As the fog of the recent economic recession continues to lift, many community banks that have weathered the storm are shifting from a defensive-minded strategy to an offensive one, which in many cases focuses on the acquisition of another institution. In the last edition of Banking Notes, we looked at five practical tips that institutions considering the possibility of partnering with a like-sized institution or an outright sale to a larger institution should consider. In this edition, we will explore five practical considerations for the would-be acquiror.
1. Educate your board of directors on the M&A process now.
The boards of directors of a majority of community banks are comprised of local community leaders, many (if not most) of whom have little, if any, experience with the mergers and acquisitions (M&A) process. For this reason, it is imperative that an acquiror educates its board on the M&A process prior to exploring potential acquisition opportunities. Directors should be advised of, among other things, their fiduciary obligations in the context of M&A activity and the additional time and effort generally required of directors as part of the M&A process. Additionally, your board may wish to consider establishing a separate M&A committee to serve as the gatekeeper for acquisition opportunities that may arise.
2. Build your deal team early and keep everyone involved.
One key to any successful acquisition transaction is a well-structured and collaborative deal team that is engaged from the beginning. The size and makeup of every deal team can vary, but most teams should consist, at a minimum, of key members of the acquiror’s executive management, the acquiror’s financial advisor/investment banking firm (if one has or will be engaged), the accounting firm regularly engaged by the acquiror, legal counsel, and key acquiror operations personnel. Many times institutions believe they can save money by not assembling and actively engaging members of their deal teams until later in the M&A process, quite frequently after a letter of intent for a proposed transaction has been signed. Unfortunately, mistakes that can easily be avoided are oftentimes made early in the M&A process by these institutions, and these mistakes can prove to be far more costly in the long run than the costs associated with organizing a deal team and consulting its members. For example, deal structure, which may be agreed upon at the outset of, or early in, the transaction process, should be carefully reviewed by an acquiror’s legal and accounting advisors, as seemingly minor differences in transaction structures can have very important tax implications for both the acquiror and a target institution and its equity holders.
3. Address people issues delicately and early on in the process.
Right or wrong, “people issues” oftentimes take center stage in the M&A process. Potential acquirors must be mindful of how target executives expect to be treated (both personally and financially) in the process, as well as how those same executives desire for the target’s other employees to be treated. Believe me, fiduciary duties of the target’s board members aside, an acquisition that makes perfect sense on paper from a financial standpoint can be stalled in no time by target executives who feel that they are somehow being treated unfairly or without the appropriate level of respect. In some instances, merely approaching a target institution executive regarding a change in his/her title or role with the acquiror post-transaction can have a profoundly negative impact on an acquisition transaction. Smart acquirors will consider from the outset how to incentivize a target institution’s executives and other employees to get behind and support a proposed acquisition transaction. In this regard there are various tools available to acquirors, including, for example, retention bonuses and equity incentive arrangements.
4. Give consideration to your preferred acquisition currency.
Generally, there are two primary transaction currencies commonly available to acquirors: cash and securities of the acquiror. Institutions with large excess capital reserves or those with access to the capital markets may prefer to fund an acquisition with cash. Alternatively, institutions that do not have large excess capital reserves or that have well-valued stock trading at a nice premium to book value may prefer to fund a proposed acquisition with their own equity securities. A few important considerations for acquirors in this regard follow.
Acquirors should consider the dilutive impact to their existing shareholders of funding an acquisition transaction with acquiror capital stock.
Acquirors should consider whether funding an acquisition transaction with acquiror capital stock will require the acquiror to amend its charter to increase the amount of its authorized capital stock (which will almost certainly require the approval of the acquiror’s shareholders).
Acquirors (particularly those not publicly traded) should consider the fact that, as a result of having to comply with federal and state securities laws, acquisitions funded with acquiror capital stock generally are more complicated from a legal standpoint and result in higher transaction costs for the acquiror.
Acquirors desiring to fund an acquisition with cash should consider whether it will be necessary to raise additional capital as part of the acquisition process in order to fund the acquisition itself or the post-transaction operations of the acquiror, along with the associated complexities of any capital raise and the acquiror’s ability to navigate the same while simultaneously pursuing an acquisition transaction.
Acquirors desiring to fund an acquisition with cash should also consider the impact of anticipated capital outlays associated with the acquisition on their post-acquisition capital levels and their ability to maintain regulatory-mandated capital levels long after the consummation of the acquisition.
5. Meet with your regulator(s) early in the process.
It is no secret that bank regulators like to know what is going on at the banks they regulate. Accordingly, keeping your bank’s regulator(s) in the dark about an acquisition opportunity is generally discouraged. If you have moved through the acquisition process to the point where your bank has signed a letter of intent to acquire another institution, it is time to schedule a meeting (or meetings) with your federal and, as appropriate, state regulators. It is seldom too early to seek regulatory buy-in for an acquisition.