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The Misconceptions of Private Bank M&A

Last week, Kevin Strachan joined me in the podcast studio to discuss the ability of privately held banks to use their securities as consideration to acquire another institution.

Sadly, since the last time we recorded a podcast, the patriarch of our banking practice, Walt Moeling, passed away.  Our previously posted memorial included several links to remember Walt, but of particular relatedness to the podcast, we encourage everyone to listen again to two earlier podcasts with Walt sharing his wisdom.  In December 2016, Walt joined us on the podcast to discuss, among other things, the future of the banking industry and what one regulatory change he would make if given unlimited power. Then, in March 2017, Walt spoke about establishing a sustainable sales culture.

Somehow, I was able to read the notes I had scribbled about Walt, and we then continued to discuss two common (and contradictory) misconceptions on private company merger and acquisition activity. 

The first misconception is that privately held companies can’t issue stock as merger consideration.  The second misconception is that privately held companies can issue stock without restriction as merger consideration.  We regularly hear both of these misconceptions when advising private companies on a potential merger transaction where they are looking to issue (or receive) private company stock.  While neither of these ideas are correct, the truth is messy and usually requires further discussion.

Among the topics covered with Kevin in this episode of The Bank Account are:

  • the additional flexibility of banks without holding companies (and the limitations of that flexibility);
  • SEC registration via merger;
  • Regulation A+ in mergers;
  • the state Fairness Hearing exemption; and
  • using Rule 506 of Regulation D to issue securities to the target shareholders.

For private companies considering an acquisition of another institution, further conversations with investment bankers and lawyers are almost certainly going to be needed, but this episode of The Bank Account can give you a head start in understanding some of the potential options that may be out there.

Please click to subscribe to the feed on iTunes, Android, Email or MyCast. It is also now available in the iTunes and Google Play searchable podcast directories.

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The Football Fan’s Guide to M&A Transactions

With both college and professional (not to mention fantasy) football in full swing, we find many conversations with clients drifting to topics from the
gridiron at this time of year.  Given that many of us are devoting a significant amount of our personal time to following our favorite teams, many times business points are best illustrated at this time of year by using football analogies.

Certain sports agents have posited that the highest achieving football coaches could easily run Fortune 500 companies but instead chose to coach football for a living.  While that point is debatable, we can certainly draw from the talking points of today’s best coaches in setting a framework for approaching a merger transaction.  While we can’t deliver Nick Saban, Bill Belichick, or Kirby Smart to your boardroom, use these sound bites to your advantage in setting the tone for how your board addresses an M&A transaction.

    1. Trust the process. “The Process” has become a hallmark of the University of Alabama’s championship dynasty.  Coach Saban focuses on the individual elements that yield the best results by the end of the season.  Similarly, a well-planned process can be trusted to yield the best long-term results.  This simple point is among the easiest for boards to miss.  We are often concerned when clients engage in “opportunistic” M&A activity.  Instead, we prefer to see a carefully planned process that includes the following fundamental elements:
      * Parameters around the profile that potential partners should have, including market presence, lines of business, and size;
      * Clearly defined financial goals and walkaway points; i.e., those metrics beyond which no deal can be justified;
      * For sellers, the forms of consideration that will be acceptable (i.e., publicly-traded stock, privately-held stock, or cash); and
      * Selection of qualified advisors.
    2. Self-scout. Great football teams have an honest self-awareness of their strengths and weaknesses and grasp them on a deeper level than their opponents.  Buyers and sellers should also have a frank assessment of their shortcomings.  In planning for the M&A process, those weaknesses should be addressed in advance to the extent possible.  To the extent they cannot be fixed in advance of embarking on an M&A process, parties should provide a transparent assessment of their weaknesses to potential partners.  Doing so enhances credibility and builds trust in the other facets of due diligence.
    3. Know the tendencies of your opponent. On the other side of self-scouting is a great team’s ability to understand and address the weaknesses of its opponents.  While we never advise clients to think of M&A partners as adversaries, advance due diligence of a potential partner to identify their needs can certainly help lead to a successful transaction.  At its core, a good M&A transaction is about giving a potential partner something it does not have and cannot build for itself.  To the extent that parties can identify the needs of potential partners in advance of their initial conversations, they can speak directly to those needs at the outset, thus positioning themselves as an optimal partner in a crowded M&A field.
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Acquire or Be Acquired 2018 M&A Simulation

We are looking forward to running the M&A Simulation at Bank Director’s 2018 Acquire or Be Acquired Conference with our friends at FIG Partners.  This is the second year we’ve teamed up with FIG Partners to present a simulation of the community bank merger and acquisition sale process.  We’ve identified the basics of this year’s fictional banks, and are looking forward to another exciting simulation.

