Valuations in Support of Going Private Transactions

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1 Valuations in Support of Going Private Transactions Business valuators are often called upon to provide valuation services in connection with transactions involving public companies. Such services may include formal valuations as well as fairness opinions related to going private transactions. These transactions are subject to public scrutiny and regulatory oversight and may involve related parties or minority interests that are impacted. As a result, the valuator needs to employ a high level of diligence in preparing these valuations as well as ensure compliance with all relevant securities laws and regulations. The Canadian Institute of Chartered Business Valuators (CICBV) has established practice standards that are more detailed, and often more stringent, than those established by the regulators. The CICBV is a self-regulating body that establishes and oversees practice standards, educational requirements, and ethical guidelines that support and promote the integrity of the valuation profession for the benefit of its members who hold the CBV designation. Issuers of formal valuations and fairness opinions should consider CICBV practice standards when relevant and hire advisors, such as Farber Financial that work to these standards. The valuator needs to employ a high level of diligence in preparing these valuations as well as ensure compliance with all relevant securities laws and regulations. Going Private Valuations Historically, going public has been used as a means to obtain increased access to financing. With strong equity markets, this benefit was seen as more than offsetting the increased compliance costs that are part and parcel of the regulatory regime governing publicly traded companies. However, the appeal of being public has been reduced in recent years as a result of volatility in the public markets, ensuing difficulties in raising capital through this vehicle, and funding the significant direct costs associated with maintaining a publicly-traded entity. As a result, the Canadian marketplace has seen a significant increase in the number of publicly listed companies going private in recent years. Going private transactions have the potential for conflicts of interest if they involve the acquisition of the shares of the minority shareholders by majority shareholders. The Ontario 1

2 Securities Commission (OSC) Multilateral Instrument Protection of Minority Security Holders In Special Transactions (MI ) provides a set of rules which attempt to ensure fair dealing in the treatment of minority shareholders, including setting out a requirement for an independent formal valuation. MI requires that a formal valuation be commissioned and that that the valuation report or summary thereof be included in any disclosure documents provided to shareholders. MI mandates that the valuation be prepared by a qualified valuator that is independent of all interested parties in the transaction. The value to be determined as part of the formal valuation is the per share value of the existing class(es) of shares using a definition of fair market value which is defined in MI as the monetary consideration that, in an open and unrestricted market, a prudent and informed buyer would pay to a prudent and informed seller, each acting at arm s length with the other and under no compulsion to act. However, the rules also state that in determining the fair market value of the affected securities, the valuator should not include in the formal valuation a downward adjustment to reflect the liquidity of the securities, the effect of the transaction on the securities or the fact that the securities do not form part of a controlling interest. The OSC rules for going private transactions emphasize the independence of the valuator in addressing the information needs of minority shareholders. MI provides guidance as to the definition of independence and sets out the requirements for disclosure pertaining to the valuator s independence in the disclosure documents, including the following: A statement that the valuator has been determined to be qualified and independent; A description of any past, present or anticipated relationship between the valuator and the issuer or an interested party that may be relevant to a perception of lack of independence; A description of the compensation paid or to be paid to the valuator; A description of any other factors relevant to a perceived lack of independence of the valuator; The basis for determining that the valuator is qualified; and The OSC rules for going private transactions emphasize the independence of the valuator in addressing the information needs of minority shareholders. The basis for determining that the valuator is independent, despite any perceived lack of independence, having regard to the amount of the compensation and any factors referred to above. The purpose of the circular is to provide shareholders with an understanding of the proposed transaction 24

3 as well as the valuation conclusions which will enable them to make an informed decision whether to accept the offer. Accordingly, MI requires that the valuation report or summary contained in the disclosure documents provide sufficient disclosure to allow the readers to understand the principal judgments and underlying reasoning of the valuator so as to form a reasoned judgment of the valuation opinion or conclusion. It should also include a discussion and rationale for any major differences between the valuation conclusions and those of other recent valuations or the values implied by recent market share prices. The valuation must disclose any distinctive material benefit that might accrue to an interested party (as defined by the applicable securities regulations or policies) as a consequence of the transaction and whether such benefit is reflected in the valuation conclusion. The valuation pursuant to MI generally assumes that an arm s length third party would operate the subject company in a manner which maximizes value, which may result in valuing the company as though it were privately held and not incurring public company costs. Fairness Opinions A fairness opinion, as defined by the CICBV is a written communication by an independent financial advisor which is usually prepared in a brief letter format containing a conclusion as to the fairness of a proposed transaction The fairness opinion is a useful governance tool which allows boards of directors to demonstrate that they have met their fiduciary duties and acted independently and objectively in forming their decision about a transaction. to certain security holders of a company. A fairness opinion, or a summary of it, is often provided to shareholders as a part of the proxy materials relating to a pending transaction. While fairness opinions are not mandated by securities regulations, the use of fairness opinions has increased in the last number of years as Canadian shareholders have become more litigious and corporate governance issues continue to make headlines. The fairness opinion is a useful governance tool which allows boards of directors to demonstrate that they have met their fiduciary duties 3

