There was a time when the paths of corporate officers and directors and those of independent business valuators rarely crossed. Occasionally an independent fairness opinion was required by a regulator or the law, but little else. But the fact is that valuators — often below the radar screen of the board — have been providing independent advice for acquisitions, reorganizations and tax purposes for a very long time.
But that was then; this is now, and today’s post-Enron, post-WorldCom corporate world is a very different place. True, the circumstances that led to the Enron and WorldCom scandals — problematic accounting practices, boards that allegedly ignored their fiduciary duties, management that simply didn’t manage — are not widespread problems. Actually, they are the exception — but the damage has been done. Investors were united in their demands for greater corporate transparency, and the U.S. Congress — alarmed that public trust in America’s corporate integrity had been shaken to its foundation — answered. On July 30th, 2002, the Sarbanes-Oxley Act was signed into law.
“Too little, too late,” some skeptics responded; others applauded the new law. But whatever the reaction, the impact of Sarbanes-Oxley has been felt far and wide. Corporations across the globe are now threading their way through a proliferation of new standards and stakeholder expectations, and versions of Sarbanes Oxley — and the more recent proliferation of valuation related standards (e.g. FAS 141 and FAS 142) of the Financial Accounting Standards Board in the U.S. — are starting to appear in countries around the world. In Canada, for instance, security regulators and accounting bodies are amending the existing legislation and standards to emulate the U.S. legal and professional standards. One result is that we are seeing a movement away from historic cost based accounting standards to fair value based accounting standards. Valuations are critical to fair value accounting which is by its nature more subjective than historical cost accounting.
In order to comply with the valuation-related demands of existing and proposed legislation, independent expert valuation advisors who have an understanding of current international accounting standards and technical valuation knowledge have become extremely important. Corporate directors and officers, especially, need to understand fair value measures and their impact on financial statement/accounting disclosure. Valuation can have a significant impact on whether or not a board of directors is willing, and justified, to recommend a proposed transaction to the shareholders. Valuation can also have a significant impact on the accounting results for operations and/or shareholders’ equity, as they relate to purchase price allocation and the impairment assessments of intangible assets. In most cases, the valuators are able to provide information that will have a direct impact on shareholders.
Given the potential subjectivity of fair value measures and the potential impact on the financial statements, corporate directors and officers, need to ensure that material valuations are obtained from a credible, objective and independent source. Independence, both in fact and appearance, is relevant. Independent professional valuators are bound by extensive professional standards and codes of ethics that among many other issues prohibit fees for opinions based on outcome.
Below are a few real life cases in which an independent valuation was — or would have been — critically important to the directors or officers in corporate accountability and good corporate governance.
Unsolicited Offer for All of the Shares of a Public Corporation
The controlling shareholder of a thinly-traded public company was prepared to sell his shares to a buyer at the offered price. The directors had to decide whether or not to support the offer and pricing on behalf of the minority shareholders. There was no legislative or regulatory requirement for the directors to request an independent “fairness” review of the proposed takeover price.
Was the price offered adequate? Did the major shareholder accept an inadequate price for unique reasons? The directors consulted with us as independent valuation counsel and we determined that the price offered was not adequate for the minority shareholders.
The directors decided not to recommend the offer, but to focus instead on restructuring operations to better enhance share values before exposing the company’s shares to the market.
Hostile Takeover, Independent Valuation Advice
A public company, the target of a hostile takeover bid, retained two investment banking firms to find a “white knight”. The investment banking firms found a buyer who, in turn, made an alternative takeover bid. The company had an information circular prepared for its shareholders in which the same two investment banking firms were retained to provide fairness opinions on the takeover price.
The investment banking firms were each able to provide positive fairness opinions, and both firms disclosed that their total fees were contingent on the success of the takeover. Plus, both firms clearly stated that they had not done valuations of the target, but had instead relied on general market data to support their opinions. The fairness opinions were an important component of the transaction corporate governance. However, the issue here is the need for advice which is independent, both in fact and in appearance.
Over the years, we have successfully worked with investment bankers in similar cases and provided both independent and joint fairness opinions, and valuation opinions. In this situation, we believe that an independent valuation, prepared by an unrelated valuation specialist with no contingent interest in the success of the transaction, would have provided additional corroboration, better compliance with contemporary standards, and also provided enhanced transaction support for the board of the target company.
