Valuations and fairness opinions
Valuation as part of an M&A process
Valuation is a necessary step in every M&A process to establish a basis for the selling price. Executed by independent experts, valuation provides the transaction parties a credible and reliable starting point for price negotiations. It is important to keep in mind, that the price is always buyer-specific and no such things as one “true” price exists. The transaction is closed only if the price of the seller and the price of the buyer meet. A carefully compiled valuation breaks down the value formation along with its bases.
Market capitalization (i.e. market value) is formed each day for companies listed in stock exchange. Yet, as not all investors agree on a company’s value, individual transactions may easily deviate +/- 20 % from the daily exchange rate. Similarly, in IPOs, some investors refrain from subscription due to high price while others hoard the cheap shares. These differences in value perception are visible also in market platforms exclusively for non-listed companies.
When selling or divesting a business, valuation can help determine a price point below which the seller should not engage in the transaction. Further, multiple valuations can be performed to estimate the maximum price point for individual buyers, as a company may have several values dependent on the buyer. For the buyer, the price is largely determined by attainable synergies which are usually buyer-specific. Closing the transaction is subject to reaching a price where the seller and buyer’s prices meet. This reflects the actual value of the company.
When acquiring a business, valuation can be also used to determine the maximum price for the buyer that can be paid without destroying the existing ownership value.
IFRS compliant accounting became requisite for listed companies in early 2005. Under IFRS, goodwill gained from acquisitions or items that hold goodwill in the balance sheet must be regularly tested for impairment. Tests must be carried out annually or if at risk of value loss. If the value of goodwill has impaired, the excess goodwill shall be written off as expense in the income statement.
In practice, goodwill test is a valuation performed as a part of an acquisition process, annually or more frequently in high-risk cases. As valuation methods have become increasingly standardized, understanding of valuations has also spread to IAS compliant companies which account for the majority of the Finnish company stock.
Valuation can be made either as an in-house project or ordered from outside professionals. While the calculation models remain fairly simple and accessible to all, outside professionals hold a significant advantage over in-house departments in terms of experience and expertise. Additionally, outside professionals are trained to challenge the management’s views, providing fresh insights and discovering matters missed by the company. The valuation process can thus deliver valuable information for the management as a by-product.
In addition to gaining access to historical and current financial figures, valuation is ideally based on a carefully executed business plan along with numerical forecasts. Only then will the valuation be based on in-depth understanding of the company. On the other end of the spectrum, the so called ”quick and dirty” valuation method can be built on public data alone or performed in cooperation with the client. Valuation remains, however, only as reliable as its most unreliable assumptions. The more thorough the valuation process, the more reliable the results.
Fairness Opinions in M&A transactions
A Fairness Opinion is a fact-based report compiled by an advisor. The purpose of a Fairness Opinion is to provide an objective third-party analysis of the received proposals regarding the transaction. A Fairness Opinion is needed, for example, in a situation where the parties to the transaction want assurance that the arrangement will be made on reasonable terms to the parties. Opinions are most often requested as a part of M&A transaction, for example regarding valuations, synergies, risks, and the purchase price. A Fairness Opinion is usually a separate report prepared by an investment bank.
A Second Opinion, as its name implies, is second opinion, for example on valuation. A Second Opinion is relevant especially when the original Fairness Opinion was compiled by an advisor who is not independent of the transaction. Such situation may occur when the Fairness Opinion was compiled by the other party’s advisor.
Fairness Opinions and Second Opinions provide security for clients at different stages of the M&A process:
- An independent statement on price / valuation provides an objective third-party analysis of the deal’s fairness for decision makers.
- When contemplating a proposed transaction, Fairness Opinions provides protection to the board members.
- A Fairness Opinion mitigates risk of potential post-process litigation and claims.
- Banks may require Fairness Opinions and Second Opinions in their financing decisions.