The simulation is an exclusive session at Acquire or Be Acquired, is open to 45 bank attendees only and fills up quickly.  If you’re planning to attend AOBA and want to ensure your spot in the simulation, please contact us.  If you’re interested in attending and haven’t already registered the conference, please contact us to receive our sponsorship code for a $400 discount.

The 2017 simulation involved competing bidders for a billion dollar community bank, identified as Bank A.  Bank B, a $1.3 billion institution, offered a merger of equals opportunity, hoping that one plus one could equal three, while Bank C, a $6 billion institution with strong organic growth, was able to win the hearts and minds of Bank A with a strong all stock offer.  The simulation ultimately mirrored what we often see, small buyers must be very creative or seek opportunities that are not coveted by larger, more highly valued public buyers. See our write-up of the 2017 M&A Simulation for additional information.

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All Dressed Up with No Place to Go

All Dressed Up with No Place to Go

November 3, 2017

Authored by: Robert Klingler

the-bank-accountOn the latest episode of The Bank Account, Jonathan and I discuss the prospects and alternatives for a small bank that finds itself without an interested buyer.   Frequently, we are finding clients and other depository institutions that have reached the internal decision that it’s time to sell, but when they check the market, the anticipated buyers are either not available, not interested, or at least not as interested as expected/hoped.

Before getting to those topics, we have a brief foray into me trying to avoid talking about college football, as well as updates on the proposed tax reform act and the announcement of the appointment of Jerome Powell to serve as Chair of the Federal Reserve Board.

Among the alternatives discussed:

  • A sale to a credit union;
  • A sale to a non-bank buyer;
  • A merger of equals, strategic merger, or stepping stone transaction; and
  • Longer term planning to set up the bank for a future sale.
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Considering a Sale of the Bank? Don’t Forget the Board’s Due Diligence

In today’s competitive environment, some bank directors may view an acquisition offer from another financial institution as a relief. With directors facing questions of how to gain scale in the face of heightened regulatory scrutiny, increased investor expectations, and general concerns about the future prospects of community banks, a bona fide offer to purchase the bank can change even the most entrenched positions around the board table.

So, how should directors evaluate an offer to sell the bank? A good starting place is to consider the institution’s strategic plan to identify the most meaningful aspects of the offer to the bank’s shareholders. The board can also use the strategic plan to provide a baseline for the institution’s future prospects on an independent basis. With the help of a financial advisor, the board can evaluate the institution’s projected performance should it remain independent and determine what premium to shareholders the purchase offer presents. Not all offers present either the premium or liquidity sought by shareholders, and the board may conclude that continued independent operation will present better opportunities to shareholders.

Once the board has a framework for evaluating the offer, it should consider the financial aspects of the offer. The form of the merger consideration—be it all stock, all cash, or a mix of stock and cash—can dictate the level of due diligence into the business of the buyer that should be conducted by the selling institution.

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Negotiating Complexity: Executive Compensation Issues in M&A

Upon reaching a letter of intent to acquire or sell a financial institution, many bank directors will breathe a sigh of relief. Following the economic challenges of the past several years, the directors of each institution have charted a course for their banks that will likely result in their respective shareholders realizing the benefits of a strategic combination. Although directors should be focused on “big picture” issues during the negotiation of a definitive agreement, they should not overlook the resolution of the many issues that can arise from executive compensation arrangements in a potential transaction. While often seemingly minor, compensation matters can raise unexpected issues that can delay or de-rail a transaction.

Procedural Issues

In addition to considering the economic features of a proposed merger, directors should also consider their individual interests in the transaction, including the potential payout of supplemental retirement plans, deferred fee arrangements, stock options, and organizer warrants that are not available to the “rank and file” of the company’s shareholder base. These arrangements may pose conflicts of interest for members of the board and are subject to different types of disclosure:

Disclosure of potential conflicts:  Early in the negotiation of a potential sale, individual directors should identify deal features that may create the appearance of a conflict of interest or an actual conflict of interest. With help from legal counsel, these personal interests should be disclosed and documented in the board resolutions approving the transaction. Appropriate disclosure and documentation of these actual or potential conflicts usually resolves these issues, but if significant conflicts exist, counsel may advise the use of a special committee or special voting thresholds for the transaction.

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Don’t Forget to Consider Deposits in an Acquisition

With many U.S. markets experiencing slow loan growth, some boards of directors looking to increase the size of their institutions have turned to acquisitions to capture greater scale and efficiencies. While asset growth is important, directors should also consider the deposits acquired as part of a merger. Many banks have found that a careful evaluation of the deposits of the selling bank can spot unexpected issues and also drive earnings for the combined institution. The issues and opportunities raised by the liability side of the balance sheet have implications for both buyers and sellers going forward, particularly as they seek to maximize the scope and franchise value of their institutions.

