As part of our transaction advisory and consulting services, Mercer Capital is often called upon to provide fairness opinions in transactions. A fairness opinion is usually provided in letter format, and generally provides an opinion concerning whether a proposed transaction is fair, from a financial point of view, to the shareholders (or a specific group of shareholders) of a company. They are generally addressed to a company’s board of directors or to a special committee of the board.
The purpose of a fairness opinion is to assist directors in making decisions concerning the transaction and to protect decision makers from claims that those decision makers violated the business judgment rule. The business judgment rule requires that the board exercises due care in the process of reaching its decision, that the board acts independently and objectively in reaching its decision, that the decision was made in good faith, and that there was no abuse of discretion in making the decision.
There are no hard and fast rules concerning when fairness opinions are required, but they are desirable in a variety of circumstances, the most common being a merger or sale of the company. In these transactions, a fairness opinion is considered a necessary step in the due diligence process of the seller. While the facts and circumstances of the transaction will dictate the areas that are explored in the fairness opinion, some issues are routinely involved.
For most transactions, a number of alternatives exist to the proposed transaction, and certain groups of stakeholders may believe that one or more of those alternatives is preferable to the proposed transaction. Deals that might be in the best interest of all the stakeholders might be delayed or killed by dissenting shareholders, and a fairness opinion can help avoid some of the misunderstandings that might give rise to unpleasant stakeholder relations during a critical time. Fairness opinions can also help to avoid disagreements in situations where there is a perception that corporate insiders might enrich themselves at the expense of the minority shareholders due to the structure of a transaction.
Among the more common situations where a fairness opinion is obtained is in a sale or merger transaction where a number of competing offers representing different exchange rates, different ratios of cash to stock, or different credit quality in terms of debt are received. The fairness opinion letter will typically interpret and compare the competing bids and explain why one alternative is preferable to the others. If a company has recently experienced poor financial performance, a fairness opinion will typically explore the idea of waiting to sell the company at a later date (after a turnaround) rather than selling at what might be perceived as a low valuation.
Unsolicited and/or hostile offers often give rise to fairness concerns, as surprised minority shareholders may perceive that their concerns were not addressed in the process. If the board of directors lacks unanimity in such a situation, it is almost certain that some stakeholders will be dissatisfied with the transaction. When the consideration offered is other than cash, and particularly when the consideration offered is an interest in a closely held company, the financial advisor must investigate not only the interest being sold, but the interest received in return.
In addition to concerns surrounding the total consideration paid in a transaction, issues of fairness can arise concerning the distribution of the consideration. For example, if different classes of stock exist, certain stakeholders may disagree as to the relative value of those classes of stock. Shareholders may also take issue with the noncompete or employment agreements received by managers, or with any other perceived differential treatment of insiders. Regardless of the reason for the fairness opinion on a sale or merger transaction, the opinion serves to memorialize the degree of effort expended by the board in order to reach its decision regarding the adequacy of the consideration received in the transaction and the fairness of the transaction to the stakeholders.
Even when an outright sale or merger is not being considered, fairness opinions are commonly sought on other significant corporate transactions. These include the sale of subsidiary businesses or lines of business, recapitalizations, stock repurchase programs, squeeze-out transactions, spinoffs, and other material corporate events. Particularly when insiders or other affiliated parties are involved in the transaction, a fairness opinion can go a long way toward avoiding disagreements among the stakeholders and between the stakeholders and the board.
Reprinted from Mercer Capital’s Transaction Advisor, Volume 5, No. 3, 2002.