four.jpgIn the current banking environment, two areas are receiving heavy attention from financial institutions large and small: risk management from regulators, and mergers and acquisitions. As I assist my clients with both, I think about the concept of risk management in an acquisition setting. The following are four tips for managing risk in financial institution mergers and acquisitions.

Tip 1: Get your ducks in a row prior to a transaction.

Whether buying or selling a financial institution, it will lessen risks if both sides are prepared and have a team identified and educated. The team should consist of internal employees and management along with external legal counsel, accountants and investment bankers. A qualified team should ensure that the cost of the acquisition will be more predictable. A prepared internal team will provide better due diligence materials for the seller, and, ultimately, better disclosure schedules. An educated and engaged board of directors is also essential to managing risk. Both the buyer and seller boards of directors have a fiduciary duty to maximize shareholder value, along with their duty of care. 

Tip 2:  Identify “deal breaker” issues early.

Whether a buyer or seller, there are issues or terms that a financial institution may consider unacceptable, and it is prudent to identify them at the beginning. For a buyer, these may include regulatory problems, large loan issues, expensive change of control agreements, and contracts with large termination payments or outstanding litigation. For a seller, deal breakers typically are more financial in nature regarding purchase price adjustments, but they can also include employee issues, as well as indemnification and survival provisions (past the closing date of the seller’s representations and warranties).

Tip 3: Build risk mitigation into the definitive purchase agreement.

Management and boards of directors should be aware of what is being included in purchase agreements to understand and mitigate the risks. In the typical acquisition scenario, the buyer obtains all of the assets and the liabilities by law. What that means is the buyer gets the good, the bad and the ugly. An asset purchase can reduce the liability and narrow the scope of the purchase, but most financial institution transactions are mergers.

One way the acquirer can mitigate risk is through due diligence. If certain assets in the loan portfolio do not pass muster, there may be opportunities to sell those loans prior to the consummation of the deal. Robust indemnification provisions in the purchase agreement also can protect the buyer from some problems and should be considered carefully. In a merger scenario, there typically is no surviving entity to pay indemnification to the buyer, so it may be prudent to consider an escrow of some of the purchase price to cover claims post-closing. There are a multitude of ways to structure indemnification, survival of representations and warranties and purchase price hold-backs, and the buyer should contribute to the discussion of the best avenue for their institution.

Another risk mitigation strategy is to consider offering key employees of the seller bonuses to stay with the combined company. From the time a transaction is announced to closing can take four to six months or longer, and bonuses may help maintain stability.

The most important thing a seller can do is prepare complete and accurate disclosure schedules. Full disclosure is the seller’s insurance policy against indemnification or other claims in the future. Couple this with a tail insurance policy for directors and officers, and seller risk should be fairly well mitigated.

Tip 4: Understand that integration is the most difficult aspect of an acquisition.

Where do most bank mergers fail? It isn’t in the transaction itself. Failure is far more likely after the two institutions become one. The risk of post-merger failure should be mitigated early in the transaction process. Much like getting prepared ahead of a merger deal, it’s crucial to pull the proper integration team together to concentrate on culture, personnel, policies and procedures, as well as training. There also are consultants who specialize in acquisition integration. This effort should not be short changed or undervalued and requires a robust plan to incorporate the merged or acquired bank into the existing company. The planning should begin as early as possible and the integration effort may take a year or two to complete.

There are many more risks to be contemplated when embarking on the purchase or sale of a financial institution, but emphasis on these four should help ensure a successful transaction for both sides.

Susan Zaunbrecher