The role of the board of directors is to represent the shareholders’ interests and hold the management team accountable. Fulfilling these duties can be difficult, and this is even more true during uncertain financial times. Today, boards of directors are on heightened alert regarding their obligation as fiduciaries and are seeking advice from legal and financial experts to guide them through these difficult times.
COVID-19 issues and the recent disputes between oil producers have upended the performance of many companies and industries. As a result, boards of directors are faced with business issues and financial scenarios that would have been unthinkable a few months ago. Third-party impartial analysis provides valuable decision-making tools to assist boards of directors in their role as fiduciaries.
While the global economic crisis we are facing is unprecedented, historically, market downturns have increased M&A activity and created unique opportunities. As the nation reopens, companies and boards of directors will continue to be faced with a number of difficult decisions. While the environment may be unique, many of the issues boards of directors face today are not.
When presented with these issues, fiduciaries can turn to investment banking professionals to render fairness and solvency opinions to minimize risk and protect shareholders. These professionals can assist boards of directors and special committees when they are asked to assess:
- Acquisition of competitors.
- Bona fide offers to be acquired.
- The sale or purchase of assets between funds with different limited partners.
- Related-party transactions.
- Capital infusions with potential dilutive impacts to existing stakeholders.
- Split-up/spin-off transactions with significant leverage.
- Dividend recapitalizations.
Boards of directors request fairness opinions from independent third parties for a number of reasons. Fairness opinions provide an independent, objective opinion of the proposed transaction, while providing the board of directors with a full understanding of its complexities. Fairness opinions reduce and eliminate potential conflicts of interest, allowing the board of directors to fulfill their fiduciary duties.
While M&A deals tend to require fairness opinions, solvency opinions are used by boards of directors, special committees, management teams and lending institutions to assess leverage and the company’s ability to repay debt obligations. As an example, through split-up/spin-off transactions, debt obligations may be apportioned to one business more than the other. In this case, a solvency opinion will give comfort to the fiduciaries that the levered company will continue as a going concern. In addition, companies may declare a special dividend that requires debt financing. In these situations, it is prudent for the board of directors to request a solvency opinion in connection with the borrowing and subsequent dividend.
Boards of directors are not required to make these difficult decisions independently, using only their collective knowledge and experience. Soliciting independent third parties for analytical support and the formation of special committees allows the members to uphold their fiduciary duties and protect the shareholders. Whether the board of directors is contemplating a transaction or recapitalization, an investment banking team can assist and provide analysis to protect the board of directors and allow them to make fully-informed decisions.
The solvency opinion seeks to answers four questions:
- Will the fair value of the company’s assets (including intangible assets) exceed the fair value of current and contingent liabilities after the proposed transaction?
- Can the company meet its debt obligations as they become absolute and mature after the proposed transactions?
- Can the company meet its operating expenses, capital expenditures and debt obligations?
- Will the company have an unreasonably small amount of capital for the business after the proposed transaction?
Greg Cook is a director with Prairie Capital Advisors