Valuation of Reverse Termination Options in Mergers and Acquisitions

Abstract

This article describes the recent development and increasing use of reverse termination options in acquisition agreements governing private equity leveraged buyouts. It derives a modification of the Black-Scholes option pricing formula for use in estimating the value of such a transaction structure to an acquirer. Relaxing the assumptions underlying the reverse termination option pricing formula as appropriate for a given transaction provides a refined estimate of a reverse termination option's value to an acquirer. Thus, targets can use the reverse termination option pricing formula to evaluate a bid containing a reverse termination option against alternate bids or valuations of the target.