Common Protection Mechanisms for Buyers

Compared with domestic acquisitions, cross-border acquisitions often take longer and face more uncertainties. As a buyer, an important issue that Chinese companies need to consider is how to minimize the risk that the target will refuse or fail to complete the transaction due to changes in the situation. Therefore, when signing a memorandum of understanding or acquisition agreement, it is very important to set up a favorable transaction protection mechanism according to the actual situation of the transaction.

The most common protection mechanism for acquirers is a termination fee. Although the memorandum of understanding or acquisition agreement usually contains clauses prohibiting the target from actively seeking other acquirers after signing the contract. If other acquirers propose more favorable deals to the target, the board of directors of the target, due to its fiduciary duty owed to shareholders, usually is required to recommend the favorable deals. In these cases, it must be agreed that the target should pay the original acquirer a termination fee. The significance of the agreed termination fee is not only to protect the acquirer from getting compensation if the transaction cannot be concluded, but also to objectively increase the cost of other acquirers initiating acquisitions. Studies have shown that the termination fees in acquisitions of US companies are often higher than those in acquisitions in Europe and Asia, with an average of about 3% of the purchase price. It is important to note that the acquirer will usually also have to pay for this increased protection, in the form of a corresponding increase in the transaction premium.

Another protective mechanism associated with termination fees is a right-to-know clause for higher third-party offers. It is agreed that the original acquirer has the right to match the higher offer received by the target company until the target company’s board of directors changes its recommendation or terminates the original transaction. The two parties to the transaction can agree on whether all higher bids can be matched and the limit on matching time and times according to specific circumstances. It should be noted that, without the restriction of the clause prohibiting the target from actively seeking other acquirers as mentioned in the preceding paragraph, the matching right may encourage the target company to seek a higher offer.

Another common transaction protection mechanism for the acquirer is that the target company gives the acquirer an option that takes effect immediately, allowing the acquirer to purchase a certain number of shares, equity or specific assets from the target company at a specific price. In such cases, even if the deal fails to close or the target moves to a third party with a higher bid, the original acquirer may partially achieve its strategic purpose.

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