Gaining Deposit Share and Margin

 With many growth opportunities centered in more densely-populated areas, some financial institutions plan to use an acquisition to establish a “beachhead” in a growing market. Unfortunately, many have found that a beachhead may not be enough, particularly with ferocious competition for quality loans in many metro markets. Other banks have taken a different approach by either consolidating market share in their home or adjacent markets, or by acquiring banks in rural areas that have solid earnings performance. For these banks, acquiring lower-cost deposits in slower-growth markets may help generate earnings that can fund loan growth in more competitive markets. What’s more, some banks have been able to diversify their CRE-heavy loan portfolio by picking up agricultural and other types of lending products through these acquisitions.

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Building a Better Mousetrap: Executing a Merger of Equals

With merger activity on the rise during 2014, some boards of directors are considering whether the time is right for their financial institution to find a strategic partner. These boards, particularly those serving institutions with less than $1 billion in assets, may believe their banks need to gain size and scope to maintain a competitive footing. However, these boards may also want to maintain the strategic direction of the institution or capture additional returns on their shareholders’ investment. For these boards, a merger of equals with a similarly-situated financial institution may hold the greatest appeal, as a combined institution could gain greater competitive resources and additional return for its investors than if it were to remain an independent institution. Although a merger of equals may be appealing to both management and the board, the particular circumstances required to execute such a transaction can often be elusive. A merger of equals may involve structural considerations that are slightly different from other acquisitions:

  • Geography. The merging institutions typically have complementary, rather than overlapping, market areas. Some commonality among the markets is helpful, but significant overlap can eliminate many of the synergies associated with a merger.
  • Competitive Advantages. A merger of equals may make sense for financial institutions that have different specialties or expertise. For example, a bank with a high volume of commercial real estate loans may be able to diversify into C&I by finding the right merger partner. Deposit pricing can also create attractive opportunities, with low-cost deposits from slower-growing markets funding loan growth in an adjacent market.
  • Enhanced Currency. Mergers of equals are usually stock deals, allowing the shareholders of each institution to maintain their investment in the combined company. The goal is for the value of the combined entities’ stock to receive an uptick in value at the conclusion of not only the initial merger, but also upon the ultimate sale of the combined institution.
  • Management Integration. Combining the management teams and the boards into an effective team for the surviving bank without bruising egos can be challenging. However, a common goal and meaningful relationships between members of the leadership team of the two institutions can be helpful in finding a path forward.

If two like-minded banks are able to identify each other, negotiating the terms of the transaction can be a complex process, as many management and cultural issues must be resolved prior to entry into the merger agreement. Who is going to be the chief executive officer of the combined institution? Who is going to be on the board? Often, new employment agreements will be negotiated in order to lock in the new management team through the integration of the two institutions. The merger partners should also use the negotiation process to formulate an identity for the resulting bank. While a strategic plan for the combined institution is not a component of the merger agreement, a merger of equals demands that the two merger partners work together to chart a future course for the combined company. Unlike other acquisitions, where the work of integration will begin in earnest following the signing of the merger agreement, formulating a management team, as well as the strategic and business plans of the combined bank, starts at the negotiating table in a merger of equals.

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M&A: How to Review Deals at the Board Level

Many bank boards are considering a sale of their institution for a variety of reasons—heightened regulatory burdens, board and management fatigue, or an opportunity to partner with a growing bank are just a few. But while the financial crisis has taught important lessons about bank management, for many bank directors, the sale of their financial institution is uncharted territory. As you typically only have one opportunity to get it right, directors considering a sale should focus first on establishing a sound process around the board table.

Although it is rational for directors to worry more about specific aspects of the proposed deal than procedural matters, we have found that establishing an appropriate process for considering a possible transaction is often a prerequisite for success on the business issues. Moreover, in today’s world of heightened scrutiny of board actions, Directors cannot neglect procedure and expect to fulfill their duties of loyalty and due care.  In most states, fulfilling those duties gives directors the benefit of the business judgment rule, which insulates directors from liability provided the decision is related to a rational purpose.

In the context of a sale, most directors can meet their duty of loyalty by acting in good faith to achieve the best result for the company and its shareholders and by disclosing any conflicts of interest to the board prior to the beginning of the deliberations. But with respect to the duty of care, establishing a thorough process leading to a sale is key. A recent court case decided in Georgia provides a helpful roadmap.

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