This is the second blog in a two-part series about community bank mergers and acquisitions. My previous blog, “Time to acquire? Consolidation calls for careful planning” dealt with the “buy side,” so this blog will deal with “sell side” considerations.
Many community banks continue to struggle with merger and acquisition identity issues. “Are we a buyer?” “Are we a seller?” “Do we remain independent and grow the bank?”
How you’ll know when it’s time to sell
For a variety of reasons, many of these community banks determine that a sale is appropriate. Three major drivers lead community banks to sell in the current environment:
First driver: The traditional reasons to sell.
These include no management succession and/or board succession, no liquidity for the shares, low return on equity, low cash flow (or none at all) coming off the shares, etc.
Second driver: Need for capital.
There are still approximately 450 troubled banks in the country, which is almost 7% of total outstanding charters. Many of the troubled banks still need capital, and the only source of capital for some is an outside injection through an acquisition transaction.
Third—and the new—driver: The board and senior management have simply had “all the fun they can stand.”
Regardless of the motivation, if the board determines that a sale of the institution is in the best interests of shareholders, then there are a number of things on which it must focus.
The number one focus: “Can we structure a transaction where the shareholders are better off holding what is offered by the buyer—stock or cash—than they are holding our community bank holding company’s stock?”
This is the fundamental test. If the board cannot answer “yes” to that question, then a sale transaction does not make sense.
Assuming a “yes”
If the board reasonably believes there is a buyer that can provide a benefit to the shareholders, then sale preparations begin. These preparations include settling outstanding litigation; keeping contracts short; locking in key personnel through stay bonuses or change in control protection; and, most importantly, maximizing core operational earnings. Because earnings drive value, maximizing core operational earnings are critical for a selling institution.
The board also needs to familiarize itself with the acquisition process for a community bank. The sequence generally starts with some type of marketing process for the selling institution. (This may be a “wide” effort or “selective” marketing, but it should not simply be discussing a deal with one potential purchaser. In that case, the board would have no way to know whether it had obtained the best transaction for its shareholders.)
First, the bank holding company identifies potential acquirers, executes confidentiality agreements, and provides non-public financial information.
The potential acquirers then, typically, would submit a nonbinding expression of interest, subject to due diligence. This expression of interest is provided to and analyzed by the target’s board, which typically would use outside resources to assist in the analysis. If the offer is credible and the analysis indicates that the shareholders of the seller would be better off as a result of the sale, then the potential purchaser or several potential purchasers are allowed into the bank for onsite or electronic due diligence.
Depending on the size of the bank, the due diligence portion may take several days or longer. Once due diligence is completed, the potential bidders are asked to confirm their bids in writing through a letter of intent, or “term sheet,” and negotiation over the definitive agreement begins.
As referenced above, the first step of the negotiation phase should be the parties agreeing on a final “term sheet,” which is a non-binding roadmap of the deal’s big-picture terms.
The definitive agreement is the “big agreement” in a community bank acquisition that builds on the term sheet after much negotiation. It runs 40 to 60 pages and has all kinds of bells and whistles detailing what the target bank can and cannot do, what the acquirers are required to do, and what the penalty is for walking away, among other things.
Once the definitive agreement is executed, then comes the time to file regulatory applications and seek shareholder approval for the selling institution. (It’s possible that the buyer’s management may also seek shareholder approval if the buyer is issuing a significant amount of its own shares as part of the payment for the transaction).
Once shareholder and regulatory approvals are obtained and applicable waiting periods have expired, then the transaction is consummated.
Upon the electronic closing of the transaction—the days of onsite “closings” are typically gone, as virtually all closings are electronic—the selling shareholders receive their cash, stock, or a mix, and the acquiring institution acquires the company.
Where the bank may need help
In connection with any community bank acquisition, there are critical issues within the marketing and negotiation phases that the board must keep in mind and generally should obtain outside expertise for assistance.
These include financial analysis, transaction structure, tax issues, securities issues, and accounting issues, particularly with respect to FASB 141R. As with being on the “buy side,” if the bank holding company does not get professional help on the sell side, then it may need professional help of a different sort later.