How to Navigate a Negotiated Sales Process

acquisition-5-26-17.pngWhen a board of directors decides to explore a sale, one of its initial decisions is whether to use a public auction, a soft shop approach, or a negotiated sales process. A negotiated sales process with an individual buyer may be an attractive alternative approach when selling a bank. In a one-on-one negotiation with a buyer, social issues may be more easily navigated, day-to-day operations of the bank are less likely to be disrupted, and post-merger integration may be easier than in other approaches. There are instances where two banks fit so well financially and culturally that it may make sense to bypass a formal bidding process. In any private negotiation, however, the seller is subject to a much higher level of scrutiny relative to a soft-shop approach or a public auction. This is primarily because of a lack of competitive bids. The importance of board participation and proper documentation cannot be overemphasized. Before entering a negotiated sale, you must understand the importance of documenting the decision-making process: if it was not documented, it did not happen.

In order to evaluate whether a negotiated sales process is an appropriate option for a sale, it is first necessary to understand two alternative approaches:

  1. Public auction: A public announcement is made that the bank is for sale. If it decides to terminate the sale, it has publicized itself as a target in the market. This process is not frequently used.
  2. Soft-shop approach: The board identifies a pool of potential buyers to contact. The most important elements of a soft-shop approach are the board’s ability to select who gets invited into the process, and the element of confidentiality, which preserves the bank’s ability to remain independent if it decides to terminate the sale. This approach is generally the most common process encountered in community bank M&A.

The business judgement rule, which places a higher burden on the plaintiff in a lawsuit and takes some of the burden off the board, does not provide assurance that the bank will avoid litigation following announcement of a sale. It only takes one stockholder to initiate legal action against the bank and if the bank cannot produce consistent, formal documentation of its duties, the board has left itself completely unprotected. This is especially the case for publicly traded companies, which often have a larger shareholder base.

It is therefore critical for the board to demonstrate duty of care from start to finish and it is incumbent on the board and its legal and financial advisors to document the process. This means that a third-party fairness opinion at the end of the process is insufficient. The board must be able to demonstrate that prior to entering a negotiated sales process, it has met to evaluate its stand-alone value, discussed other potential buyers in the market, and analyzed all possible strategic paths. A capacity to pay analysis is a useful tool in determining if there are buyers that could, in a soft shop process, pay higher consideration than the buyer engaged in the one-on-one negotiations. In a cash transaction in particular, if there are buyers that could have potentially paid a higher price, the bank may be open to criticism if it cannot demonstrate a sound rationale for not undergoing a soft-shop process.

A pro forma analysis can also be used to ensure that the risk profile of the combined entity is likely clean from a regulatory perspective and can also be used to evaluate future upside potential to shareholders in the combined entity relative to future stand-alone value. Creating long-term value for shareholders should be at the forefront of considerations in any transaction, and is perhaps one of the most compelling reasons to enter a negotiated sale in a deal with a stock component. The combined entity should continue to thrive and build value long after the deal has closed, mitigating the weaknesses and enhancing the strengths of the two stand-alone entities.

Remember to always look at long-term value of the combined entity in a stock transaction. Documented board participation along with quality analytics will protect the board and allow the combined entity to prosper going forward. Above all else, have advisors that you can trust to tell you if a transaction is not in the best interest of your stockholders. Have a disciplined approach and know when to walk away from a deal. Strong corporate governance and sound understanding of value will be your greatest allies in any sales process and will ensure that a negotiated transaction is executed seamlessly and in a manner than unlocks value for your stockholders.

Doom Diligence: Don’t Let Your Due Diligence Hurt You

bank-auction-8-18-15.pngAs M&A activity continues to steam forward in 2015, we are seeing a growing number of banks being sold through true active auctions: multiple qualified and interested buyers all place bids with similar pricing, leaving the seller’s board of directors to look beyond the “sticker price” to choose a partner.

Beyond the more traditional non-financial considerations, an increasing number of sellers now focus on the buyer’s ability to move quickly from a letter of intent to an announced transaction.  These considerations include not only the legal negotiation of a definitive agreement but also the post-letter of intent due diligence that will be conducted by the proposed buyer. To that point, we are now seeing some sellers request a full due diligence list as part of a buyer’s final bid.

With the depth of due diligence becoming a competitive matter, how does a buyer balance the need to identify potential risks in a target with a need to win a competitive process? This question is important even for buyers who do not desire to participate in competitive auctions because a buyer’s reputation will follow it from deal to deal. Those buyers who are deemed to be efficient partners will have an advantage over those who are viewed as conducting time consuming, onerous processes.

The best buyers have a well defined set of financial parameters that they require to be met in each transaction. These parameters might be stated in terms of a required internal rate of return or a required level of accretion to earnings per share. These criteria typically become the “non-negotiables,” while the buyer may be more willing to be flexible with respect to other non-financial terms.

A similar philosophy can and should be applied to due diligence efforts. That is, there should be a well defined universe of risks that should be carefully examined as a priority in due diligence while the buyer can be more flexible with respect to other items. As an example, if a seller has a small mortgage operation that will not be retained, diligence could be limited to matters that could present go-forward risk even after the operation is shut down. On the other hand, if a seller has a mortgage operation that is a material part of the acquisition, detailed diligence would be necessary to ensure that it can be smoothly integrated into the business of the buyer.

Buyers make two common mistakes in this area that can be relatively easily remedied. The first is hurriedly requesting a “standard” due diligence list from an advisor without carefully thinking about whether the request fits with the goals of the acquisition and the risks presented by the target bank. Without a tailored and focused request list, there are likely material issues that are not being thoroughly explored and immaterial issues that are causing sellers angst for no benefit.

A second common mistake is the failure to communicate to the diligence team (including outside advisors) the transaction’s key drivers of value so that they can focus most on those issues. In addition, the diligence team should be aware of the “tone” of the negotiations. If the buyer has promised a highly flexible and efficient process, the diligence team should be similarly accommodating in the diligence process. The diligence team, after all, should portray the buyer in a manner that is consistent with management’s overall view toward the potential deal.

Through a thoughtful approach, the due diligence process can allow buyers to manage potential risks while also demonstrating flexibility. If key drivers of value and potential risks are identified and communicated early in the process, the diligence team can add value without drawing the ire of the would-be seller. In an M&A environment that only seems to be getting more and more competitive, focus in this area can yield real benefits when it comes to winning deals.

This article originally appeared in Bank Director digital magazine’s Growth issue. Download the digital magazine app here.