Fairness Opinions
How do you know when you’re receiving good value? In the supermarket, you might be comparing prices per 100g or unit. But in the world of mergers and acquisitions, with many uncertain variables in play, it’s sometimes harder to determine.
Written by a human
Fortunately, that’s where fairness opinions come in. A detailed analysis of investments pricing, fairness opinions help companies go into negotiations with confidence and defend against any claims of a rip off.
What is a fairness opinion?
Fairness opinions are decisions about whether a transaction price is fair in relation to the financial value received. These opinions are driven from an independent analysis of pricing, non–cash value, transaction structure, tax, contingencies, asset value and more.
By in large, fairness opinions are sought during mergers and acquisitions settings. When one company buys out another, there is always a chance that a disgruntled shareholder could try to sue, arguing that the price should have been higher. But fairness opinions provide concrete evidence that the financial matters are correct.
Fairness opinions are also performed in significant stock transactions and management changes. They are part of the due diligence process and help to ensure that decision makers get access to as much, and as impartial, information as possible.
Who makes fairness opinions?
Fairness opinions are typically made by qualified financial advisors at investment banks. These individuals are often trained in the complex financial analysis required for fairness opinions.
However, there are usually other parties involved in the due diligence process for fairness opinions. Employees at every level of the company may be required to provide unbiased evidence, although it’s often senior members of staff that are involved the most.
Finally, it’s members of the board who usually receive the findings and then make decisions based on them.
When are fairness opinions necessary?
It’s important to note that fairness opinions are not required by law in the UK or the US. However, they are a strong way to protect any deals you’re entering into, especially in preventing later legal trouble.
Fairness opinions are most often requested when:
- public companies go private
- companies merge
- companies engage in a material transaction
- private companies have a large and diverse group of shareholders
- private companies are at risk of litigation
In particular, fairness opinions help to reveal conflicts of interest, which if left hidden, could throw deals into disarray, or leave companies and employees at risk of legal consequences.
What’s included in a fairness opinion?
Fairness opinions are usually delivered during the negotiations stage of a deal.
That’s because many mergers and acquisitions deals fall through at early stages, meaning that when fairness opinions are performed too early, there is a risk that they will never see the light.
Here’s a typical fairness opinions process:
- The seller hires an external investment bank, which isn’t involved with other parts of the deal to preserve impartiality
- The bank asks for documentation like income statements and cash flow for a primary analyst or team to manually calculate key metrics like the EBITDA margin
- A secondary analyst checks the numbers, before an associate and potentially a VP also verifies the accuracy and reliability of the report
- The team presents their fairness opinion to their internal Fairness Committee, where they explain their findings and opinion on the deal
- The Fairness Committee either then accepts the findings, or asks the analysts to rework and make changes
- Once approved, the senior bankers will then present their findings to the board of directors at the sellers company (or a special committee if one was formed for the deal), and typically accompany this with a letter
Fairness opinions in the real world
Would properly valued assets have prevented liquidation?
In January 2015, a gaming company called Caesars Entertainment Operating Company (CAOC) went bankrupt. An investigator was assigned to figure out whether the financial advisor firm retained by CAOC made transactions that contributed to the downfall.
During a key part of the examiner’s report, it was revealed that a huge error was made in terms of fiduciary duty.
In 2013, an asset was sold to a third party. The valuation of this asset was based on cash flow figures that skewed the EBITDA projection, lowering the overall valuation. This meant that it was:
- Officially valued between $268 million and $420 million
- Sold for $360 million
- Actually valued between $797 million and $953 million
The financial documents were later revealed to be outdated by 10 months! In fairness, there were lots of records of the financial advisors asking for these updates, but CAOCrefused and failed to provide them.
Unfortunately, we’ll never know if the lost millions could have prevented the liquidation of CAOC.
Historic negligence by a CEO
In 1985, TransUnion was having financial difficulties and the board decided they wanted to sell. Their CEO, Van Gorkom, suggested a merger with an external company and arrived at the figure of $55 per share.
He then produced a 20–minute presentation to the board, stating the proposed share price without really explaining it. The board was informed that they weren’t legally required to complete a fairness opinion provider, so opted not to.
It was at this point that the board were taken to court, and a judge ruled that the $55 per share value was unfounded. The board members were deemed to have been negligent in their duties as they failed to protect shareholders and find the true value of the shares.
The merger was prevented from going through.
Create policies: prevent these mistakes in your own fairness opinions
When it comes to proving fair value, fairness opinions are vital forms of protection.
We believe in pre–determining when you’ll need to get a fairness opinion, how you’ll maintain unbiasedness, and what analysis needs to be performed in order to make a business valuation decision. Moreover, your fairness opinion policy should consider who needs to approve these reports before a decision is made, and on what time line.
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