The percentage of transaction professionals who believe solvency opinions will have a direct impact on the terms or completion of a transaction over the next year has doubled since before the onset of the credit crisis, according to a study released by mergermarket in association with Houlihan Lokey.
This shift in sentiment underscores a rising importance of these types of opinions for transaction professionals and boards of directors worldwide.
The study, conducted during the third quarter of 2009, compiles interviews of senior corporate executives, private equity practitioners and lawyers from the US and Europe regarding their recent and historical experience with solvency and related valuation opinions.
A solvency opinion is a financial opinion issued typically at the close of a transaction that addresses certain financial tests of solvency. The opinion is often required by boards and/or lenders as additional protection in the case of a subsequent fraudulent conveyance claim.
An overwhelming number of respondents—86 per cent in Europe and 82 per cent in North America—believe that M&A professionals have become more aware of solvency and fraudulent conveyance issues over the past two years, most likely due to the sudden appearance of the solvency opinion in business headlines.
Further, 78 per cent of respondents said that the valuation process has been directly impacted by poor economic conditions, with the availability of financing and volatility in the equity markets cited as two variables that have a strong influence on the process.
“There is still a lot of uncertainty in today’s markets,” says Ben A. Buettell, managing director and head of Houlihan Lokey’s solvency opinion practice. “In the transactions that are coming to market, buyers and lenders are taking a closer look at the valuations of assets and liabilities on a pre-and post-transaction basis. The study’s findings are in line with our observations that professionals are responding to ongoing market complexities and the growing concern that solvency opinions are more likely to be challenged in the future by spending more time on these valuation issues.”
The study also illuminates key differences between the market for solvency and related valuation opinions in Europe versus North America. Two thirds of North American respondents reported to have been involved in a transaction that included a solvency opinion over the past three years, compared to just one third of European respondents. However, three quarters of European respondents expect demand for solvency opinions to increase in their region compared to only half of North American respondents, indicating that Europeans can expect to be hearing more about solvency and solvency opinions in the coming months.
E.W. “Sandy” Purcell, managing director and co-head of Houlihan Lokey’s financial advisory services in Europe, says: “While concepts of solvency and viability vary across the EU, we’re seeing a convergence around heightened concerns over solvency issues, both in and out of the transaction context. The regime varies across jurisdictions. For example, in France, the legal framework for solvency is still under development, while in Germany, directors of companies are obligated to file for insolvency if the company cannot pass the ‘cash flow test’ (liquidity) projected over the next 24 months. Accordingly, directors will often hire an independent advisor to determine whether the company in question has in fact entered the ‘zone of insolvency.’ Perhaps most importantly, the study revealed a sense that solvency opinions have gone from being a ‘check-the-box’ exercise, to a detailed, carefully handled analysis that offers greater security from litigation post-transaction.”
The survey also found that 82 per cent of respondents say the process of projecting future cash flows has been directly impacted by poor economic conditions and uncertainties regarding a recovery.
A further 76 per cent of respondents expect the increase in demand for solvency opinions to be most significant for refinancings, while an additional 61 per cent say asset sales will see the greatest increase in solvency opinion demand.
Just over 40 per cent of respondents say solvency opinions will be used primarily to address concerns that the buyer is taking on more debt than it can service over the next 12 months.
