When 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:
- 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.
- 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.