Fairness opinions offered for business transactions generally ensure the best interests of the equity holders of a company are protected. Occasionally, at least under current criteria, consideration may also be given to creditors.

Think only multi-national conglomerates are confronted with million-dollar lawsuits filed on behalf of disgruntled investors? While it may be tempting to assume such pricey legal entanglements only apply to corporate giants like the Enrons and WorldComs of the world, a recent milestone for a cash settlement belongs to a much more modest business. What began as a single store stocked with athletic footwear that opened in Birmingham, Ala. in 1977 has become famous for much more than its shoe selection.

New guidelines impacting common stock valuations may result in identical classes of stock being assigned widely varying values. The different methodologies acceptable under the criteria established for IRC Section 409A could create conflicting valuations, which would create varying results for FAS 123R purposes. Private equity firms may be particularly vulnerable to resulting inconsistencies because of the potentially dramatic changes in the equity values of their portfolio companies due to operational improvements and/or top-line growth. Clearly there needs to be a better understanding of the purpose and application of each methodology.

The Phone Call

Whether you are a CFO holding stock options or an employee looking forward to a year-end bonus, you need to be aware of the new provisions in Section 409A of the IRS code. Broadening the definition of deferred compensation, the rules now cover stock plans, option plans, stock appreciation rights (SARs), bonus arrangements, and more. Penalties for noncompliance are significant, making it essential that you are aware of how your compensation is valued and reported.

Often, cash and cash equivalents held by partnerships are considered by the IRS to be subject to no discounts or to only minimal discounts, because of the obvious liquidity. However, let’s take a look at the recently decided Tax Court case, Estate of Kelley v. Commissioner, T.C. Memo 2005-235, which considers the question of discounts applied to the interests of a family limited partnership held by the Estate. The partnership’s assets consisted solely of cash and certificates of deposit. In this case the overall discount allowed by the court was an amazing 32%! Why?

The court date has finally arrived and it’s your business valuation expert’s opportunity to provide testimony. You’re expecting a stellar presentation. His credentials are impressive and he’s cool under pressure, but does he understand the importance of applying a common sense analysis to the valuation issue? Can he separate the “art” of business valuation from the “science”? Let’s take a look at the important areas your expert should have researched before his day in court and ways he can help when testing an opposing expert.

Fairness opinions are a fact of life in transactions involving public companies. There is a general consensus that the fairness opinion is a powerful tool in protecting boards of directors from liability related to a transaction. For a public company, a board of directors’ careful consideration of an independent fairness opinion can be the strongest protection against accusations of, and liability for, fiduciary failure. But, why is a fairness opinion needed by privately held companies?

Valuations professionals are often expected to know the value of every business to the penny; however, business appraisal is not an exact science, even as it follows the parameters of a standardized methodology. The analyst’s expertise and judgment are equally important in the process of analyzing value. Each valuation has a certain amount of wiggle room, which is valuable and necessary to the process. While it’s true that a valuation has an element of subjectivity, much of the benefit a client receives from a valuation is from that same subjectivity.

Fairness opinions may be vulnerable to conflicts of interest if the firm that is providing the fairness opinion is also providing other services as well, such as merger and acquisition support. Because of the increased scrutiny from regulators and the financial investment communities, boards of directors are proceeding cautiously when considering if the value of the planned merger or acquisition is fair to shareholders.