- By Daniel M. Kerrigan, CFA, ASA, Tracey M. Jasey
- August 31, 2016
In general, a fairness opinion is an analysis conducted by a third party valuation firm or investment bank that assesses whether the terms of a transaction are fair, from a financial point of view. If properly done, a fairness opinion is a powerful method to protect boards of directors, trustees and other corporate fiduciaries (collectively referred to herein as fiduciaries) from transaction-related liability. Unfortunately, too often, fiduciaries associate fairness opinions with acquisitions of large, public companies. Indeed, obtaining a fairness opinion is a best practice when considering a wide range of transactions, including minority redemptions, recapitalization, combinations and spin-offs, just to name a few. Moreover, a fiduciary’s duty of care is no less important when such transactions involve a closely-held company. Deeming fairness opinion studies too expensive, time consuming, or simply unnecessary, fiduciaries of privately held firms routinely engage in corporate transactions without relying on them. In reality, however, these same fiduciaries may, in fact, be more at risk than their publicly traded counterparts due to heightened appearances of conflicts of interest and self-dealing.
Over the past several years, MPI has been retained to provide fairness opinions for both traditional buyout transactions, as well as in a number of less-traditional situations, such as those demonstrated in the case studies noted below.
At its core, a fairness opinion is a method by which a firm’s board of directors satisfies its fiduciary duty to its stakeholders. To that end, the need for an independent assessment of the fairness of a transaction does not exist solely in the domain of for-profit enterprises. On the contrary, the fairness of transactions involving nonprofits (such as 501(c)(3) organizations) must be demonstrated to the relevant state’s Attorney General, who is charged with oversight over charitable assets.
MPI has significant expertise dealing with valuation matters involving nonprofit organizations ranging from healthcare providers to research institutes. Largely on the basis of that specific experience, MPI was retained to conduct studies sufficient to assess the fairness of a transaction involving the proposed sale of a 501(c)(3) nonprofit provider of analytical software to a foreign entity. Ultimately delivering MPI’s opinion to the State Attorney General, the board unanimously voted in favor of the transaction and, in the end, consummated the deal.
Complex Recapitalizations & Management Team Participation
Transactions involving capital restructuring, multiple classes of ownership, and groups including members of management are prime candidates for a fairness opinion. Such a situation was presented to MPI when it was engaged to provide an opinion to a privately-held, New York based real estate investment, development and management company. Depending upon the terms of the transaction, management could have structured the recapitalization in a way that benefited one class of claimholders (a subset of which included members of the management team) at the expense of another. Thus, the inherent potential conflict of interest gave rise to the need for a fairness opinion as a means for the board of directors (also including members of management) to satisfy its fiduciary responsibility to negotiate “fair” consideration on behalf of the existing owners.
In the instant case, the board engaged MPI to provide fairness opinions in connection with a series of transactions that involved the exchange of loans made between affiliate entities for equity securities with convertible preferred attributes.
Combined Acquisition of Sister Companies with Unique Shareholder Bases
It is quite common that a company’s subsidiaries serve different operating functions. The subsidiaries may be formed to provide different services, serve distinct customer bases or act as suppliers to one another in the context of a vertically integrated system. Understandably, third party acquirers often view the entities as necessary (and cohesive) components of a single enterprise and therefore assign a single valuation in a proposed deal. Deal complications may arise when companies are not only separate legal entities, but also have ownership bases that do not perfectly overlap. A critical question that arises (and must be answered by the board of directors) is how a single purchase price should be allocated between these companies in a fair manner.
Having completed transactions involving sister companies with different shareholder bases, MPI was engaged to conduct studies to sufficiently assess the fairness, from a financial perspective, of the allocation of proceeds between two related business process outsourcing firms. The subject companies had common, but not identical, shareholder bases and were in negotiations with a strategic acquirer. Working under a tight deadline and employing all appropriate valuation methodologies, MPI delivered its opinion to the board of directors, who voted in favor of the transaction.
De-Leveraging Capital Structure Changes
Leverage buyouts are commonplace in going-private transactions involving micro-cap public companies. Often resulting in significant leverage and a complex capital structure, post-transaction equity valuations may be highly sensitive to relatively modest operational underperformance.
A well-known, publicly traded manufacturer and distributor of gift products was taken private a few years before the Great Recession. The transaction was primarily funded with debt. Several years following the transaction, continued challenging market conditions eroded operational performance at the acquired company. Compounding matters was an impending maturity of the original LBO debt. Led by new management and the private equity sponsor, the Company took steps to effectuate a major capital overhaul that would result in the conversion of a portion of the debt and existing equity into several layers of newly created preferred stock. Based upon our familiarity with the industry and experience dealing with complex capital structures, the board of the acquired business engaged MPI to assess the fairness of the exchange to certain of the shareholders.
With knowledge spanning a broad spectrum of industries and a demonstrated track record serving as a trusted advisor to the boards and management teams of all types of organizations, MPI leverages its 80 years of valuation experience and extensive transaction expertise to deliver the credible opinions demanded by today’s complicated transactions. Contact MPI to learn more about which situations may require a fairness opinion and how MPI can be available to assist with advice and services tailored to meet your needs.
MPI, a prestigious national consulting firm founded in 1939, specializes in business valuation, forensic accounting, litigation support and corporate advisory work. MPI provides fairness opinions, sell-side and buy-side advisory services through its investment banking affiliate MPI Securities, Inc. MPI conducts every project as if it is going to face the highest level of scrutiny, and its senior professionals have extensive experience presenting and defending work product in front of financial statement auditors, management teams, corporate boards and fiduciaries, the IRS, other government agencies, and in various courts.