Fairness Opinion

A fairness opinion is a report prepared by an external financial advisor or investment banker assessing the details of a business deal. It is standard procedure for mergers, acquisitions, takeovers, buybacks, and spin-offs. It facilitates unbiased evaluation of transaction terms and offered prices.

This assessment requires expertise; the analyst determines an appropriate value of the target. Thus, it protects investors from inflated valuations—crucial for transactions involving a large sum.

• The fairness opinion is a document that states the expert view over relevant terms & conditions and offered prices—pertaining to a particular financial transaction. It is commonly seen during business deals—takeovers, buybacks, spin-offs, carve-outs, capital restructuring, divestiture, mergers and acquisitions (M&A), etc.
• The fairness opinion report of a financial transaction like a merger or acquisition must be filled with the SEC under form S-4. It can be located and viewed publicly on the EDGAR database at any point in time.
• When members of the board of directors express conflicting views pertaining to a particular deal, an external report is called upon to resolve the conflict.

The fairness opinion is a third-party evaluation of a financial transaction. An independent party checks the veracity of the offered price and terms of the contract. This assessment requires expertise—a financial advisor or an investment banker ascertains a suitable price.

A fairness opinion expert thoroughly reviews the financial proposal to understand the price. Next, they analyze the target’s (concerned company) capital structure, financial position, profits, the book value of assets, current budget, and future budget. Based on the assessment, the investment's worth is determined. Further advisors evaluate the buyer's benefits from the deal—earning potential, capital structure, the book value of shares, earnings per share, etc.

However, the firm must conduct its own due diligence to gauge the reliability of the third-party report. This is crucial as financial judgment at times involves subjectivity. The accuracy of the assessment depends on the experience and expertise of the financial advisor (or investment banker). But this report doesn't include the highest price a company can quote or the compensation paid to the company's executives. Moreover, it doesn't mandate the board of directors to follow such an opinion. In fact, the firm that pays for the financial analysis might even opt for a second opinion.

Let us look at an example to understand the financial assessment of a firm.

Let us assume that VU Ltd. manufactures cell phones. The firm initiates a merger with MN Software Ltd.—an application developer. VU Ltd. plans to acquire a 40% stake in MN Software Ltd. for $16 billion.

Now, MN Software Ltd. wants to assess the offer—to ascertain whether the deal is fair. MN Software Ltd. approaches DC Financials to get a fairness opinion.

A financial advisor scanned through the financial records of MN Software Ltd. and studied its financial position, annual profits, future plans, budgets, and capital structure. DC Financials also assesses the target’s industry standards and best practices. Then, the analyst inspects the target's financial ratios (like EV to EBITDA multiple). Finally, the advisor prepares a report.

According to the report, the premium offered by VU Ltd. is higher than the $15.81 billion fair valuation of MN Software Ltd.

The board of directors (of a firm) is answerable to the shareholders, creditors, investors, financiers, and other associates. They are accountable for any strategic decision that either leads to capital restructuring or affects the company's finances. Thus, an outside opinion becomes crucial.

Following are other scenarios where a 'fairness opinion' is required:

• Restructuring or Recapitalization - An outside assessment is required when an organization decides to change its dividend structure—debt to equity ratio.
• Mergers and Acquisitions - In an M&A deal, the acquirer can consider one or more opinions to gauge a reasonable premium that can be offered to the target company.
• Divestiture - When a company decides to write off its assets or file for bankruptcy, an unbiased financial assessment is required. The external party ascertains an accurate value of assets, outstanding debt, creditors, and shareholders’ equity.
• Bond Indenture - Transactions confined by the terms of a bond indenture require proper evaluation of the conditions and price. 
• Major Stake Purchase - Whenever public companies go private or when a dominating party purchases a majority stake, the board of directors needs an external assessment.
• Hostile Takeover - If a company encounters a hostile takeover, an external opinion becomes necessary to ascertain an unbiased counteroffer.
• Competing Bids - When a business chooses between multiple competitive options, it enlists a third party to assess the financials of each target.  
• Involvement of Insiders - If a business transaction of significant value involves affiliates or insiders, an external financial advisor is recommended (to avoid potential conflicts of interest).
• Going Private Transaction - In the case of leveraged buyouts, management buyouts, or tenders, companies undertake fairness opinions to quote appropriate prices.
• Dissatisfied Shareholders - If a stakeholder disagrees with the board of directors' decision, a 'fairness opinion' is undertaken to settle the dispute.
• Disagreement Between Directors - When members of the board of directors express conflicting views pertaining to a particular deal, an external report is called upon to resolve the conflict.

This article has been a guide to what is Fairness Opinion & meaning. We explain fairness opinion definition, valuation, letters, & reports using an M&A example. You can learn more about it from the following articles -

• Auditor’s Opinion
• Adverse Opinion
• Financial Audit