Do Boards Need an Independent Financial Advisor?

Verit Advisors’ view is that boards of directors, even those of private companies, are well advised to retain an independent financial advisor whenever considering a significant equity transaction. There are situations where the need for such counsel may be less obvious, but in our experience an emerging best practice is for boards to receive a fairness opinion even when the company (i) was sold through a competitive M&A process and (ii) is 100% ESOP-owned and the trustee is receiving its own independent fairness opinion.

Fairness Opinions

A fairness opinion is an independent analysis of the fairness of a transaction, from a financial point of view; it is not an endorsement or assessment of a deal’s business merits. Fairness opinions, we believe, are important for a number of reasons. Among other things, they provide evidence that a board of directors has fulfilled its fiduciary duty, its duty of care, when considering a transaction. While some transactions, in hindsight, appear to have been ill-conceived and not in the best interest of the selling shareholders, as long as a board has not breached its duties of good faith, loyalty, or due care, members are afforded protection under a doctrine known as the Business Judgment Rule. That is, as long as a board has acted in good faith and acted prudently, its members will not be held liable for poor decisions. The importance of this “insurance” aspect of fairness opinions is exemplified in those situations where a board member intends to participate in a management buyout. Here the board member’s loyalty to the company’s shareholders may be in question, and presents a conflict of interest. An independent fairness opinion helps mitigate the risk such a scenario presents.

According to a recent Wall Street Journal article, shareholders challenged 94% of U.S. public-company deals last year, up from 44% in 2007. The average deal now faces five lawsuits, often filed in different state and federal courts.

We believe fairness opinions are important for private-company boards of directors. The process itself is valuable to board members, particularly those who are not financially sophisticated. The methodologies deployed by the financial advisor, its due diligence process, including vetting financial forecasts with management, and the in-depth review of the terms and conditions of the contemplated transaction, will all be discussed with the board when the financial advisor delivers its opinion presentation. Board members will have ample opportunity to ask questions at that time, thereby thoroughly informing themselves in anticipation of a vote to approve the deal.

ESOP-Owned Businesses

When some or all of a company’s equity is owned through an ESOP, a trustee is designated to represent the interests of the ESOP trust and its employee participants. When the sale of such a company is being contemplated, the ESOP trustee retains a financial advisor who, among other things, provides a fairness opinion. This opinion, however, is invariably only for the benefit of the trustee and the employee-owners. Because boards of such companies continue to have the same duties of good faith, loyalty, and due care, a separate fairness opinion, directed to non-ESOP shareholders (e.g., founders, management, and other investors), should be considered. Certain corporate characteristics – such as multiple classes of stock, passive shareholders, or multi-family / multi-generational ownership – deserve special attention when considering a sale or merger transaction.

In the case of 100% ESOP-owned companies, where the ultimate transaction is the result of a comprehensive M&A process, an independent fairness opinion is a reasonable precaution for a board of directors to take. Even if shareholders in such companies would be hard pressed to make a case, board members owe it to themselves to be well versed on all aspects of the transaction being contemplated, especially with regard to what is generally the critical question: What’s the business worth? And that question, of course, lies at the heart of all fairness opinions.

As always it is Verit’s vision to bring a fresh approach and customized solutions to advise private business owners on ownership transition.