Fairness Opinion
A document created by a competent investment banker or adviser to assist the parties in evaluating the facts
What is a Fairness Opinion?
A fairness opinion is a document created by a competent investment banker or advisor to assist the parties in evaluating the facts of a merger, acquisition, spin-off, buy-back, or other types of corporate purchase based on professional knowledge.
Fairness opinions have been a crucial component of mergers, acquisitions, and associated business deals for more than 35 years.
Before the middle of the 1980s, fairness opinions were primarily concerned with transactions, but the Smith v. Van Gorkom ruling in 1985 gave it a more significant role in the process.
These opinions focus on assessing whether the terms and price offered by the buyer in a deal are fair to the shareholders of the company being bought. Importantly, fairness opinions can be used in friendly or hostile transactions. In friendly deals, they are usually positive, but in unwelcome takeovers or when directors disagree, they might be negative.
Fairness opinions serve several crucial functions. They enhance communication among parties, help in decision-making, and reduce risks associated with the deal. They also give shareholders and other concerned parties the ability to legally challenge a director's decision regarding a takeover offer.
When creating a fairness opinion, the investment advisor considers the deal's price, terms, and how they compare to the market's norms for similar transactions. Analysts assess the deal's fairness from the perspective of the company's investors. These opinions are typically prepared late in the negotiation process, just before a deal is expected to close.
It's important to note that if the deal falls apart or the terms change significantly, the fairness opinion becomes irrelevant. In cases involving publicly traded companies, fairness opinions are not always required by law, but they can be a helpful way to minimize risks and facilitate communication among the parties involved in significant financial transactions or acquisitions.
Key Takeaways
- Fairness opinions play a crucial role in mergers, acquisitions, and corporate transactions, providing an expert judgment on the fairness of the terms and price offered to shareholders.
- They are typically created by competent investment bankers or advisors and are used to facilitate communication, aid in decision-making, and mitigate potential risks in transactions.
- The significance of fairness opinions was emphasized by the Smith v. Van Gorkom ruling in 1985, highlighting the importance of unbiased advice from independent financial experts.
- Fairness opinions should be conducted by independent consultants who use due diligence to gather necessary information, and they should strike a balance to provide an unbiased conclusion.
- While fairness opinions can be beneficial in defending a company's actions, they can be expensive and may raise concerns about impartiality, especially when the same investment bank is involved in both the transaction and creating the fairness opinion.
Importance of a Fairness Opinion
The decision in Smith v. Van Gorcombe by the Delaware Supreme Court marked a turning point in the understanding of the significance of fairness views in merger negotiations. The lawsuit concerns TransUnion's leveraged acquisition offer from Marmon Group.
Without seeking advice from outside financial experts, defendant Jerome Van Gorkom, chairman and CEO of TransUnion, decided on the $55-per-share offer. He simply sought advice from the CFO of the business to calculate a share price appropriate for a leveraged buyout.
Van Gorkom and the CFO, however, were unable to ascertain the company's true total value.
The verdict received harsh criticism from the court, which stated in its written opinion that "there is no convincing evidence in the record that $55 a share represents the intrinsic value of the corporation."
Even though the board must approve the proposed transaction, numerous details, including Mr. Van Gorkom's dubious technique for determining the proposed price, were not made public at the board meeting. However, in the end, the idea was accepted by the board.
The issue in this precedent-setting case was whether the TransUnion board's decision to approve the deal was a legitimate business decision.
The lack of unbiased advice from independent financial experts, according to the court, was a factor in overturning the board's decision to vote in favor of the LBO.
The board was held by the Delaware court to have violated its fiduciary duty of care to the company and was consequently responsible for the plaintiff shareholders' losses.
The court determined that, if the directors had "got an objective judgment from someone who knows the value of the company," the responsibility might have been avoided.
In the case of Smith v. Van Gorkom, the court disfavored the TransUnion Corporation Board, which supported the LBO, in part because it lacked the unbiased advice of an independent financial adviser.
Fairness, from then on, was given significant importance.
Management must honestly represent shareholders by business principles. Directors manage the company's activities because stockholders are not involved in the day-to-day operations.
The goal of a fair opinion is to persuade shareholders that management and directors are acting in their best interests and that the terms are fair or unfair based on a report from an impartial expert the company has hired.
There may be some shareholders who disagree with the value that the buyer and seller have agreed upon in the absence of a fair view.
Some shareholders might want to know whether there are any better bargains available, how the deal will be negotiated, etc. Therefore, by assuring that the price reflects a fair appraisal, guidance from a trained consultant can help allay such fears.
If the firm is sued by a disgruntled shareholder, a company director can utilize a third-party opinion report to show that the transaction was done in good faith.
Important Considerations in a Fairness Opinion
The price of the investment adviser's services is the first factor to be taken into account when creating a report with an unbiased view.
The consultant may be under a great deal of time pressure to finish the fairness assessment because the report is being created at the same time that discussions between buyers and sellers are happening.
The ability to recognize any parts of the agreement that need stakeholder attention demands a high level of skill throughout the preparation.
Analysts are expected to give highly accurate and meticulous reports because they may be used in court. From business to business, opinion fees differ.
Concerns regarding impartiality can arise if the investment bank involved in the purchase deal is tasked with creating the report.
