Acquisition continues to be a preferred strategy for financial institutions (FIs) seeking to gain economies of scale while also expanding service offerings and reach. Choosing the correct merger candidate usually centers on factors like strategic fit, market footprint and business integration. There is another less exciting but important factor to consider during these talks: vendor contracts which can cause costly, tactical headaches if not identified early in the process. However, if the contracts are assessed early enough in the acquisition process, an institution can reap benefits greater than expected through due diligence process.
When combining two FIs, there will likely be a considerable number of contracts to review. Vendor contracts related to technology solutions that touch consumers directly tend to be the more complex contracts to emerge during this review process. In recent years, the terms in these contracts have grown more restrictive. In addition, termination fees and similar penalties seem to have become de facto industry standards for such contracts in a number of verticals, including financial services.
The Easier Way and The Harder Way
In an ideal situation, contract expiration dates for the combining FIs will be closely aligned. If this is the case, there is clear opportunity to negotiate with vendor(s) for fair market rates for the now-larger entity, which will clearly have more clout following the acquisition.
However, when this is not the case, transfer fees, termination penalties and other elements in the contracts can affect the value of the deal. While it’s unlikely these items will change the result of the deal, it could delay a closing while also causing these late in the game value adjustments, which are no fun for anyone. For this reason, involving experts in vendor contract management as early in the process as possible is recommended.
Contract Terms When Considering an Acquisition
What about when an FI is looking for acquisition targets and perhaps has a vendor contract that might end before the target is identified? Should the institution “go short” limiting the term plus the amount of penalties that might be associated with longer term agreements?
Every case needs to be evaluated on its own merits, of course, but the fact is things are seldom cut and dry when it comes to this kind of decision. While going short may seem logical at first glance, an acquiring FI might receive a better deal economically by signing a longer-term agreement since these often include volume-based growth incentives, competitive discounts and, perhaps, considerable signing bonuses.
As a rule of thumb, the bigger the contract value, the fewer the number of competing providers – and the better the chances that the FIs involved in a merger are working with a common vendor. Yet, even in cases where both FIs work with the same provider, they’ll need to reconcile the specific services covered. In addition, the technologies institutions license from vendors vary in terms and their complexity. As most of us know, core system are good examples of the complex end of that spectrum with conversions taking months or even years and vendor contracts with terms that typically average seven years.By the time an FI has entered active merger talks it has likely engaged legal counsel well versed in coordinating vendor contracts. While this assistance is valuable, these resources typically lack the benchmark information and experience needed to help an institution navigate through fair market pricing for the situation when it comes to technology vendor contracts. In fact, if your FI is actively seeking acquisition opportunities, it is best to engage with experienced, third-party vendor contract management firms early in the process, maybe even before an acquisition is identified.