by Mike Costello
posted March 22, 2008
 Mike Costello |
What they are
A fairness opinion is a letter, typically addressed to a company’s board of directors (or other decision maker), stating whether a major transaction is “fair” from a financial perspective (but not necessarily a legal or procedural perspective). In deciding whether a transaction is fair, the financial expert considers the transaction’s price and terms as well as the company’s characteristics.
In many ways, a fairness opinion’s analysis is similar to that of a business valuation. For instance, in determining whether a company’s purchase price is fair, a valuation professional considers the company’s net asset values (the asset-based approach), sales of comparable companies (the market approach) and the company’s cash flow’s present value (the income approach).
Although most traditional valuation assignments require the valuation practitioner to estimate a finite value (such as $5 million), fairness opinions call for experts to derive a range of reasonable values (such as $4 million to $6 million). Thus, if the transaction’s price falls within this reasonable range, it’s considered fair.
Why are they needed?
Currently, statutes don’t require fairness opinions. But both publicly traded and privately held companies can benefit from obtaining them for major transactions as well as for related-party or other controversial transactions.
Think of a fairness opinion as an insurance policy. Just as your homeowner’s policy protects you if a guest trips and injures him- or herself on your property, a fairness opinion protects you from a minority shareholder claiming you didn’t obtain a fair value in a given transaction. In addition, a business loan covenant may require management to obtain a fairness opinion before embarking on a major transaction such as a business segment’s merger or sale.
If you’re an executive about to embark on a major (or controversial) business transaction and you’re concerned minority investors may claim you’ve violated your fiduciary duties, consider obtaining a fairness opinion. This is especially important in light of recent accounting scandals—which many believe will shift the legal pendulum even farther in favor of minority shareholders. Fairness opinions provide evidence that management complied with the “business judgment rule,” which determines whether an executive acted:
• On an informed basis,
• In good faith,
• In the best interests of the company’s shareholders, and
• Without fraud or self-dealing.
Even if you aren’t concerned about disgruntled minority investors, a fairness opinion can give you peace of mind if you’re inexperienced or unsure about a complex deal. It also can reassure bankers providing financing.
Who Prepares Them?
Executives increasingly are turning to independent business appraisers for fairness opinions. Both a company’s accountant (who performs ongoing audit, tax and consulting services) and its investment banker (who receives a variable commission when the deal closes) have future interests in the company. Thus, opposing counsel could argue that these parties were biased and concluded that a transaction was fair only to protect their future interests in the company.
An independent valuation professional’s fairness opinion can circumvent this argument. What’s more, a business appraiser is more likely than a traditional CPA or a banker to have the specialized valuation experience fairness opinions require.
Be Fair
In any case, fairness opinions can be an important safeguard. Please call with your questions about this or other valuation matters. If we lack independence and are unable to perform the analysis ourselves, we would be glad to refer you to another qualified expert professional.
Local Case Studies
We have been hired in many instances to provide fairness opinions. In one local case, we opined that a company could meet its current obligations in the normal course of business after a stock redemption that occurred along with the sale of the business. We have also provided fairness opinions in a couple of company sales that involved Employee Stock Ownership Plans. In these cases, our fairness opinions provided the ESOP participants “peace of mind” that the transactions were fair, not only to the majority shareholders, but also to the individuals (minority shareholders) owing company stock through the ESOP.
(Mike Costello, CPA/ABV, CFE is a Certified Public Accountant, Certified Fraud Examiner, business appraiser and consultant with more than 20 years of training and experience in business valuations and appraisals, business acquisitions and divestitures, and forensic accounting.
He has written several articles for the Tennessee CPA and the AICPA’s Management Consultant newsletter.
He was the Managing Director and President of Costello, Strain & Company, PC, a CPA firm he established in May 1984. The firm was merged with Joseph Decosimo and Company, LLP, CPA’s in September 2003. Joseph Decosimo and Company, LLP was founded in 1972 and today is one of the top 100 CPA firms in the nation.)
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