Our firm has been brought into a couple of transactions lately in order to “unscramble an egg” that other professionals had scrambled because they didn’t know what they were doing. That experience triggered some thoughts.
With consolidation of the industry continuing and community banks contributing heavily to the buyer and seller mix, I thought it would help to discuss five basic issues that any community banker contemplating an acquisition must consider:
1. Understand Structure.
2. Understand Pricing.
3. Understand what the regulators expect.
4. Have some rudimentary understanding of tax and accounting issues.
5. Get professional help now—or you may need true professional help later
Acquisition transactions demand appropriate structure. That structure may differ depending on a number of things, such as whether the seller is a Subchapter S or a C Corporation.
As a practical matter, a Subchapter S seller provides the buyer with much better structuring alternatives than a C Corp seller. This is basically because the buyer can structure the transaction as an asset purchase, which allows depreciation of the assets post-closing. (That’s a 338(h)(10) election, for you tax-code junkies.)
In addition to identifying the appropriate structure, a community bank entering the acquisition game also needs to understand how the structure is actually going to play out and how the purchase price is going to be paid. (No, you cannot use bank assets to directly pay for the transaction.)
One situation I ran into recently involved a community bank holding company that was owned 100% by one individual. The holding company owned 100% of the stock of the bank.
The holding company wanted to purchase some shares in another community bank holding company from one of that holding company’s shareholders, which is permissible.
It was not permissible, however, when the purchasing holding company attempted to provide as part of the purchase price bank assets (loans) as compensation to the seller. There are many ways to do this—but that is not one of them.
Understand the structure and the flow of the transaction—or get people who do understand it to help you.
As you often hear, anything is for sale … for the right price. Community banks, for the most part, are no different, though there are exceptions.
One bank I was with recently could have commanded a good price. However, in light of its commitment to the community, its shareholder base, its employees, and other constituents, management and shareholders felt the bank was better off by remaining independent.
If you are going to go forward, however, the real impact on your bank as a buyer or seller is whether the purchase price makes your shareholders better off or worse off after the deal. This is usually tested by whether the purchase is accretive to earnings per share for the buyer and not dilutive or significantly dilutive to book value. (The latter is a more recent focus).
Do not just review the current pricing multiples and conclude that if the average price for a community bank in my market is, for example, 138% of book, then that is what I should pay. That may give you some indication of value to a similar bank and marketplace, but it is not what the target you are looking at is likely worth to your holding company.
Understand what regulators expect
This means make sure, if your community bank holding company is a buyer, that the regulators will at least give you a “wink and a nod” that they will approve the transaction.
If you are a seller, you may also have to get regulatory approvals, depending on how the transaction is structured.
Do not make assumptions when it comes to dealing with the regulators.
We recently ran into a situation where our consulting and law firms were representing the buyer. The firm representing the seller, notwithstanding our direction early on that they needed to file appropriate regulatory applications, failed to do so. This held up the transaction unnecessarily.
Make sure you understand what the regulators want and provide it to them in a timely and professional manner.
Have some understanding of tax and accounting
• From a tax standpoint, if you are a seller and you get cash, it is taxable. If you are a seller and you get stock, you do not want it to be taxable. That is generally known as a “bad result.”
Make sure you understand how that stock comes to you so that it is tax-deferred (nothing is tax-free—this is the U.S., after all). Generally, a tax-deferred transaction that is part-stock/part-cash must be structured to provide at least 40% of the purchase price in stock.
That is the general rule of thumb to live by. But again, make sure you get professional help.
• From an accounting standpoint, transactions are accounted for under FAS 141R. This is affectionately known in the business as the “Accountant’s Relief Act.”
The bottom line is, all the target’s assets and liabilities as of the date of acquisition have to be valued at fair value. This determines whether there is a purchase price premium or a negative premium or good will, etc.
Make sure you understand what happens. The biggest surprise for most purchasers: When the target’s loan loss reserve goes away because the loans are revalued to fair value.
Start with expert assistance
Get professional help as part of the transaction, or you may end up needing a different kind of professional help later.
This isn’t a commercial. As I briefly alluded to at the beginning of this blog, this topic was really prompted by new clients bringing us into transactions that other people had failed to handle appropriately (to put it politely).
If your community bank is going down the acquisition road, make sure you have somebody experienced helping you, both on the financial side and the legal side.
Do not be penny-wise and pound-foolish. You may regret it later on.