareholders that describes how the company should be operated and outlines shareholders’ rights and obligations – usually includes the right of first refusal or the right of first offer.


Right of first refusal (ROFR). After the selling shareholders receive third party offers for their shares, non-selling shareholders have the right to accept an offer from selling shareholders on the same terms.

Right of first offer (ROFO). The non-selling shareholders have the right to be offered the selling shareholders’ shares before any third-party negotiations.

Quite often, price and protection provisions are finalized at the very end – higher price may be accepted by the buyer in exchange for a more favorable deal protection package and vice versa. Disagreements over these issues may lead to deals falling apart since correct price and deal protection are extremely important for a deal to work out for both the buyer and the seller.

Mergers & AcquisitionsGuide to Distressed M&A · Understanding a Merger and Understanding a Merger Model · Introduction to Hostile Takeovers and Unsolicited Bids · Sale and Leaseback Transactions in Investment Banking · Compiling a Buyers List in Investment Banking · Interview With A Mergers & Acquisitions Investment Banker – Part II · Interview with a Mergers & Acquisitions Investment Banker – Part I · Bid Pricing Strategy: Part II · Bid Pricing Strategy: Part I · Deal Protection in Mergers & Acquisitions · Investment Banking Bake-Off or Beauty Contest · Acquisition Finance: Equity Consideration · Acquisition Finance: Bullet Debt · Acquisition Finance: Bank Debt · M&A Process Walkthrough · Types of M&A Sell Side Processes · Investment Banking Teaser · Accretion/Dilution Analysis – Part IV: Synergies and Source of Funds for M&A · Accretion/Dilution Analysis – Part III: Using Debt for Acquisitions · Accretion/Dilution Analysis – Part II: Accretion/Dilution Math and Breakeven Premium · Accretion/Dilution Analysis – Part I: EPS, Earnings Yield and All-Stock Transactions · Purchasing a Company via Cash or Stock ·
Investment BankingElite Boutique Investment Banks Versus Bulge Bracket Investment Banks · Introduction to Fairness Opinions · Investment Banking Fee Study · Investment Banking for Dummies · What Do Investment Bankers Mean When They Say “Sell Side” or “Buy Side”? · Should You Start Your Investment Banking Job Early? · Why Investment Banking? · Breaking into Investment Banking as a Big 4 Accountant in Audit · Activist Shareholder Defense · Investment Banking in Canada · Investment Banking Hierarchy – Analyst to Managing Director · How Has Investment Banking Changed Over Time? ·
Alexey is a finance and accounting student at University of British Columbia’s Sauder School of Business. He interned at a Vancouver-based equity research start-up, Canalyst. Outside of school, he plays electric guitar and enjoys Muay Thai training.

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