Aidan Jobe Sea


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Private Equity is giving away the Option

The private equity industry is giving away its option to withdraw from acquisitions where market or company-level conditions change before the deal's completion. This trend increases the cost and risk to funds of buyout transactions, and promotes risk aversion in fund managers who no longer have the option of easily walking away from deals when conditions change. Reversing this trend is important to maintaining the industry's historic returns and risk neutral character.

As private equity has grown and competition for deals and financing intensified, funds are competing in part by assuming greater liability for deal financing in the merger contract. Starting with the acquisition of SunGard Data systems in 2005, reverse termination fees generally equaling approximately 3% target company value have become standard in most private equity contracts. In 2009, Apax Partners completed the year's second largest acquisition of a US public company by doing away with the reverse termination fee entirely and instead bearing the entire risk of financing by completing the transaction with its own equity.

These terms make bids more appealing to both target companies and lenders, but they also increase the cost and risk of transactions for funds and thereby prohibit some profitable bids. Reversing this trend will require either finding new mechanisms for acquiring target companies that avoid the standard bidding process, innovations to the private equity contract allowing for increased flexibility, or a significant change in bargaining power between funds and target companies. Until the private equity industry reclaims bid optionality, it will continue to bear the costs of financing risk.

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