March 6, 2017
What Every Business Owner Should Know About Fairness Opinions
A fairness opinion is a professional evaluation used to determine if the terms of any significant transaction are fair, from a financial point of view. Fairness opinions provide decision-makers with essential transaction information and protect directors from fiduciary duty and corporate waste claims. Included in the document are the price, terms, and other unique characteristics of the transaction. These data are compared to similar historical transactions and any discrepancies are explained. While many factors are considered in great detail, a well-written fairness opinion is based upon at least the following:
- Financial performance and factors impacting earnings
- Dividend-paying history and capacity
- Pricing of similar transactions
- A review of the investment characteristics of the consideration to be received
- A review of the transaction agreement and its terms
When do I need a fairness opinion?
Any time shareholders may call into question management’s motives or processes on any significant transaction, it is in management’s best interest to obtain a fairness opinion. The following scenarios are examples of when obtaining a fairness opinion would be ideal:
- Purchase of significant amount of assets outside normal course of business
- Acquisition with major impact on how acquirer does business
- Transaction that will require shareholder approval
- A change of control is involved
- Disposition of major operating division
- Public company share buyback
- Management buyout
Why do I need a fairness opinion?
While there is no legal requirement as to the timing or necessity of obtaining a fairness opinion, as the board of directors strives to demonstrate that it is acting in shareholders’ best interest, an objective third party evaluation goes a long way toward easing shareholder doubts. The risks of forgoing the fairness report are illustrated in an article from Investment Digest, while discussing the Solomon Brothers-Smith Barney merger in 1997, in which the former chose to proceed without a fairness opinion:
“‘It’s extraordinary,’ said a prominent M&A lawyer who asked for anonymity because his firm sometimes works with Salomon and Travelers. ‘I tell clients they are nuts not to get an opinion if the deal is up for a shareholders’ vote. Directors may have conflicts of interest, and a fairness opinion is relatively cheap.’
“The risks of Salomon’s decision were highlighted by the proxy’s declaration that four complaints were filed in Delaware’s Court of Chancery against the firm in late September (1997). They allege that Salomon’s directors breached their fiduciary duty by negotiating the deal without first ‘obtaining a market check of Salomon’s value.’”
Executive decisions are expected to be made in the best interest of the company’s shareholders, as subject to the business judgment rule. As its name suggests, the business judgment rule gives directors and management fairly wide discretion in directing the business. They are trusted to make decisions based on the same amount of care that an ordinary person would take to manage the business. A necessary part of that process is for management to be informed about the parties involved and the rationales behind both sides of a transaction, and the fairness opinion provides management with those insights.