Five Questions That Directors Should Ask About Capital Raises

One of the most critical decisions a board must make is how and when to raise capital. This is not so easy to do. Regulators have been putting pressure on banks to raise capital levels in the face of economic uncertainty and loan losses, but much hasn’t been decided about future capital and liquidity requirements. Plus, bank boards themselves are uncertain about what the future may hold, given weak growth and the potential for even more consumer-driven regulation. What’s next exactly and what kind of capital will your bank need? The following is a primer to help come up with some questions your board might want to address.

Do you need capital?

This question can best be answered by your own strategic plan. Of course, there is much uncertainty as to what capital levels regulators will require in the next three to five years for community banks. Some people are waiting on the sidelines but others are forging ahead with raising capital if they need it to meet growth goals, says Derek Cunningham, an Atlanta-based managing director at investment bank Commerce Street Capital. You may need to raise capital just to meet current regulatory demands. This is obviously difficult to do. In the past, board members who chipped in heavily by purchasing shares helped raise confidence for other investors.

Should your bank work with an advisor?

If you’re going to raise money from directors or people in your community, you might not need a financial advisor. If you want to raise money in the public markets, you had better get an advisor. You could even hire more than one financial team to help get more advice and potential contacts with investors, says Sean Kehoe, a partner in the law firm Kilpatrick Townsend in Washington, D.C., who specializes in capital raises.

Here are some of the things an advisor can do for you: Help you understand what the market is like for similar banks trying to raise capital, help you find investors, help you price your offering.

Much depends on the region of the country and the health of your bank, but your bank’s size is also important. If your price is too high and you’re unable to raise the capital you need at that price, the market may view that as a failure. Pricing is all across the board, with banks in some regions of the country, such as Texas and the Northeast, commanding higher prices to tangible book value than others. Investors are interested in the economic vitality of the area the banks serves.

What kind of offering should you do?

Do you want to do a public or private offering? A public offering will take longer, four to six months, but may open you up to more investors, says Kehoe. A private offering will be limited to mostly accredited investors. If you market yourself to private equity investors, they are interested in high dollar investments, such as $5 million to $20 million, and will often want a board seat in return, says Cunningham. But most institutional investors will also want to own less than a 9.9 percent voting interest in your bank or bank holding company to avoid certain filing and disclosure rules, which shuts out a lot of small banks from private equity investment.

Do you want to offer common stock or preferred stock or some other kind of debt? Learn your terms. Cumulative preferred shares guarantee investors that if you miss a dividend payment, you will pay them back later, so it is attractive to investors, yet it won’t count toward your Tier 1 Leverage Ratio, a very important barometer used by regulators. So if you are worried about needing higher regulatory ratios, debt or debt-like instruments, such as cumulative preferred shares, are usually not a good option.

Do you want to avoid diluting shareholders? That happens when stock ownership and voting interests are reduced through the issuance of new shares or conversion of preferred shares to common stock. You can avoid this by issuing debt that is not convertible, but that may be less attractive to new shareholders.

How will you sell your story?

It is important to have a good story to sell to investors. The more specific you are, the better. If you just say you want to raise capital for growth, that doesn’t do well anymore, says Cunningham. Investors are looking for compelling stories. Do you want to buy a bank? Do you want to buy branches? Say that.

Is this in the best interest of your company?

What will your company look like three to five years from now if you raise capital-or if you don’t? Do you have the capital to meet your strategic goals over the next three to five years? Would it be a better option to team up with a stronger bank and sell your bank? Evaluate your options for the best interests of the company and its shareholders.