While we’ve written on this topic in the past, given the high volume of transaction (M&A, investment, etc) activity over the past few years, we thought it might be relevant to throw out a few reminders on some of the key issues related to fairness opinions.
When a company contemplates a major transaction, key decision makers have a lot to consider. One thing that shouldn’t cloud their judgement is the question of whether they will be held personally responsible if the transaction turns out poorly. In the US, courts give a lot of deference to the judgement of managers and board members, under a doctrine referred to as the business judgement rule. However, if a plaintiff objecting to a decision by the board can show that the board breached either the duty of care or the duty of loyalty, then courts will grant no deference to the board’s judgement and will review both the procedure and substance of their decision under the strictest standards. One of the most common ways that a board can demonstrate that it is fulfilling both the duty of care and duty of loyalty is to obtain a fairness opinion.
A fairness opinion is an opinion as to whether the consideration paid or received in a transaction is fair from a financial point of view to the party paying or receiving the consideration. When faced with a particularly important decision, such as whether to approve an acquisition involving the company, a board of directors often will hire independent experts to evaluate the contemplated transaction. A fairness opinion should be just one of many factors that the board considers in deciding whether to approve a transaction. However, it can be very helpful from both strategic and legal perspectives, as it will provide an independent assessment of the company’s value in addition to demonstrating that directors fulfilled both the duty of care and duty of loyalty.
Duty of Care and Duty of Loyalty
Duty of care refers to a director’s responsibility to act in an informed manner in making a business decision and requires that the director must review all information reasonably available. Duty of loyalty refers to a director’s responsibility to act for the benefit of the corporation and all shareholders. Engaging independent experts before making a decision helps directors demonstrate that both standards were seriously considered, and the decision was consistent with the contemporaneous judgement of a neutral expert.
Not Only for Public Companies
While many assume fairness opinions are important only in transactions involving publicly traded companies, they can be just as important for private companies. On the one hand, a public company has a broader shareholder base, making it more difficult for directors to gauge shareholder sentiment and potentially more likely that some shareholders will be unhappy enough to bring suit because of a board’s decision. On the other hand, the economic interests of all shareholders of a public company usually are aligned. By contrast, the economic interests of shareholders of a private company can differ substantially if there are different classes of stock. In particular, the interests of common shareholders can be very different from those of preferred shareholders. Because preferred shareholders are likely to have more seats on the board of directors, directors need to be very careful to avoid actual or perceived conflicts of interests.
Potential Conflicts of Interest
One clear example of a conflict of interest that would call into question a director’s duty of loyalty is if the director is involved with companies on both sides of a transaction. More subtle conflicts can also raise suspicions about a board’s motivation, though, making it especially important to obtain a fairness opinion. For example, if a company is contemplating a sale for a value only a little above the liquidation preference of the preferred stock, preferred shareholders will be made whole (and may even receive a healthy return depending on dividend and participation rights), while common shareholders may receive very little consideration in the transaction. To the extent that a director’s financial interest isn’t aligned with all the financial interest of other shareholders, the duty of loyalty can come into question.
Fairness opinions provide both useful perspective and legal protection for boards that are weighing important financial decisions. They can inform deliberation about a potential merger, acquisition, or sale, but also frequently are obtained when a company is considering the redemption of securities or a restructuring. If a transaction goes poorly, it can be very difficult for a board to demonstrate that its decision making was well informed and unbiased. Obtaining a fairness opinion is a very strong argument that the board sought out the opinion of experts, considered the transaction from the perspective of all shareholders, and exercised appropriate judgement based on the best available information at the time.
How can we help?
A good fairness opinion follows strong procedural guidelines and also scrutinizes the economic substance of the proposed transaction. The professionals at Teknos understand valuation techniques and the special requirements of technology companies. We utilize a variety of different valuation approaches, examining everything from historical trading in the company’s stock (if the company is public) to current acquisition premiums being paid to the discounted value of projected earnings.
In addition to providing the traditional opinion letter which forms the core of a fairness opinion, Teknos completes an extensive written analysis and explains that to the Board of Directors or Special Committee, both before execution of the transaction documents and again just prior to the closing. We have performed fairness evaluations in connection with purchases, sales, inside financings and other transactions and opinions by our team members have been included in SEC filings.
Teknos would be pleased to provide a proposal for a fairness opinion in connection with a transaction. We can complete our work rapidly, if necessary, and our fees are reasonable, varying with the size and complexity of the proposed transaction. For more information please contact us: info@teknosassociates.com .
Teknos Associates provides valuation and advisory services for emerging growth companies and their venture capital backers. Clients rely on our financial expertise, knowledge of technology markets, and high standards to deliver relevant and timely valuation reports, opinions, and analyses.