Stalking Horse Bidder

When a company goes bankrupt, creditors — meaning everyone the company owes money to — need to recover as much as possible. One way to do this is through a public auction: the company or parts of it are sold to the highest bidder. For this auction to take place at all, someone is needed to make the first bid and kick things off. This first bidder is called the stalking horse bidder. They negotiate their price in advance with the insolvent company, thereby setting a floor price and giving other interested parties a point of reference. The special thing about this: they receive special protective rights in return, compensating them for taking on the risk of ultimately walking away empty-handed.

Why the process makes auctions possible in the first place

Without a stalking horse bidder, a bankruptcy auction would often never come about at all. No serious buyer wants to spend months examining an insolvent company, paying for expert assessments, and negotiating a contract — only to then be outbid in an auction by someone who skipped all that effort. This problem is known as the free-rider problem: others benefit from the groundwork without doing it themselves.

The stalking horse process solves this problem by compensating the initial bidder. They receive contractually guaranteed benefits that secure their expenses in case they lose the auction. This gives them a reason to take on the risky preliminary work in the first place. This is also good for creditors: a binding opening bid means that, in the worst case, they will at least receive this minimum price.

Procedure and protective rights of the initial bidder

The stalking horse bidder first negotiates a purchase agreement privately with the insolvent company and its bankruptcy trustee. This agreement sets out the price, the terms, and the protective rights. A bankruptcy court then approves the process, and the auction is publicly announced.

The most important protective rights are the so-called break-up fee and the expense reimbursement. The break-up fee is a compensation payment that the initial bidder receives if another bidder wins — typically between one and three percent of the purchase price. The expense reimbursement also covers their due diligence costs, such as for lawyers and expert assessors. In addition, many contracts set a minimum overbid amount, meaning competing offers must be noticeably higher to displace the stalking horse bidder.

If the initial bidder loses the auction, their effort was therefore not in vain: they get money back even if they don’t end up buying the company. If they win, they buy at the price they were willing to pay anyway. The auction itself ensures that this price has risen further through competition — to the benefit of the creditors.

Stalking horse bidders in tech and startup insolvencies

The process originates from U.S. bankruptcy law, specifically from the so-called Chapter 11 or Chapter 7 proceedings, and has been common practice there for decades. In the tech world, it is particularly well known because startups and technology companies going through insolvency often hold valuable assets — patents, software, customer data, or trademarks — that are well suited to being auctioned off.

A well-known example from recent history is the insolvency of the cryptocurrency exchange FTX in 2022. In the subsequent auctioning off of parts of the company and its subsidiaries, stalking horse bidders played a central role in establishing binding starting prices in the first place. The process also appeared in the insolvencies of the streaming service Veoh and the smartphone manufacturer Palm.

In financial reporting, the term comes up whenever there is speculation about a potential buyer for an insolvent tech company. Whoever is named as the stalking horse bidder has usually already been through months of negotiations — and is considered the most serious interested party, even if someone else ultimately wins the bid.