Valuation to Support Reorganization Plan
The directors of a company in financial difficulty wished to prevent a formal reorganization, or insolvency procedure, in order to retain its valuable customer base and preserve the business. The directors and officers were concerned that a more lengthy reorganization procedure would have resulted in the loss of a key customer which would then precipitate the downfall of the remainder of the business. With the consent of the company’s major creditors/debt holders we were retained to provide an independent valuation opinion to be used as a basis for renegotiating the debt holders interests.
With the support of our independent valuation opinion, the parties were able to quickly and successfully reorganize the capital structure of the business. The company was able to carry on without adverse consequences, and debt holders’ losses were kept in check. In this case the approach selected by the directors enhanced the position of both the debt holders and shareholders.
Valuation for “Down Round” Financing
We have provided independent valuations for boards of directors and shareholders who require support for the amount of equity that will be given in a new source follow-on financing of an existing venture. The valuations upon which follow-on financings are based can raise significant conflicts, given the potential for dilution of those not participating.
In one such instance, the board of directors sought our independent valuation advice as the basis for determining the pre-money value in a much needed “down-round” financing. Cash infusions were being withheld from the business, while shareholders and the board disputed a valuation obtained from another source. We provided an independent valuation opinion that was accepted by all parties, and used by the board of directors as the basis for the new financing.
Accounting for Intangible Assets in a Transaction
Under our present accounting rules, valuation associated with transactions has become more important. On the purchase of a business, the price paid for tangible — and, more importantly, intangible — assets must be properly allocated to specific balance sheet accounting categories. Improper valuation can affect operating results for many years. Some intangibles have definable lives for accounting purposes, requiring a write-off over the course of their existence, but intangibles designated as indefinite do not require amortization. These will become both a write-down and a valuation issue when their original or restated value is impaired and/or diminished.
It may be possible for earnings to be manipulated by creative asset allocation and goodwill and intangibles review, making it important that checks and balances be employed. We have seen both inadequate or improper valuation and allocation of intangibles due to the complex valuation and accounting issues involved, the potentially subjective nature of the valuation, material amounts involved and constantly evolving rules, regulations and practices. Valuations of assets with significant potential value or profit and loss amortization impact should be performed, or supervised, by qualified independent valuators, to ensure that large financial misstatements are not made.
Case in point: a major player in its industry in North America had just completed a significant acquisition with more than 50 per cent of the purchase price attributed to acquired goodwill and intangibles. Given the limited intangibles accounting precedents in this industry, the materiality of the transaction to the financial statements — and the fact that the purchase price accounting rules were relatively new — the officers of the company retained us to complete an independent valuation of the acquired intangibles. Our valuation opinion was accepted by the company’s auditors and used as the basis for the accounting values of the intangibles. The independent valuation opinion provided comfort both for the auditors, the officers and for the board of directors.
Valuation has gone from being a relatively obscure background function to one of critical importance in the governance of corporations. In the cases discussed above, the use of fully independent expert valuation advice did — or could have — provided comfort in both fact and appearance in the corporate governance process for boards of directors and officers. In these times of heightened shareholder activism, and demands for strong corporate governance, the use of credible, independent valuation advice can be a strong tool for officers and directors.
There are many more traditional valuation-related areas — such as strategic planning and value creation, tax planning and reorganization, assessment of financial claims for commercial litigation and shareholder disputes — that can have a positive impact on the operations and life of a corporation. We believe it is critical that officers and directors be aware of the rewards, and the pitfalls, of the valuation function in the life of a corporation.
Helen Mallovy Hicks is a partner in PricewaterhouseCoopers LLP’s Valuation & Strategy Advisory practice. She is a Chartered Business Valuator (“CBV”) with over 19 years of independent expert business valuation, litigation support, and related financial advisory experience in Canada, the U.S. and London, England. The focus of Helen’s activities is providing business valuation advice in the context of corporate governance (independent valuations, fairness opinions and fairness reviews), acquisitions and divestitures, corporate reorganizations, estate planning, and shareholder disputes.