Tapping a Rich Vein: Boosting Capital with IRAs
The banking market in Chico, California, about 100 miles north of Sacramento, has been hit hard by consolidation. Outside buyers, including PremierWest Bancorp and Umpqua Holdingsu00e2u20ac”two Oregon institutions making a move on northern Californiau00e2u20ac”have completed deals here recently, reducing the number of locally owned banks. Mark Francis, a former executive with Tehama Bank, an Umpqua acquiree, saw opportunity in the decline, and last year set out with some partners to raise between $12 million and $14 million to capitalize startup Golden Valley Bank, now a year-old, $15 million institution where heu00e2u20acu2122s the CEO.
Like a lot of other bankers seeking to raise capital nowadays, Francis quickly discovered what he calls u00e2u20acu0153the dirty little secret your broker doesnu00e2u20acu2122t tell you about,u00e2u20ac namely that individuals can invest their personal retirement assetsu00e2u20ac”IRAs, 401(k) rollovers, Keoghs, and moreu00e2u20ac”in pretty much anything they want, including startup banks. Francis turned potential investors on to the notion, and largely as a result of retirement funds, which contributed about 25% of the total, the issuance was way oversubscribed, at $22 million. u00e2u20acu0153People had more to invest, because they could pull money from their IRAs,u00e2u20ac Francis says.
Welcome to whatu00e2u20acu2122s quietly emerged as one of the hottest trends in the bank capital-raising world. Investors have been able to use retirement money to buy stock in bank startups for more than 30 years, and itu00e2u20acu2122s not at all an uncommon use of that money. Dan Hudson, CEO of NuBank, a San Luis Obispo, California consulting firm, says heu00e2u20acu2122s helped launch 140 banks u00e2u20acu0153and weu00e2u20acu2122ve never done one without using retirement money.u00e2u20ac
But the practice is gaining more attention of lateu00e2u20ac”perhaps because thereu00e2u20acu2122s so much retirement money available. At the end of 2005, Americans held some $14.5 trillion in retirement assets, according to the Investment Company Institute. Itu00e2u20acu2122s a big, relatively patientu00e2u20ac”and growingu00e2u20ac”pool of money, and just the type of funding that organizers of a community bank would love to tap into.
While no one is keeping specific track of exactly how much retirement money has been invested in banks, the evidence suggests that at least several hundred million dollars have flowed into bank balance sheets since the beginning of the decade. Most of that tally has gone to startups such as Golden Valley. But increasingly itu00e2u20acu2122s also considered a viable option for existing banks in need of a secondary round of capital.
Jim Wagner, CEO of Trust Administration Services Corp., a Carlsbad, California firm that specializes in self-directed retirement plans for individuals, says his company has helped about 75 private-bank startups tap into investorsu00e2u20acu2122 retirement accounts.Those banks typically get about 20% to 30% of their overall capital from investorsu00e2u20acu2122 retirement accounts. Hudson says the average amount invested is about $22,000 per individual.
Managers of self-directed investment plans, including Trust Administration, a division of Los Angeles-based First Regional Bancorp, and The Entrust Group of Reno, Nevada, donu00e2u20acu2122t find investors for organizers. Rather, they serve as the facilitator/custodian for investors the bank has already lined up, who want to pump some of their retirement assets into a financial institution but run into resistance from incumbent brokers.
The process is pretty much a winwin for all sides, says Peter Weinstock, a Dallas-based head of the financial institutions practice for law firm Hunton & Williams, who has worked on dozens of such deals. For investors, banks are viewed as a safe playu00e2u20ac”no bank has failed in more than two years, according to the Federal Deposit Insurance Corp.u00e2u20ac”and typically provide good returns. u00e2u20acu0153To own stock in a bank that will appreciate over time, and then be able to sell it for a nice price, and not have to pay taxes on it, is extremely attractive,u00e2u20ac he says.
For banks, the appeal is no less compelling. Firms like Trust Administration make their money by serving as custodians to investor accounts, charging nominal management fees.The bank pays nothing. Since the money in retirement accounts typically has a longer-term investment horizon, folks are less likely to agitate for quick returns or a sale. More than that, retirement funds are home to big chunks of local money.
