Evaluating the Deal
A fairness opinion can provide needed objectivity
Shareholders may become suspicious of deals that seem to benefit “insiders” at their expense, especially if the deal’s projected results fall short, acquisition synergies fail to materialize or insolvency becomes likely. They often challenge such transactions under the assumption that decision makers aren’t fulfilling their fiduciary duty to act in the best interests of the company and its shareholders. This can lead to costly litigation. A fairness opinion from an experienced, independent valuation advisor can help avoid this situation.
Finding a range of values
Simply put, a fairness opinion addresses whether a transaction appears “fair” from a financial point of view.
To create one, a valuator usually begins by estimating a range of values regarding a proposed transaction.
Theoretically, the ceiling of this range represents the highest price a prudent buyer would be willing to pay; the floor is the lowest price a prudent seller would accept. The analysis typically presumes that neither party has been forced to buy or sell, and that both parties have reasonable access to relevant financial data.
Another proxy for the lower end of a fairness range is the amount that dissenting shareholders could reasonably expect to obtain in a statutory appraisal action. Legal counsel can help the fairness opinion provider define the appropriate standard of value.
Addressing the details
Estimating fairness is especially challenging if a transaction involves noncash terms, including earnouts and stock-for-stock transactions. Evaluating these deals may require looking at future expectations as well as the buyer’s current and prospective financial position.
Timing is another important consideration. A fairness opinion is only valid on a particular date. A transaction may be fair one day but unfair the next because of changing market conditions or product obsolescence, for example. Generally, fairness opinions are performed as close to the transaction or proxy date as possible. Opinions dated too early or not updated for changing conditions may not withstand scrutiny — especially in volatile markets.
Facilitating a deal
Most people associate fairness opinions with public companies undergoing high-profile management buyouts, hostile takeovers or going-private transactions. But fairness opinions have become increasingly popular among private businesses with vocal minority shareholders, complex deal structures and related-party transactions.
Fairness opinions aren’t legally mandated, but they can help facilitate major transactions, such as mergers and acquisitions (M&As), spin-offs, stock repurchases, and divestitures. Businesses that reorganize out of court or under Chapter 11 of the U.S. Bankruptcy Code may choose to obtain fairness opinions on behalf of creditors and other stakeholders.
In addition, buyers and sellers use fairness opinions to support their strategic decisions and to defend against lawsuits. And some loan covenants require fairness opinions to protect the bank’s financial interests against fraudulent conveyances.
Generating the opinion
Fairness opinions are typically more abbreviated than traditional appraisal reports but require similar analyses. For example, they rely on the same valuation approaches — cost, market and income — to value ownership interests or assets.
Moreover, they also may address issues unique to fairness opinions, such as financial structure, tax and accounting consequences, and executive compensation from change-in-control and other bonus provisions. Most fairness opinion letters include these components: 1) description of the transaction, 2) summary of procedures and analyses, 3) list of sources used, 4) conflict-of-interest disclosures and 5) statement of assumptions and limiting conditions.
Of course, every fairness opinion arrives at a conclusion. If an expert concludes a deal is unfair from a financial perspective, it typically falls through — or management renegotiates the terms. Bear in mind, however, that fairness opinions don’t address legal or structural fairness, nor do they constitute an endorsement or a guarantee for a particular transaction.
Backing it up
A fairness opinion tells whether a proposed transaction is fair, from a financial perspective, to the company’s shareholders. An opinion that’s backed by an independent valuation expert’s research and verification can help protect directors and officers from personal liability and minimize the risk of shareholder litigation.