Fairness Opinion

A fairness opinion is a third party assessment report on the financial aspects of a merger, takeover or buyout, to ascertain whether the deal is made at a fair price.

As deals such as acquisitions can cost millions or even billions of dollars, it’s worth getting the opinions of independent third party experts on their thoughts over the terms of the deal.

For example, if a leveraged buyout price is at $5 a share and the share is publicly traded at $4.50, then the buyer needs to know whether the 50 cents premium is a fair price that is worth paying for.

Maybe it’s over-priced as there are simply to many liabilities. Maybe it’s under-priced as it’s financial performance should bring the PE ratio higher towards industry levels. Maybe it’s a fair market price. Or maybe the company is so deep into debt that it only has enough cash to last for another two weeks.

An impartial expert opinion should help bring a clearer picture of things.

As mergers and acquisitions decisions are purely made by the key people of a company, fairness opinions are not necessities for a deal to go ahead.

But they do aid the management to determine how fair or how risky the decisions they intend to make are.

The rise of shareholder activism is also making company boards more accountable for what they do.

It used to be that the investments of shareholders are at the mercy of the actions of CEOs. Now CEOs are being questioned and challenged constantly by shareholders.

Getting the inputs of third party experts can help create the perception that decisions were not made hastily.

The work conducted by third parties might also include investigative findings that uncover adverse information about a target company that is unknown to the client.

These research reports are usually done by investment banks or other third party firms with relevant expertise for a fee.

Moral hazard

In recent years, the topic of moral hazard has come to prominence.

Moral hazard basically refers to a party quietly benefiting from a deal by suggesting the victim to take certain action.

This can occur when an investment bank hired to provide the fairness opinion would benefit from the success or failure of the deal they are researching.

This would actually not be surprising as investment banks tend to hold various positions in various public and private companies.

If for example, a third party owns a stake in the company being bought over and don’t want the sale to happen, it could very well recommend them not to purchase the company. Or if it wants the sale to happen, it might try talking the buyer to increase the buying price.

The problem with moral hazard is that it is not illegal as long as service providers meet some basic disclosure requirements.

So a third party advisor could very well get away with such acts. After all, they are paid a fee to just offer an opinion. It is up to a client whether to act on an opinion or not.

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Imputed Cost

EBITDA

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