drafting-transaction-opinions

# Drafting Transaction Opinions

## When To Use

- Board or special committee requests a solvency opinion in connection with a leveraged transaction, dividend recapitalization, or spin-off
- Counsel or financial advisor needs a fairness opinion framework for an M&A transaction
- A transaction requires documented analysis that consideration constitutes reasonably equivalent value under UFTA/UVTA standards
- Lender or sponsor requires independent capital adequacy assessment before closing a leveraged financing

## Inputs To Gather

- **Financial statements** — audited historicals (3–5 years) and management projections (base, downside, severe downside)
- **Transaction documents** — merger agreement, credit agreement, equity commitment letter, sources & uses, and pro forma capitalization table
- **Valuation materials** — DCF models, comparable company analysis, precedent transaction analysis, and any third-party appraisals
- **Capital structure detail** — debt maturity schedule, amortization terms, covenant package (maintenance and incurrence), revolver availability
- **Business context** — industry dynamics, customer/supplier concentration, capital expenditure requirements, working capital seasonality
- **Engagement scope** — confirm whether opinion covers solvency only, fairness only, or combined; identify opinion date and any post-closing conditions

## Workflow

1. **Define scope and standard of review**
   - Confirm opinion type: solvency opinion, fairness opinion, or reasonably equivalent value opinion
   - Identify the governing legal standard — state UFTA/UVTA provisions, federal Bankruptcy Code § 548, or contractual requirements [VERIFY: applicable state statute and lookback period]
   - Document reliance on management representations, third-party reports, and any limitations on independent verification

2. **Perform balance sheet solvency test**
   - Restate assets at fair value (not book value) — use orderly liquidation value or going-concern value as appropriate
   - Restate liabilities at fair value, including contingent and off-balance-sheet obligations
   - Calculate net equity: fair value of assets minus fair value of liabilities
   - Apply the test on a pro forma post-transaction basis
   - Flag any material valuation assumptions with [VERIFY] markers

3. **Perform cash flow solvency test (ability to pay debts as they come due)**
   - Build or validate a 13-week near-term cash flow model and a long-range projection (3–5 years)
   - Stress-test under downside scenarios: revenue decline of 10–25%, margin compression, working capital deterioration
   - Confirm debt service coverage in each scenario — EBITDA-to-interest coverage and EBITDA-to-total-debt-service ratios
   - Identify the break-even point where the entity can no longer meet obligations as due

4. **Assess capital adequacy**
   - Analyze pro forma leverage ratios (Debt/EBITDA, Net Debt/EBITDA) against industry benchmarks and lender covenant thresholds
   - Calculate covenant headroom under base and downside cases — flag scenarios where maintenance covenants would be breached
   - Evaluate refinancing risk: assess debt maturity wall, amortization schedule, and market conditions for refinance
   - Determine whether the entity retains sufficient capital to operate its business and meet reasonably foreseeable obligations

5. **Evaluate reasonably equivalent value**
   - Quantify total consideration received by the transferor (cash, assumed debt, contractual rights, releases)
   - Compare against fair value of assets or interests transferred using at least two independent methodologies (DCF, comparable companies, precedent transactions)
   - Assess whether the exchange is arm's-length — identify any insider relationships, badges of fraud, or coercive deal dynamics
   - Document the valuation range and where the transaction consideration falls within it

6. **Draft the opinion document**
   - **Executive summary** — transaction description, opinion type, and conclusion (1 page)
   - **Scope and assumptions** — engagement terms, reliance on management data, limitations
   - **Solvency analysis** — balance sheet and cash flow tests with supporting schedules
   - **Capital adequacy analysis** — leverage, coverage, covenant headroom, and stress results
   - **Reasonably equivalent value analysis** — valuation methodologies, ranges, and conclusion
   - **Risk factors and qualifications** — material assumptions, market conditions, forward-looking disclaimers
   - **Conclusion and certification** — opinion statement, effective date, signature block

7. **Sensitivity and scenario analysis**
   - Present key assumptions in tabular form with base / bull / bear outcomes
   - Show sensitivity of solvency conclusion to changes in EBITDA, discount rate, and working capital
   - Highlight the margin of safety — how much deterioration before the solvency conclusion reverses

## Output

A transaction opinion document containing:

- Clear statement of the opinion standard applied and legal basis
- Dual solvency analysis (balance sheet and cash flow) with pro forma financials
- Capital adequacy assessment with covenant headroom under stressed scenarios
- Reasonably equivalent value determination supported by multiple valuation methodologies
- Sensitivity tables showing the robustness of conclusions under adverse conditions
- Explicit assumptions, limitations, and qualifications section
- Supporting schedules: pro forma balance sheet, cash flow projections, valuation summary, debt maturity profile

## Quality Checks

- [ ] Both solvency tests (balance sheet and cash flow) are performed and documented separately
- [ ] Assets are stated at fair value, not book value, with methodology disclosed
- [ ] Contingent and off-balance-sheet liabilities are identified and included
- [ ] At least two independent valuation methodologies support the REV conclusion
- [ ] Stress/downside scenarios are quantified, not merely described qualitatively
- [ ] Covenant headroom analysis covers the full projection period, not just Year 1
- [ ] All material assumptions are flagged — no inferred data presented as confirmed
- [ ] Opinion date and effective date are clearly stated and consistent with transaction timing
- [ ] [VERIFY] markers are placed on jurisdiction-dependent standards (UFTA vs. UVTA, state lookback periods, applicable insolvency definitions)
- [ ] Document does not express a legal opinion — scope is limited to financial analysis and conclusions