A fairness opinion is a letter prepared by a corporate finance firm that states whether the financial terms in a transaction are fair. Independence is critical for fairness opinions. This requires an advisor to be mandated on a fixed-fee, rather than deal-contingent, basis ...
Directors of companies have a fidiciary duty of care to their shareholders. Some corporate transactions involve the change of control of the company. This necessitates valuation of the company. Dissenting, perhaps minority, shareholders may initiate legal action against the directors on the basis that valuation was too high or too low.
A board of directors seeks impartial advice from a technically expert and reputable firm, with relevant industry and geographic knowledge, and at a reasonable cost. In that order. Although a M&A Advisor mandated to a transaction may be expert and knowledeable, they can never be considered independent.
The fees of M&A advisors are primarily contingent on successful deal closure. Other legal, tax or accounting advisors may also have deal-contingent fees. Objectivity demands that the fairness opinion advisor has no vested interest, actual or perceived, in the success or otherwise of the transaction.
Sources: Mergermarket, Financial Executive magazine
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” - Warren Buffett, CEO Berkshire Hathaway (1989 Annual Report)
WHAT IS A FAIRNESS OPINION?
A fairness opinion is a letter prepared by a corporate finance firm that states whether the financial terms in a transaction are fair.
A fairness opinion can have multiple objectives
- Legal protection for Board of Directors
- Commercial reality check on transaction value
- Encourage shareholder approval for transaction
- Mediation within shareholder dispute
- Fulfilment of securities regulation obligations
WHEN IS A FAIRNESS OPINION SOUGHT?
A fairness opinion is mandated by a company’s board of directors in connection with a transaction that involves change of control. The board will rely on the fairness opinion to satisfy its legal duty of care and determine whether to proceed. Therefore a fairness opinion offers some protection against any shareholder legal action. This is particuarly evident for public companies. Sometimes, a fairness opinion is used to encourage shareholders to accept a proposed transaction.
WHEN IS A FAIRNESS OPINION VALUABLE?
- Related party transactions
- Insider-led financings
- Corporate acquisitions and Divestitures
- Management Buy Outs
- Recapitalizations and Restructurings
- Shareholder disputes
- Liquidations & Bankruptcy proceedings
A Fairness Opinions is an effective risk management tool, often mandated by securities regulations, in a transaction that involves change of control.
“Eliminating any conflict of interest is vital in order to make sure that the opinion is independent and objective.” - Mergermarket “Fairness Opinion Insight”
WHO PROVIDES A FAIRNESS OPINION?
Many types of firms provide fairness opinions- major investment banks; corporate finance boutiques; accounting firms and even sole practioners.
Independence is critical for fairness opinions. Only an independent firm, free from any success fees or other deal-contingent revenues, can credibly provide an opinion that is objective, neutral and free from actual or perceived conflict of interest. Other attractive attributes - as perceived by board level appointees - of an advisor to prepare a fairness opinion are technical expertise, firm reputation and specific industry or geographic knowledge.
For extremely large or complex transactions, major investment banks dominate fairness opinions. However on small and mid-cap transactions then corporate finance boutiques are popular - offering experienced, independent advisors with in-depth knowledge of the local industry and its participants, at a fee that is competitive, reasonable and fair. In recent years, financial journalists have highlighted the potential conflict of interest within investment banks. Particularly when an investment bank acts as M&A Lead Advisor, and so has substantial success fees, also provide a related fairness opinion.
WHAT INFORMATION IS PROVIDED?
A fairness opinion letter notes the credentials of the advisor, their opinion and related key assumptions. Popular valuation methods employed are:
- Discounted cashflow
- Precedent trasactions (public, private)
- Comparable firm mulitples
- Sum of parts valuation
- Net asset value
Comments