In my previous blog, I identified five steps to assisting your community bank in remaining independent in the midst of all the merger and acquisition activity across the nation. This blog will identify five common mistakes of community bank buyers in the current merger and acquisition market.
For many banks, the long-term strategy of capital allocation to enhance shareholder value involves acquiring another institution. Far too often, community bank boards of directors approach a potential acquisition without considering all of the moving pieces.
Things will get dicey quickly unless there is a specific strategy clearly identifying the steps the community bank needs to take with respect to an acquisition, as well as the steps the board needs to avoid.
The following are five common mistakes of community bank buyers in connection with bank merger and acquisition transactions.
1. Getting the board ahead of the numbers.
Once a ball gets rolling, it can become difficult to stop. Often, a community bank board of directors will decide that an acquisition makes sense for the bank before it sees or analyzes the numbers.
Don’t fall in love so fast! An acquisition may be feasible, or even ideal, from a geographic expansion or competitive standpoint.
But if it is not financially feasible, and does not enhance shareholder value, then the board should not be afraid to walk away.
An “acquisition bias,” while understandable, may not be in the best interest of enhancing shareholder value. If the acquisition does not make financial sense from the shareholders’ point of view, then it should not be pursued.
2. Not conducting adequate due diligence.
It is common sense that appropriate and adequate due diligence of a potential target is essential. Most community banks do a good job of that, which is one reason that community bank acquisitions are taking longer than ever to complete. No one can afford to make a mistake on due diligence.
Keep in mind that in a community bank merger transaction, the buyer acquires all the target’s assets and liabilities, known and unknown. Conducting thorough due diligence of the target’s books is tough enough. Anticipating contingent liabilities is even more cumbersome.
Particularly coming out of the Great Recession, due diligence needs to be thorough and analyzed completely.
3. Failing to lock in key personnel.
A significant risk facing the banking industry as a whole is whether there will be enough talent in the younger generation to run our nation’s community banks. The reality is that most institutions do not have excess management. The need for additional management expertise is a common driver for the community bank merger and acquisition game.
There are few situations more disheartening than an institution completing an acquisition only to have the target’s management group ride off into the sunset. Not only can such a situation substantially damage bank morale, it invites shareholder criticism of the transaction and the board’s oversight of the process. It also allows the relationships to leave the bank.
To avoid potential heartache, it is crucial that the buyer secure employment contracts or non-compete agreements with the senior management team of the target. Simply paying enough for the target institution is not enough.
Quality talent is becoming harder and harder to come by. If the target has the talent, make sure it sticks around.
4. Using the wrong form of payment.
In merger and acquisition terms, there are three alternative forms of payment—cash from the buyer, stock of the buyer, or a mixture of both.
The payment type will generally be driven by what the target prefers or requires. If the target wants cash only, then the buyer must analyze whether it has sufficient cash reserves or access to leverage to fund the transaction. If the buyer’s stock is listed and regularly traded, then stock may be an attractive currency to the target’s shareholders.
If the target is willing to accept buyer stock, multiple considerations come into play:
• What is the appropriate mix of cash and stock?
• What are the relative values of the two institutions’ stock?
• Will issuing additional shares significantly dilute the ownership percentage, earnings per share, or after-tax cash flow of the buyer’s current shareholders?
• If the buyer has an active Subchapter S election, will using stock as consideration cause the buyer to have more than 100 shareholders?
Failure to address such issues can present significant problems post-acquisition.
5. Why buy it (if you can steal it)?
Some institutions’ only means of growth is through acquisition. The question is, is your community bank really one of those institutions?
Sometimes, acquiring another institution is the easy way out. The buyer’s inability to grow may be the result of unaddressed internal issues. Such problems will surface, regardless of how many millions of dollars of total assets you bury them under.
Community bank boards need to identify whether the benefits of an acquisition can be achieved by branching or simply making strategic or cultural adjustments.
Why spend your capital to assume an institution’s “issues” and face execution and integration risks if you can take the business organically (steal it) for significantly less cost?
It is not an option for every community bank, but each community bank board should address the issue before venturing off and buying another institution.
Many potential deals have fallen apart because the buyer made one or more of the mistakes identified above.
The list of mistakes is not exhaustive (I have witnessed many more). These are simply the most common.
If your institution is considering merging with or acquiring another institution, avoid these mistakes. Doing so will serve the bank and its shareholders well.
Part 3, the conclusion of this three-part series, will discuss “Five Common Mistakes of Sellers.”