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.

Poll: Price Remains Obstacle to Deals


Brighter days are ahead for community banking, according to 68 percent of the more than 200 bank CEOs, board members and senior executives participating in a series of audience surveys at Bank Director’s Acquire or Be Acquired conference, held January 25-27, 2015, in Scottsdale, Arizona. The annual event, which focuses on bank mergers and acquisitions, was attended by more than 520 financial executives and board members, primarily bank CEOs and board members, representing more than 300 banks, the majority of which are headquartered in the central United States. Two-thirds of attendees represented banks with less than $1 billion in assets.

The crowd at the event revealed a strong focus on acquisition opportunities, with 60 percent indicating that their bank will most likely buy another financial institution in 2015, and 16 percent indicating plans to sell. The audience revealed a greater likelihood to participate in M&A in 2015 than the banking community as a whole: Bank Director’s 2015 Bank M&A Survey, conducted in September 2014 and sponsored by Crowe Horwath LLP, found that 47 percent planned to buy, and just three percent to sell, this year.

When asked about the biggest barrier for banks seeking an acquisition in today’s market, attendees cited high price expectations on the part of the seller, at roughly one-third. Attendees were also asked which part of the M&A cycle worries them most: 44 percent cited pre-deal considerations, including price and negotiating the deal. This trumps post-deal concerns, such as integration, cited by 36 percent of attendees. 

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Thirty-four percent said that many targets don’t want to sell, underscoring that confident spirit that brighter days are ahead. Potential sellers may be willing to wait it out for a higher price. While the vast majority of the audience expressed confidence that they understand the value of their bank, 40 percent revealed they are not confident that their board knows what the bank is worth. 

On stage at the event, Rick Childs, a partner in Crowe Horwath’s financial advisory services group, said that price and an unwillingness to sell on the part of the target bank really fit hand-in-glove. Many banks don’t want to sell because they expect a high price. High dollar deals—those with pricing about 2.5 times tangible book value—receive a lot of attention, but “there’s a big chunk of deals that get done for less than tangible book value,” said Childs. The expectations of board members and shareholders may not align with those of the market.

There may be more buyers than sellers, but it’s not entirely a seller’s market. A track record of growth and profitability make for a more attractive seller. Almost half of the audience at Acquire or Be Acquired revealed that their primary reason to make an acquisition is to increase earnings per share. Childs said that investors have shifted focus to earnings potential, as opposed to worrying about tangible book value dilution as much, representing a positive step for the industry. Earnings are improving for banks, and targets are more attractive. “I think it’s the right focus to have on deals these days,” he said.

So how do you grow if your bank can’t find the right target at the right price? Not surprisingly, given the audience, 82 percent of attendees said that lending is the primary path to growth for their organization. The best opportunities for loan growth are in commercial real estate, according to 58 percent of attendees. Almost one-third cited commercial & industrial (C&I) lending, and 9 percent cited residential loans.

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Commercial real estate loans have been steadily rising since the fourth quarter 2012, according to the Federal Reserve Bank of St. Louis, following a steep decline beginning in the fourth quarter 2008. C&I lending experienced a similar fall, but recovered more quickly. Recovery in the residential loan market has been unsteady.

Childs told the crowd that he sees pockets of the country where lending is picking up, as companies that were forced to live within their means during lean years look to expand and invest in their businesses. But demand hasn’t picked up everywhere. Almost half of the audience said that, aside from regulatory costs, constraints on loan growth, including weak demand, have the most negative impact on the profitability of their institution.

M&A 101 for the Board


Whether your financial institution is looking to buy or sell, the board of directors has several important responsibilities during an M&A transaction. In this video, Steve Kent of River Branch Capital LLC outlines the board’s role in the M&A process including negotiations, due diligence and after the deal is done.


Negotiating Complexity: Executive Compensation Issues in M&A


10-31-2014_BryanCave.jpgUpon reaching a letter of intent to acquire or sell a financial institution, many bank directors will breathe a sigh of relief. Following the economic challenges of the past several years, the directors of each institution have charted a course for their banks that will likely result in their respective shareholders realizing the benefits of a strategic combination. Although directors should be focused on “big picture” issues during the negotiation of a definitive agreement, they should not overlook the resolution of the many issues that can arise from executive compensation arrangements in a potential transaction. While often seemingly minor, compensation matters can raise unexpected issues that can delay or de-rail a transaction.

Procedural Issues
In addition to considering the economic features of a proposed merger, directors should also consider their individual interests in the transaction, including the potential payout of supplemental retirement plans, deferred fee arrangements, stock options, and organizer warrants that are not available to the “rank and file” of the company’s shareholder base. These arrangements may pose conflicts of interest for members of the board and are subject to different types of disclosure:

  • Disclosure of potential conflicts: Early in the negotiation of a potential sale, individual directors should identify deal features that may create the appearance of a conflict of interest or an actual conflict of interest. With help from legal counsel, these personal interests should be disclosed and documented in the board resolutions approving the transaction. Appropriate disclosure and documentation of these actual or potential conflicts usually resolves these issues, but if significant conflicts exist, counsel may advise the use of a special committee or special voting thresholds for the transaction.
  • Shareholder disclosures: While specific requirements may vary for private and publicly-traded companies, compensatory arrangements for directors and officers will need to be disclosed in detail as part of proxy materials mailed to shareholders. In particular, the SEC has begun requiring detailed compensation disclosures for directors and officers, even for deal consideration issued to these individuals simply by virtue of being a shareholder.

Cultural Issues
Directors of the selling bank should also monitor the negotiation of new employment contracts for selected members of its management team. Typically, these contracts will be completed prior to the seller’s entry into a definitive agreement and will indicate which members of its management team will be retained for a transition period or even long-term following the completion of the transaction. The cultural issues arising from the negotiation of these contracts can also require additional attention be paid to those who will not be offered positions following the transaction. These short-term employees can play an important role in preserving the value of the organization prior to closing and may even have value in terms of assisting with the integration of the two institutions, so providing them with clear roles and concrete expectations early in the process can resolve many issues.

Tax Issues
Responsible choices made to manage the economic crisis, including the suspension of director pay, may give rise to unexpected tax issues that must be resolved as the definitive agreement is negotiated. Here are some examples:

  • “Golden parachutes:” If applicable, Section 280G of the Internal Revenue Code will treat most transaction-related payments or accelerated vesting of options or warrants for directors or officers as parachute payments. If these payments exceed a certain percentage the individual’s average compensation over the past five years, then both the individual and the bank will be subject to significant tax penalties with respect to those parachute payments. When financial institutions have previously suspended director compensation, 280G presents an even greater challenge because directors in those situations have little or no average compensation history.
  • Restrictions on changes to existing compensation arrangements: Changes in the timing or form of payment of existing compensation arrangements contemplated or revealed as part of a transaction can also result in significant additional tax liability under Section 409A of the Internal Revenue Code. Few compensatory arrangements are free from 409A issues, but the amendment or termination of employment contracts, bonus plans, supplemental retirement plans, and equity awards are among the deal-related events where this tax liability can be triggered.

Existing compensation arrangements are often highly problematic for a transaction, so developing a strategy for managing the procedural, cultural and tax implications of these arrangements early in the negotiations is key. Resolving these issues can take time and effort, but if the parties do so successfully, they will have taken an important step toward consummating a successful transaction.