Fairness Opinions or Valuations Required for Adviser-Led Secondary Transactions
During March of 2022, the U.S. Securities and Exchange Commission published a rule (IA-5955) proposing to require Fairness Opinions or Valuations for Adviser-Led Secondary Transactions. The SEC solicited comments from industry participants as to whether it should require Fairness Opinions or Valuation Opinions for Adviser-Led Secondary Transactions wherein a registered investment adviser of a private equity fund (General Partner) has a conflict of interests. The SEC voted (3-2) to pass the Final Rule (IA-6383) on August 23, 2023.
What type of engagement is required by the SEC for Adviser-Led Secondary Transactions?
The SEC announced the requirements of the Final Rule (IA-6383) on August 23, 2023. Under the Final Rule, the SEC requires investment advisers of private funds to:
1) obtain either a Fairness Opinion OR a Valuation Opinion from an independent opinion provider in conjunction with adviser-led secondary transactions;
2) distribute the Fairness Opinion or Valuation Opinion to private fund investors prior to the due date of the election form; and
3) distribute a disclosure to investors of all relationships between the registered adviser and the opinion provider during the prior two (2) years.
Definitions (Rule 211(h)(1)-1)
Adviser-led secondary transaction means any transaction initiated by the investment adviser or any of its related persons that offers private fund investors the choice between:
(1) Selling all or a portion of their interests in the private fund; and
(2) Converting or exchanging all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons.
Independent opinion provider means a person that: (1) Provides fairness opinions or valuation opinions in the ordinary course of its business; and (2) Is not a related person of the adviser.
Fairness opinion means a written opinion stating that the price being offered to the private fund for any assets being sold as part of an adviser-led secondary transaction is fair.
Valuation opinion means a written opinion stating the value (as a single amount or a range) of any assets being sold as part of an adviser-led secondary transaction.
What is the difference between a Valuation, Appraisal, and Fairness Opinion?
Fairness Opinion is an industry term for an analysis that determines the reasonableness of a business transaction from the point of view of one party to the transaction. There are no uniform professional standards for the content or deliverables of a Fairness Opinion. Generally, a Fairness Opinion will consider all applicable standards of value, including Fair Market Value, Fair Value, Investment Value, and Strategic Value.
A Fairness Opinion can be provided by a variety of professional types with expertise in investment banking or valuation. Fiduciaries are usually the only parties that commission Fairness Opinions. The fees for Fairness Opinions typically start at $100,000 and increase with subject complexity and turnaround times. Fairness opinion fees for some public company transactions have exceeded $1,000,000.
Professional standards for valuation and appraisal are maintained by multiple different authoritative organizations. The definitions, terms, and standards are not perfectly consistent among them. The following comparison of Valuations and Appraisals closely follows USPAP Advisory Opinion 21 (AO-21), which attempts to reconcile the differences between valuation services and appraisal services.
Valuation is a broad term describing analyses that determine the values of an assets, businesses, and liabilities. A valuation analysis can be prepared by anyone for the benefit of any specific party. For example, a financial analyst at a private equity firm may perform a valuation analysis of a business for his or her supervisor. A valuation may or may not adhere to professional valuation standards (i.e., AICPA SSVS, IVS, NACVA), but compliance or non-compliance with standards should be disclosed when engaging a professional.
A valuation can opine upon one or more specific standards of value, like Fair Market Value, Fair Value, Investment Value, or Strategic Value. Business valuation fees typically start at $25,000 for each business and increase with subject complexity and turnaround times.
Appraisals are valuation assignments that are completed by independent and impartial professionals according to identified professional standards. The appraisal professional standards are always identified (USPAP, ASA). Appraisal standards address aspects of independence, ethics, performance, deliverables, and reporting.
An appraisal usually opines upon one specific standard of value—like Fair Market Value, Fair Value, Investment Value, or Strategic Value. Appraisers are independent and impartial and do not advocate for their clients. Clients exert no control or influence over an independent appraisal result. Business appraisal fees typically start at $25,000 for each business and increase with subject complexity and turnaround times.
Who may rely upon a Valuation, Appraisal or Fairness Opinion?
Professional Valuation Opinions, Appraisal Opinions, and Fairness Opinions clearly identify their clients, intended users, intended purpose, and intended use. Valuation professionals are engaged by their clients. Professionally prepared reports may not be relied upon by users who are not the intended users or for purposes not clearly identified as the intended purpose. The client relationship has two important implications.
1) Confidentiality: An appraiser or valuation professional upholding standards of client confidentiality will be prohibited from speaking to non-client parties regarding an assignment without express written permission from the client.
2) Intended users: An appraiser or valuation professional only has a client relationship and engagement contract with the engaging client. Unless specifically identified as an intended user, third parties are usually prohibited from relying upon an opinion that was not prepared for them. Valuation professionals do not want third parties, who are not clients, to rely on valuation opinions. Non-client third parties that do not sign service agreement contracts with valuation professionals are not subject to the terms, conditions, and limitations of client agreements. Valuation professionals are reluctant to expose themselves to liability with parties with whom they have no client relationship or contract.
The General Partner has a fiduciary responsibility to the Limited Partners of both the selling and buying funds. If a General Partner is the client, a third-party opinion can serve as evidence as to whether the General Partner is upholding its fiduciary responsibility with regard to the proposed transaction. The primary purpose of the SEC’s requirements for third party opinions is to validate that General Partners are acting in the best interests of Limited Partners.
Since General Partners have a regulatory obligation to distribute Fairness Opinions or Valuation Opinions to private fund investors, it makes sense to either (i) specifically identify the Limited Partners as intended users of the report at the outset of the engagement or (ii) have the General Partners and Limited Partners jointly engage the independent opinion provider under a joint client engagement.
Under the latter scenario, both the General Partners and Limited Partners are clients of the valuation engagement. Both clients are subject to the terms, conditions, and limitations of the valuation service agreement.
Independent opinion providers may increase their engagement fees substantially if a dozen or more Limited Partners are identified as intended users of an opinion, but the Limited Partners are not parties to the client service agreement.
Who should you hire to prepare a Valuation, Appraisal or Fairness Opinion?
Fairness Opinions are commonly prepared from the perspectives of fiduciary clients to determine if fiduciaries have fulfilled their fiduciary responsibilities for public company transactions. The benefit of Fairness Opinions is that they can consider all relevant standards of value and specific buyers and sellers.
Appraisals have the highest and strictest professional standards, but also allow the least flexibility in content and deliverables. Valuations, with or without professional standards, can be viewed as a middle ground between Fairness Opinions and Appraisals.
Business valuation professionals prepare private-held business valuations all day long.
Business appraisers prepare privately-held business appraisals all day long.
Investment bankers spend some of their time selling business, some of their time raising capital, and some of their time preparing Fairness Opinions.
The SEC’s new Fairness Opinion requirement for Adviser-Led Secondary Transactions specifically requires getting third parties to opine on pricing for sales of privately-held businesses (not publicly traded businesses).
A business valuation professional or business appraiser prepares privately-held business valuations and business appraisals all day, every day. They do not do anything else. If you read the various professional standards for valuation and appraisal you will see words like impartial, unbiased, objective, and independence.
The primary role of an investment banker is sales. Investment bankers are excellent salespeople. Salespeople are NOT known for being impartial, unbiased, objective, and independent.
Who do you want to certify you are upholding your fiduciary duty to your investors?