Because they obtain advice fees when clients sell their businesses, several people have noted that investment banks may be implicated in conflicts of interest.
When determining if the agreed price is fair to the company's owners and purchasers, the investment bank must strike a balance to provide an unbiased conclusion.
They should disclose this information in the report if any people or organizations are giving their thoughts and will profit either directly or indirectly from the transaction.
Independent consultants must also use due diligence while creating a fair opinion report to guarantee that all data required to draw a judgment is available.
To achieve this, they go to the selling company's offices and go over records that can be used to establish a judgment on the selling company's worth.
Independent advisors should look at elements such as a company's history and capacity for paying dividends, historical financial performance, and elements affecting earnings. It is also advisable to study the terms of any merger or acquisition agreements.
The scope of due diligence should extend beyond company sales. Advisors should take a similar approach when purchasing businesses.
The council should examine the buyer's financial records, historical mergers and acquisitions, and the most recent public disclosure documents if the buyer is a publicly-traded company.
To gather information that might be essential to negotiation, they should also get in touch with other advisers who have worked with the company.
The report will be forwarded to the board for consideration after the consultant has finished its review and written a report on its findings. The fairness memo summarizes management's consideration of each of the fairness report's identifying characteristics.
Consultants are welcome to take part in these talks and address any issues or queries management may have regarding the report.
Example of a Fairness Opinion
Here are some good examples.
Example #1
A firm wants to pay $20 million to acquire company B. The board of directors of company B is interested in learning whether the offer made by company A is fair.
However, they have not yet received any additional bids. To conduct the analysis and evaluate the fairness of the offer, firm B, the target company in this scenario, recruited a consultant from an independent investment bank.
The consultant has found three similar transactions between businesses. The three businesses engaged in transactions within the last six months with businesses operating under similar business models to company B in the same industry, by best practices.
For each of the three businesses, the adviser determines the EV-to-EBITDA multiple. Earnings before interest, taxes, depreciation, and amortization, or EBITDA, has a duration of one year and is referred to as "EV" (enterprise value).
The research showed that $20 million was the transaction's fair value, and the consultant informed Company B of this.
Following this, the sale of the business at that price is authorized by Company B's board of directors. Local market experts are frequently required to offer unbiased counsel in cross-border international transactions as well.
Example #2
A fair opinion was provided to the LinkedIn board by Qatalyst Partners, the investment bank for Linkedin, as the last stage before the board approved the acquisition by Microsoft in June 2016.
This was provided through an oral presentation to the LinkedIn Board of Directors by Qatalyst Partners representatives.
Qatalyst Partners subsequently confirmed in a written opinion filed on June 11, 2016, that, as of that date, the transaction is fair from a financial perspective based on and subject to the various assumptions, considerations, limitations, and other matters set forth therein.
A fairness assessment is part of LinkedIn's merger proxy. In essence, it states that Qatalyst believes the arrangement to be fair.
The benefits and drawbacks of a fair opinion
A fair assessment considers both sides. The benefit is that it can defend the business in crucial situations. The drawback is that it is pricey and possibly unjust.
Benefits
A fair evaluation doesn't say whether the offer is the best one currently on the table; it only says whether the bid is fair. In this approach, a fair view would lessen the board's accountability rather than increase the company's profits.
Even if it just absolves the board of accountability, it might be a critical defense if a public firm is being acquired because many shareholders might sue the board over a deal they believe to be dubious.
When there is an anomaly in a takeover deal, such as one involving a related party, or when there is just one bid, this can be especially significant. The evaluation mentioned above will be extremely beneficial to the business.
Disadvantages
Fair reporting also creates questions.
They are pricey, to begin with. Bills in the six-figure or multimillion-dollar range are not unusual, making them unaffordable for many businesses. However, the cost of this report is significant because it requires a high degree of expertise and a quick turnaround (the report is often finished in a few days to a week).
Second, the accuracy of fairness opinions is essential because they may be used as evidence in shareholder litigation. To verify their accuracy, a lot of work is required. Which brings up the question, "Why is it so expensive?"
There are also worries that the investment banks currently participating in the bid won't get a fair evaluation, which would mean they'd also get contingent fees in the event the company is sold.
Therefore, an investment bank that takes part in both buy-out and fairness opinions isn't necessarily an unbiased observer.
In other words, it costs money to evaluate the appropriate balance between accuracy, hazard, time restrictions, and capacity.
Fairness Opinion FAQs
When everyone is given the same respect and treatment, it is said to be fair. In sports, games, and other activities, fair people adhere to the rules. They can be trusted.
Fairness opinions are documents written by trained investment bankers, typically from commercial banks. Investment bankers can put in up to 100 hours per week on research, financial modeling, and architectural presentations.
M&A valuation is a suggestion or recommendation to management regarding the cost of a transaction.
Because the people giving the advice are experts in finance and value, fair opinions are only valid from a financial perspective.
For publicly-listed companies, they are filed to the SEC and stored in the EDGAR database, which is available to the public.
The writing process is under great time pressure. The author of the report usually only has a few days, perhaps a week or a little more.
It is exceedingly important for a transaction and is difficult to create. This combination of elements makes it extremely costly and urgent to construct.
Opinions are only made when everyone is 99% certain they will close. This usually only happens at the eleventh hour.
Reviewed and edited by James Fazeli-Sinaki | LinkedIn
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