A fairness opinion is a black and white finding from an investment bank or business valuation firm, stating that a transaction (such as a merger or divestiture) is either fair or unfair from a financial point of view. Generally considered a requirement in public deals, a growing number of private, middle-market firms seek fairness opinions.
Boards of Directors seek independent guidance as well as added legal protection from such opinions. The opinion is partial proof that the Board acted in a fair manner and used sound business judgment.
Part of the increase in middle-market use stems from the more litigious state of business, but it also reflects the evolving nature of private companies where there are potential conflicts due to:
- Large number of shareholders
- Different classes of shareholder (preferred, common, convertible)
- Outside shareholders such as ESOP, trust, and private equity
- Complex tax laws involving competing interests
Business owners and directors find that fairness opinions are useful for many transactions, including insider deals, minority buyouts, business sale without an auction, and financings involving substantial equity dilution. Legal counsel usually is the first to suggest a fairness opinion, given its knowledge of the risks of not having such an opinion.
Variety of Opinion Providers
Fairness opinions encompass a broad range of providers. Investment banks and business appraisers are the two most popular categories, but many accounting firms and consulting firms entered the field in recent years. Each category has its plusses and minuses. Before selecting a provider, you should consider a number of factors.
How to Select a Fairness Opinion Provider
A business owner or a Board of Directors (either one could be the client) is well advised to review the following prior to making a decision on a fairness opinion provider
- Size of the Transaction: Optimally, the Client should select a provider that specializes in the transaction size that is similar to the deal under scrutiny. Thus, a major New York investment bank is a good candidate to opine on a $10 billion merger deal, but it is a poor choice for a $50 million middle-market transaction. A large bank working on a small deal assigns its most junior people to the transaction yet charges big time fees. In the middle market, the Client is better off with a provider that focuses on that segment. Such a provider knows the transactional nuances in that segment and the unique due diligence aspects for such businesses. Furthermore, the fee is likely to be more in line with the transaction’s size.
- Industry Knowledge: The provider does not have to be an in-depth expert to render a fairness opinion, but it helps the process if the provider has had some exposure to the industry in which the client operates. Industries frequently have specialized valuation ratios, important data points and certain documentation attributes. The provider can pick these up with some research, but the process moves smoothly if the provider has worked on a number of industry transactions in the past.
- Practical M&A Experience: Many fairness opinion providers claim expertise by having participated in accounting, due diligence or consulting services to M&A transactions. However, this is no substitute for the real world experience in actually advising on closed deals, and thus gaining the first hand knowledge of how a transaction is developed, researched, priced, negotiated, and closed. Hiring a provider with an M&A advisory background is a good idea. It adds substance to the opinion and credibility in future disputes, if any, over the work product.
- Broad Deal Knowledge: Most fairness opinions revolve around corporate M&A, assets sales or divestiture, but many involve more esoteric transactions such as recapitalizations, highly dilutive equity financings and buy-sell agreements. Besides M&A experience, consider an advisor staffed with senior professionals that have seen a large variety of situations.
- No Conflicts: In the past, public companies typically received fairness opinions on M&A deals from the very investment banks that gave them advice on the transaction. Since the bulk of the advisory fee was success-based, the conflicts inherent in the bank rendering a fairness opinion were obvious. Lawyers and regulators now encourage prospective users of fairness opinions to retain a provider who is conflict free, with no perceived bias on whether the transaction at hand closes or not.
The FOCUS Difference
In the middle market, FOCUS is well qualified with regard to each of the above five factors. The firm assigns senior personnel to middle-market deals, because that market segment is the FOCUS specialty. Regarding industry knowledge, the firm has investment bankers with ‘real world’ practical experience in over two dozen industries, enabling them to provide true operating insights to the process.
FOCUS has been advising on M&A deals for many years, and its professionals have experience in advising on any number of unique and complex transactions. The firm’s fairness opinion practice leader has had broad exposure to many public, private, and international deals, and has authored highly regarded books on M&A and valuation. Finally, the firm prides itself on its independence in providing fairness opinions and its ability to stay objective in serving it clients.
Contact Jeff Hooke at FOCUS at Jeff.Hooke@Focusbankers.com if you wish to discuss a fairness opinion.