Balancing the Relationships of Constituents

Oftentimes, as supporters of community banks, we can perceive an inquiring shareholder might not favor the bank remaining independent. But there are times when this perception might be warranted.

Shareholders, in the end, are still people. Though they align into different groups with different interests, people are ultimately in charge. Often, it is a misunderstanding of the role of management and the board, the bank’s role, the shareholder’s role, and the goals and objectives of each that cause distractions.

Here are several points to consider.

Management and the board
Management must understand that they work for the board. The board works for the shareholders. The amount of influence any board can have is directly correlated to its collective ownership of the company. Without a meaningful stake, outside investors will have the most say. If the board doesn’t own 100 percent of the stock, it has a fiduciary duty to the other shareholders. This seems an elementary concept, but if the board and management team don’t really understand the legal and practical implications of ownership and reporting, it can precipitate a communication breakdown and misalignment of interests.

Insiders must align independent shareholders’ interests with their own and avoid setting themselves up for a lifetime job to only serve themselves.

Transparency and communication
Banking is one of the most transparent industries in the U.S., so communicate often with your shareholders. A lack of communication and transparency leads to mistrust and misalignment of interests. If the bank is private, then a quarterly newsletter with summary financials should be included, along with book value per share and market value per share, if known or done by a third party. At minimum, book value per share should be provided.

Market for stock
If the bank is public, this is not much of an issue, but privately-held banks need a market of some kind. The bank should get a valuation once a year, and engage a third party to make a market in the stock or facilitate communication between shareholders with knowledge of last trades.

Pricing is important. If you have your private bank stock selling for tangible book or less, an enterprising shareholder may seek to put the bank in play for control value.

If the private bank stock is selling at 1.5 to 2 times tangible book value, it makes it much more difficult to put it in play, and most shareholders feel thankful for the rich minority valuation. Valuation can be very important as a strategy for independence.

Types of shareholders
When adding shareholders during a capital raise, consider their investment horizon, type, and propensity for involvement and activism. An ongoing assessment of these qualities is very important.

Generational transfers can change all these goals, and if the bank’s management and board are not prepared for these different investment goals, it can be a shock.
Private equity funds are short term, focused on internal rate of return (IRR) and controlling, or at least heavily involved, as investors. Some institutional investors are passive and long term. Some are very familiar with long-term community bank investing, and some are not.

Local, long-term community-based individuals can make wonderful investors but can present problems as well. A good investment banking advisor will categorize these diverse investor types and offering type situations, and analyze them with the bank.

Inquiring shareholders
When a shareholder asks about performance, liquidity or selling the bank, your first reaction is key to setting the tone. You should always take a meeting, listen and politely consider your response.

This will probably be a two-meeting process. Two things to make certain: Don’t bring your lawyer and investment banker to the initial meeting, and certainly don’t ignore the shareholder.

Bringing the bank’s lawyer and investment banker, and ignoring the shareholder are two responses by management teams and boards that have things to hide. Attorneys and investment bankers may provide you counsel and advice but need not participate in the initial meeting.

The bottom line
Hold an annual or semi-annual meeting at your bank to address potential shareholder issues. Frequently, too little importance is placed on all constituent groups involved in the success of the bank and its future.

The management team and the board can and should be steering toward a successful future for their bank, and doing so with satisfied shareholders.