Last week we talked about a unique bidding process, which ended up being a success for the selling bank. This week we will look at an example of how not to conduct an auction.

Recently, after a more traditional auction process, the winning bidder began nitpicking the loan and investment portfolio. It wanted certain securities sold prior to closing and escrows set up for undesirable loans. After months of finagling, the deal died, and negotiations were initiated with the runner-up in the bidding. The lesson here is to know your weaknesses and be prepared to deal with them. Be strategic in the months leading up to the auction to eliminate loans or investments that may cause potential buyers to request price adjustments or reserves for risky loans or aggressive investments.

Today a bank that is interested in selling will typically consult with its lawyer or accountant, and an investment banking firm may be engaged to identify a list of possible candidates and inquire of them whether they would be interested in making a bid. Those who respond positively will be asked to sign a non-disclosure agreement (NDA) and then be given a bid package. The package will usually consist of selected financial statements, a summary of the loan portfolio and investment accounts, copies of key agreements such as data processing and employment agreements, and employee and executive benefit plans. Initial bids will be due within two or three weeks.

From this initial round of bids, the top ones will be invited to conduct due diligence. This might be on-site, at an off-site location such as a lawyer’s office, or increasingly, through access to a data room on the internet. The opportunity to speak directly to bank personnel is allowed only late in the bidding process or prohibited altogether.

After the finalists have their due diligence opportunity, a second round of bids is requested. From these bids the successful bidder is chosen, although it is not unheard of to request a third and final round. From that point the typical selling process takes over with the signing of a letter of intent followed by the negotiation and signing of the acquisition agreement, the filing of regulatory applications and finally, the closing. The whole process can take six to nine months. The unsuccessful bidders will be told to stand by, in case an agreement with the finalist is not reached or the deal otherwise falls through.

The selling bank will not disclose the bids, but will likely keep the bidders in the dark as to where they stand relative to the other bidders, only telling bidders whether they are still in the running or out of luck. I’m not convinced that this secrecy generates the best bid. Before submitting a final bid, there is a lot of speculation by the finalists as to the strength of their bid, who might still be in the running and whether they should just sit on their bid or bid more. If they knew where they stood, higher bids might be generated from those who see the acquisition from a strategic point of view or those trailing behind who only need to push their bid a little bit to come out on top. High bidders may still sit on their bids or bid a little higher to keep themselves above the rest. However, there is also a risk that a high bidder will see that it bid way too much, based on the bids of its peers, and withdraw its bid. Given the aggressive pricing climate we have today, that risk is probably low, and transparency may very well be the best route to take.

Almost invariably the question comes up whether a bidder should make a preemptive bid, a bid so high that the seller agrees to stop the auction (a right always reserved to the seller) and agree to the preemptive bid. From the perspective of the bidder, so long as there are strategic reasons to make this bid and the pricing won’t put too much strain on capital, go ahead and try it, but don’t expect to succeed. From the seller’s perspective, unless the preemptive bid is certainly higher than anything that can be expected from the auction, there is no reason to accept the bid, and the seller will know what at least one bidder is willing to pay. This could be useful information when promoting the bank before the beginning of future rounds.

A cautionary note on preemptive bids. Recently I was representing a selling bank that received what appeared to be a preemptive bid of nearly 2x book value. The seller was elated, nay ecstatic. But fortunately the seller did not treat the bid as preemptive but merely allowed the bidder to participate in the next round. After initial due diligence the bidder dropped its bid to less than 1x. And this wasn’t the fault of the selling bank, other bidders stayed in and even increased their bids well over the 1x level. Keep in mind the adage: “If it is too good to be true, it probably is.”

Takeaway: If you are thinking of selling your bank, carefully consider whether an auction or bidding process will best address your concerns and provide the best outcome.

To read Part One of this blog, click here.