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