4 and acted independently and objectively in forming their decision about a transaction, by taking into consideration the opinion of independent and experienced financial professionals. While a valuation may form the basis for the financial advisor s conclusions as to fairness, a fairness opinion is not a formal valuation and does not provide a conclusion as to the value of the entity or shares on which the valuator is opining. The fairness opinion merely speaks to the fairness of the transaction for the benefit of a defined group of shareholders. Furthermore, it should be noted that the fairness opinion only comments on whether a transaction is fair not whether it is the most fair or whether other transaction alternatives exist that may maximize value to the subject shareholder group. Accordingly, the fairness opinion is not to be considered a recommendation to approve or not approve the transaction, and boards of directors are advised to consider the fairness opinion as only one amongst numerous factors in deciding whether to recommend that the transaction be approved. The fairness opinion goes beyond the notional value of the security involved and examines the specific features of the transaction. While the OSC does not mandate fairness opinions in support of certain transactions, it has clearly stated that independence is a key feature of the fairness opinion. Without independence, the fairness opinion does not provide value to a board of directors in concluding as to the fairness of the prospective transaction and does not demonstrate that the board has met its fiduciary duties. Accordingly, in selecting a financial advisor to provide a fairness opinion, it is important that the board of directors ensure the independence and perceived independence of the chosen candidate. Some of the factors to be considered in assessing independence are set out in MI , and include: The past, present or anticipated relationship between the valuator and the company; The type of consideration being paid to the valuator for the fairness opinion; and Other services being provided to the company and consideration being paid in connection therewith. Any form of contingent consideration being provided in connection with preparation of the fairness opinion or other services could be perceived as impacting the objectivity of the of the advisor. Furthermore, if the preparer of the fairness opinion is concurrently advising on the transaction which is the subject of the fairness opinion, this could be perceived as impacting the objectivity of the opinion and not aid the board of directors in achieving its objective. Accordingly, it may be preferable for a board to separate the two mandates and avoid having their transaction advisor also be the preparer of the fairness opinion. The fairness opinion goes beyond the notional value of the security involved and examines the specific features of the transaction itself. 4

5 While there is only limited guidance from regulators relating to fairness opinions, Standard 510 of the CICBV Practice Standards sets out the detailed requirements for fairness opinions to ensure that they are viewed by all parties as objective and comprehensive and that the fiduciary duties of boards of directors have been met. Some of the disclosure recommendations in Standard 510 include: A description of the proposed transaction and the consideration being offered to the security holders; The purpose and the effective date of the fairness opinion; The identity and credentials of the fairness opinion issuer; A description of any past, present or anticipated relationship between the fairness opinion issuer and any interested party which may be relevant to the fairness opinion issuer s independence for purposes of providing the fairness opinion; A statement that the fairness opinion was prepared by the fairness opinion issuer acting independently and objectively or facts that might result in the possible actual or perceived lack of independence and objectivity. A statement that the fairness opinion issuer s compensation is not contingent on an action or event resulting from the use of the fairness opinion or disclosure the nature of the actual or perceived contingent consideration; Any restrictions that affect the fairness conclusion, including:»» Where the fairness opinion issuer was limited in the scope of review or where information provided to the fairness opinion issuer was substantially incomplete, disclosure should be made of the limitation and of the incomplete information, reasons given and the potential impact of such limitation on the fairness opinion conclusions; and»» Any qualifications or limitations to which the fairness opinion is subject. Sufficient information to allow the reader to understand how the fairness opinion issuer arrived at the conclusion expressed including a discussion of the methodology used to conclude on the fairness, major assumptions and the scope of review; A discussion of any bona fide offer or prior valuation or other material expert report considered by the fairness opinion issuer in coming to the Fairness opinion s conclusions; and A conclusion as to fairness of the proposed transaction to the security holders, from a financial point of view. Even though a fairness opinion may not be mandated by regulation, it is often a prudent best practice that a board should observe. 5

6 Conclusion There are many circumstances today in which a formal valuation or fairness opinion may be required in the context of public company transactions. While the circumstances in which formal valuations are required are often mandated by regulatory authorities, obtaining formal valuations and fairness opinions prior to executing a transaction is prudent and can be considered best practice in light of the increasing litigious shareholder community in Canada as well as the greater focus on corporate governance matters. Properly selected professional advisors as well as properly prepared formal valuations and fairness opinion reports can help boards of directors in deciding whether to approve a transaction and can aid them demonstrating that they have met their fiduciary duties in applying due care when assessing a transaction. Boards of directors must be careful to select professional advisors that clearly have experience in issuing reports of this nature and the advisors must be objective and independent of the company and any interested parties, both in fact and in appearance. Boards of directors must be careful to select professional advisors that clearly have experience in issuing reports of this nature and the advisors must be objective and independent of the company and any interested parties, both in fact and in appearance. Furthermore, the analysis undertaken by the financial advisors and disclosure in their reports must be comprehensive enough to demonstrate that they performed a thorough analysis as required by the circumstances, but it is also important for the board to ensure they understand the analysis and considerations of the advisors in reaching their conclusions. Financial advisors need to ensure that they are complying with the requirements of the relevant regulatory authorities with regard to valuation work and disclosure and it is highly recommended that boards choose advisors that follow the more comprehensive guidelines set out in the CICBV Practice Standards. Blair Roblin, LLB, MBA, CBV, CF is a Managing Director with the Corporate Finance, Transactions & Valuations practice of Farber Financial Group. Blair can be reached at or broblin@farberfinancial.com. Nathan Treitel, MBA is a Vice President with the Corporate Finance, Transactions & Valuations practice of Farber Financial Group. Nathan can be reached at or ntreitel@farberfinancial.com. 6