Solvency Opinion Critical for Dividend Recapitalizations
Hello. I’m John Bintz, and this is Bryan Browning. We’re both managing directors at Valuation Research Corporation. Today we want to talk about why solvency opinions are so important as it relates to dividend recapitalizations. Dividend recapitalizations have increased over the recent years, primarily due to stabilized cash flows as well as a low-interest rate environment. Bryan has been providing solvency opinions for the last 20 years. So Bryan, what is a solvency opinion?
Bryan Browning: Well, John, generally, a solvency opinion is a document that states that, after a transaction is consummated, the company is solvent. And this usually means that new debt is taken on as part of the transaction.
John Bintz: And who would request them?
Bryan Browning: Well, typically, boards of directors, private equity firms, and lenders to a transaction request solvency opinions.
John Bintz: And what are the requirements?
Bryan Browning: Requirements are three-fold. There are three tests of solvency. The first is a balance sheet test and, in this test, the fair value of the assets are compared to the liabilities that are taken on as part of the transaction. And if those assets exceed the liabilities, it meets this test of solvency.
The second test is a cash flow test. In this test, the management’s forecasted cash flows, including the new debt and interest payments, are analyzed. If the cash flows support the new operating structure, then it meets this test of solvency.
And then, third is a capital surplus test. And, in this test, the forecasted cash flows of management are stressed to see if, in a downside scenario, we want to see how much cushion there is if the company misses its forecasts.
John Bintz: So in 2010, there was approximately $54 billion of dividend recapitalizations. In 2011 there was $57 billion. If you’re a private equity fund, why would a solvency opinion be so critical?
Bryan Browning: Well, John, it’s absolutely critical because no party to the transaction wants to see a fraudulent conveyance or a fraudulent transfer. So, if the company is found to be solvent at the time of a pending transaction, then boards of directors, private equity firms, and lenders can take satisfaction that a qualified independent firm provided or rendered an opinion of solvency.
John Bintz: Bryan, thank you very much for your insight and your remarks on this topic.