Business acquisition: Fairness of the negotiated purchase price

last updated on 22 February 2022 | reading time approx. 2 minutes

 

The appropriateness of the purchase or the sales price is one of the key questions in M&As. If it is disputable, a so-called fairness opinion can be obtained for it. It makes it easier to assess whether the responsible management has fulfilled its duties of due care, acted in the best interests of the company and made the decision to carry out the transaction on the basis of appropriate information.

 
A fairness opinion is an opinion prepared by an independent expert on the appropriateness of the financial parameters of a corporate transaction or other business decisions. The key question here is: Is the management acting in the best interests of the company and its shareholders when making the decision? The most prominent cases in which these questions were precisely examined in the aftermath of the transaction include the acquisition of Hypo Alpe Adria by BayernLB or the purchase of EnBW by the state of Baden-Württemberg.
 

High relevance also for medium-sized companies

In order to prevent such disputes afterwards, it is advisable to commission a fairness opinion already at the stage of deciding whether to embark on the respective business venture. However, fairness opinions are not only of relevance in transactions and public takeover bids of listed companies under the German Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz, WpÜG). They can also cover other significant business initiatives, e.g. financing decisions or restructuring measures, and are increasingly being used also by medium-sized companies. For example, they can be used in the sale of essential assets of a company on the brink of insolvency or in transactions with one of a company's shareholders.

In the former case, the fairness opinion should prove that it was not the withdrawal of assets that was the cause of the insolvency or that the asset was not sold at an inappropriate purchase price, as otherwise the transaction could be declared null and void by the appointed insolvency administrator. In the latter case, a fairness opinion serves to prove that the shareholders not involved in the transaction were not disadvantaged in any way. This proof is often provided in the case of family businesses with a large number of shareholders. Furthermore, as in the two cases mentioned at the beginning, fairness opinions are also prepared retrospectively to aid legal disputes.
 

What should be taken into account when commissioning such a fairness opinion?

In order to ensure a high degree of objectivity and to increase the confidence of the addressees in the fairness opinion, the preparation of fairness opinions in Germany is governed by two standards of the German Association for Financial Analysis & Asset Management (Deutsche Vereinigung für Finanzanalyse & Asset Management, DVFA, “Principles for Fairness Opinions”) as well as the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer in Deutschland e.V., IDW, “Principles for the Preparation of Fairness Opinions - IDW S8”). Both standards are equally recognised in Germany and should be applied when preparing a fairness opinion. In addition, very strict requirements apply as regards the independence of the person preparing a fairness opinion, which must be taken into account accordingly when commissioning the opinion. Advisors who are involved in the conduct of the transaction based on the performance-based fee structure are often not free of conflicts of interest. The same applies to an audit firm to be commissioned to audit the annual financial statements of the target after the successful completion of the transaction.
 

What criteria are used to assess financial fairness?

As criteria for assessing fairness, an independent valuation of the target is always carried out and compared with the planned purchase price. The German capitalised earnings method (EWV) or discounted cash flow methods are used and supplemented by other methods such as trading or transaction multiples. Depending on whether the fairness opinion is prepared for the buyer or the seller, genuine and non-genuine synergies must also be taken into account in determining the value of the target. An example for non-genuine synergy is when a new management is expected to better utilise the existing earnings potential. Genuine synergies, on the other hand, are advantages that can be generated exclusively due to the transaction, such as economies of scale in production or better purchasing conditions. In addition, there are other financial advantages that are taken into account, which can be seen in the following example: so, for the purpose of acquiring a supplier's company in danger of becoming insolvent, it has been examined what the amount of any penalty payments that the buyer would have to make to its customers would be, as the insolvency would have delayed the delivery of the buyer's products. Only by acquiring the supplier's company could the provision of the buyer's products be ensured and the payment of penalties avoided.
 
In addition to the monetary valuation and any synergies, other factors can also be taken into account to assess the appropriateness, such as whether the purchase price was achieved in a bidding procedure with multiple participants and competing bids.
 

Decision-making aid, but not a binding recommendation

In terms of good corporate governance, an independent fairness opinion is an important building block for the decision-making process and a means to safeguard corporate governance. It provides valuable information regarding the appropriateness of the transaction and can contribute to minimising the liability risk and help the management in the fulfilment of its duty of care. If there is a dispute about the appropriateness of the purchase price after the transaction, the fairness opinion can be used to justify the decision. However, a fairness opinion is not a recommendation to actually carry out a transaction. The final decision is ultimately up to the company's management, which must consider many other factors in addition to the financial appropriateness.