Capital Bank of New Jersey, based in Vineland, opened its doors this April with about $20 million in capitalu00e2u20ac”one quarter of it retirement money.The minimum investment was $25,000, and u00e2u20acu0153a lot of people donu00e2u20acu2122t have that kind of scratch just lying around. But they do have it in their retirement accounts,u00e2u20ac says CEO David Hanrahan.u00e2u20acu0153We had a lot of folks jumping at the opportunity to invest their IRAs this way.u00e2u20ac
The approach wonu00e2u20acu2122t work for everybody.Weinstock says the tax implications can make raising funds from retirement accounts inefficient, and u00e2u20acu0153unlawfulu00e2u20ac for a subchapter S company. u00e2u20acu0153To the extent that a bank wants to go subchapter S, that could be a big hurdle,u00e2u20ac he says.Weinstock worked with one bank in Dallas that intended to go sub-S. u00e2u20acu0153They wound up not being able to raise all the money they needed from individuals and trusts, so they changed their organization to a C corporation so they could take plan money.u00e2u20ac
Wagner says many prospective bank boards are initially leery about steering local investors toward a relatively unknown strategy. To overcome such misgivings, he says, one or two board members usually u00e2u20acu0153will run through the process themselves first to see what itu00e2u20acu2122s like, before they cut us loose on their investors.u00e2u20acThatu00e2u20acu2122s what Hanrahan did. u00e2u20acu0153What helped me sell it to people was that I was able to say that my $100,000 investment was retirement money,u00e2u20ac he explains. u00e2u20acu0153I was the guinea pig, so to speak. It wasnu00e2u20acu2122t a hard process.u00e2u20ac
Even so, insiders also should watch their steps,Weinstock says. In some cases, board or management investments u00e2u20acu0153could potentially be prohibited under ERISA and invalidate the IRA,u00e2u20ac he says. u00e2u20acu0153Each case has to be analyzed individually to understand the implications.u00e2u20ac
For investors, the biggest stumbling block might be resistance from the brokerages that administer their retirement accounts. Hanrahan says about half of his investorsu00e2u20acu2122 incumbent brokers were willing to shift the money to his banku00e2u20acu2122s stock. The other half cited compliance concerns. u00e2u20acu0153The bottom line is, most brokers donu00e2u20acu2122t stand to make anything off the transaction, so theyu00e2u20acu2122ll look for excuses not to do it,u00e2u20ac he says.
Despite the challenges, investors are happy with the results of this strategyu00e2u20ac”and so are the banks.u00e2u20acu0153We didnu00e2u20acu2122t want outside speculators as investors.We wanted local shareholders who would also be customers,u00e2u20ac Golden Valleyu00e2u20acu2122s Francis explains. u00e2u20acu0153Tapping retirement assets allowed us to achieve that.u00e2u20ac u00e2u20ac”John R. Engen
Six Tips for Superior Due Diligence
Experts say the key to effective due diligence is to look beyond the numbers and focus on the people and other forces that drive value.The thought leaders at Crowe Chizek and Co. LLC, a nationwide public accounting and consulting firm, have developed six tips for successful acquisitions.They include:
Account for human capitalu00e2u20ac”Mergers and acquisitions fail most often because companies overlook the importance of managing human capital. To ensure the buyer retains the management talent needed, the buyer must communicate future roles early and often with both companiesu00e2u20acu2122 employees during the due diligence process.
Kick the tiresu00e2u20ac”A selleru00e2u20acu2122s financial statements provide buyers with information about its assets, liabilities, and operations, but reveal little about its quality. A tour of the selleru00e2u20acu2122s facilities can give the buyer a feel for its condition and help the buyer determine whether significant capital investments will be required.
Look carefully at IT systemsu00e2u20ac”Information is the lifeblood of most organizations and integrating two companiesu00e2u20acu2122 information technology systems can be costly.The buyeru00e2u20acu2122s due diligence team should determine whether the selleru00e2u20acu2122s IT system is compatible with the buyeru00e2u20acu2122s system. Do not forget the cost of integrating systems when projecting capital expenditures and obtaining financing.
Defuse financial time bombsu00e2u20ac”Detailed due diligence can reveal hidden costs that may not be apparent from an initial review of financial statements and other documents. Some sellers may attempt to enhance their companyu00e2u20acu2122s perceived value by reducing spending on certain functions such as research and development, advertising, or maintenance. Downward trends in spending on advertising and other essential business activities can be a red flag. Buyers can uncover deferred compensation practices by analyzing historical salary patterns, obtaining local comparable pay rates and interviewing the selleru00e2u20acu2122s employees.
Uncover liabilitiesu00e2u20ac”Hidden liabilities can quickly erase the value of an otherwise promising transaction. Buyers should thoroughly analyze and evaluate potential exposure to environmental risks, employee legal claims and other liabilities and, if necessary, adjust the purchase price accordingly. Interview employees to assess potential liability for wrongful termination, discrimination, sexual harassment, or other employment-related claims.
Analyze supply and demandu00e2u20ac”A companyu00e2u20acu2122s future growth depends on its relationships with customers and suppliers, but all too often these relationships are neglected in the due diligence process. Determine why customers do business with the seller. Buyers also should conduct a thorough review of the selleru00e2u20acu2122s supply chain.