What Is a Solvency Opinion?
A solvency opinion is a formal written opinion, typically provided by an independent valuation or financial advisory firm, that a company will remain solvent immediately after and for a reasonable period following a specific transaction. Solvency opinions are most commonly obtained in connection with leveraged buyouts, leveraged recapitalisations, special dividends, and other transactions that significantly increase a company’s debt or reduce its equity.
The solvency opinion serves a distinct purpose from a fairness opinion: while a fairness opinion addresses whether the price is fair, a solvency opinion addresses whether the company can survive the transaction financially.
The Three Tests
A company is generally considered solvent if it satisfies three tests immediately after the transaction:
| Test | Standard |
|---|---|
| Balance sheet test | Fair value of assets exceeds total liabilities (including contingent and identified liabilities) |
| Cash flow test | Company can pay its debts as they become due in the ordinary course of business |
| Capital adequacy test | Company has adequate capital to conduct its business as currently planned |
Key Distinctions
- Fair value — not book value; solvency opinions use fair market value or fair value standards
- Going concern — the analysis assumes the company continues operating, not a liquidation scenario
- Projection period — typically 1-3 years forward, based on management projections and the financial advisor’s independent analysis
When Solvency Opinions Are Required
Leveraged Buyouts
In an LBO, the target company takes on significant debt to finance its own acquisition:
- Lenders and sponsors obtain solvency opinions to demonstrate the company can service the new debt
- Protects directors from claims that they approved a transaction that rendered the company insolvent
- Required by most senior lenders as a condition precedent to funding
Leveraged Recapitalisations and Special Dividends
When a company borrows money to pay a large dividend to shareholders:
- High risk of fraudulent transfer claims if the company later becomes distressed
- Solvency opinion provides evidence that the board acted prudently
- Particularly important for PE-backed companies returning capital to sponsors
Spin-Offs and Divestitures
When separating businesses, both the parent and the separated entity should be solvent post-transaction:
- Ensures neither entity is left in financial distress
- Protects against creditor claims that the separation was a fraudulent conveyance
Legal Context
Fraudulent Transfer Law
Solvency opinions are primarily defensive tools against fraudulent transfer claims:
- Under US fraudulent transfer law, a transaction can be unwound if the company was insolvent at the time (or rendered insolvent by the transaction) and did not receive reasonably equivalent value
- The lookback period is typically 2 years (federal) or up to 6 years (state law)
- A solvency opinion provides contemporaneous evidence of solvency, though it is not an absolute defence
Director Protection
Directors who approve transactions with solvency opinions benefit from the business judgment rule:
- Evidence that the board obtained independent expert analysis before approving the transaction
- Demonstrates the directors fulfilled their duty of care
According to analysis by Duff & Phelps (now Kroll), solvency opinions are obtained in over 90% of leveraged buyouts with total debt exceeding 4x EBITDA and in virtually all significant dividend recapitalisations.
APAC Context
Australia — while formal solvency opinions are less common in Australia than in the US, directors of Australian companies have personal liability for insolvent trading under the Corporations Act. Independent financial analysis supporting solvency is increasingly obtained for leveraged transactions, particularly following the introduction of safe harbour provisions.
Japan — solvency analysis is conducted as part of the broader financial due diligence in Japanese LBOs, though formal standalone solvency opinions are less prevalent. Directors of Japanese companies have fiduciary obligations that require consideration of creditor interests in leveraged transactions.
India — the Insolvency and Bankruptcy Code has heightened awareness of solvency considerations in Indian M&A. Directors face personal liability for wrongful trading, making solvency analysis an increasingly important component of leveraged transaction planning.
“Solvency opinions are the financial safety check for leveraged transactions — they provide contemporaneous evidence that the board acted responsibly,” observes Daniel Bae, founder of Amafi. “In APAC markets where director liability regimes are tightening, this analysis is becoming essential rather than optional.”
Evaluating leveraged transactions across Asia Pacific? Amafi helps companies and investors assess capital structure and transaction solvency. Learn more.