Looking at the deal through an unfiltered lens
The future had never looked so bright for Big Large Corporation (BLC). Business was booming, and the company was looking at several acquisition opportunities.
Even though the future was promising, members of the Board of Directors were apprehensive. Two of the possible transactions involved arrangements with board members and advisors, and the directors had concerns that the arrangements could be perceived as conflicts of interest.
Given the current regulatory and legal climate, a higher level of diligence would be required to demonstrate the appropriate level of corporate governance regarding the ultimate transaction. Clearly, increased transparency and documentation were key.
But what was the best way to gain that transparency? How should the board document its actions?
The future indeed looked bright, but for the BLC Board, the hard work was just beginning. Fortunately, a key component for the job was readily available: an independent fairness opinion.
The relationships among board members, financial advisors and counterparties in mergers and acquisitions (M&A) transactions face increased scrutiny.
As the perceived risk of monetary judgments against companies rises, boards are increasingly asking how their actions may be viewed by shareholders, courts and regulators.
There is always a focus on a board’s actions in evaluating a transaction. The evaluation process must include, among other things, robust and well-documented diligence and analyses.
Further, in today’s increasingly skeptical financial environment, investors are seeking more transparency and independence, which can be unknowingly compromised in the complex, global web of financial relationships.
Shareholders, stakeholders and regulators alike are seeking more independence and transparency in the decision-making process, citing the boards’ fiduciary responsibilities.
Regulators in the US and other countries have shown an increasing appetite for enforcement. Investors have also not been shy about pressing their concerns — often via the courts.
With heightened stakeholder scrutiny of board decision-making around transactions, the focus on robust, independent analysis has never been more relevant.
Expectations now require directors to gain more knowledge and background regarding the transaction as part of the execution of their fiduciary duty in the decision-making process.
With the heightened level of interest in corporate governance, directors face not only regulatory pressure but also the threat of lawsuits outside of the normal course of business.
Responding to both requires resources and time better spend on dealing with pre- and post-transaction business issues and determining the company’s strategic direction. In addition, good corporate governance is one of the building blocks of shareholder value.
Directors can help create value by meeting shareholders’ expectations for transparency and independence in decision-making. Independent fairness opinions for material transactions can help directors meet those expectations.
Boards need to demonstrate that their executive management team has taken the appropriate steps to evaluate transactions in a diligent manner free of bias, providing a foundation for the Board to fulfill their fiduciary duties. There are certain steps on the path to a rigorous and well-documented evaluation:
1. Assess strategic alternatives. Executive management should be engaged in a regular review of their company’s position in the market and the strategic alternatives available to maximize shareholder value.
2. Develop well-thought-out and documented support for the contemplated transaction price, deal structure and strategy. This may include, but is not limited to The Board of Director’s understanding of the following actions:
- Perform detailed financial and business diligence around the historical and projected accounting and operations.
- Understand and document the portion of deal value derived from synergies, the realistic probabilities of achieving synergies and their expected timing.
- Document the bidding and negotiation details, including the independence of the parties who are negotiating.
- Understand and document key value drivers and sensitivity of the price to these assumptions.
- Understand and document possible deal-breakers — any changes to key assumptions or any points at which key synergies must be achieved.
3. Obtain a fairness opinion for all material transactions when the board and its advisors deem it appropriate.
4. Consider a second independent fairness opinion for transactions where the company is receiving an opinion from its M&A advisors, in particular where the primary advisor is receiving additional transaction-related fees that are contingent upon the transaction.
The performance of appropriate and independent diligence provides a strong foundation for the Board against future scrutiny of its actions.
In particular, an independent fairness opinion can help boards of directors gain a level of comfort around a transaction. Independent fairness opinions are a critical part of the fiduciary process for a board of directors in any corporate transaction, but they are particularly valuable in situations where conflicts of interest and/or perceived conflicts of interest have been identified.
While the vast majority of publicly disclosed, independent fairness opinions are associated with change-of-control transactions, a fairness opinion might prove useful in some instances where there is no change of control. This can include:
- Related-party transactions
- Debt-for-equity exchanges
- Stockholder transactions that may or may not benefit the unaffiliated minority shareholders
Deal-related litigation, conflicts of interest, investor perception and fiduciary duty are just some of the many heightened issues that boards have to deal with in the post-credit crisis global economy. There is no silver bullet that will protect a board from criticism, but careful planning and execution of corporate finance strategy and the use of appropriate, independent advisors provides for a higher level of corporate governance.