Make Sure Your Lender Gets Current Information

RAISING SECONDARY CAPITAL PRIVATELY

by Jeff Wilder

The toughest money to raise in a hotel deal is, without question, reasonably priced secondary financing. While most people can find 25 -30 % equity or 50 - 60 % in first mortgage debt, there’s often an additional capital gap that needs to be plugged with money that’s more difficult to find. Whether you’re thinking of buying a hotel, or fixing up one you already own, it is predictable that a project’s cash needs will often exceed its availability from traditional sources , leaving an entrepreneur scrambling to cover the gap.

In the case of prospective acquisitions, a buyer will often try covering project cash demands by offering the seller less down payment money, since he needs to husband it in order to cover " the down-stroke" plus working capital and a portion, or all, of property’s modernization demands. Usually, this approach goes nowhere, and can even cause bad feelings, because the seller thinks a buyer is simply trying to "low-ball" him. Then, there’s the situation of an owner who is hit with a big modernization bill by upgrading demands of either the marketplace or the franchiser. Things can get pretty uncomfortable, as well, when there’s insufficient owner’s cash or fresh debt to accomplish the upgrading and a franchise affiliation hangs in the balance. Regardless of whether one’s goal is an acquisition, modernization or working capital injection, it’s often the case that first mortgage financing, in combination with available equity, will only reach 75 - 80 % of a project’s overall capital needs and one is left scurrying to figure out ways to fill the differential. Unfortunately, this gap financing usually winds up being scarce, expensive, or simply unavailable.

Demographics to the rescue ! Recently, I represented two partnerships in arranging secondary acquisition and upgrading financing totaling around two million dollars; the capital was priced at, or below, the cost of both hotel’s first mortgage debt. How was this accomplished? Basically, through by-passing the middleman, that is the traditional lender market, and going to individuals. Many people who are in their 50’s and older have been able to save significant levels of capital in their IRA’s and other types of pension plans. Often, the capital they hold is parked in bank C.D.’s or short term Treasuries, yielding rates in the range of 4 - 6 %. Alternately, the funds are held in stocks which, while appreciating, often pay dividends in the 0 - 3 % range. We have found that this is a ripe source of reasonably priced secondary capital, though there is no one pipeline source to access it. However, the entrepreneur’s own circle of family and acquaintances usually is a wonderful place to start the search.

Retirement funds can invest in secured hotel debt as long as it meets the test of being a prudent risk and pays a market rate of interest. For most hotel projects this means a 10 - 12 % interest range for interim term debt, say three or four years. While pension funds can also be placed in equities, we have found that older people would rather have a monthly interest check than a story about the future. Depending on the investor’s age, the interest income may also be tax-deferred, making it an even more enticing investment opportunity. Often, those who invest their retirement funds in private ventures are, or were, business people so they can analyze the risk/reward benefits of your proposal with acumen. Too, they usually have professional advisors, such as their accountants, who can assist their decision-making. Importantly, they are forbidden by law from putting money into business ventures that they own a significant percentage of, as this is considered by the government to be self-dealing. Therefore, they may invest their retirement funds with you, but not in their own businesses. This is a critical caveat and very important point to know.

Though hotel lending is riskier than investing in C.D.’s, it’s also more than twice as lucrative to the pension plan. Of course, the ability to source out private pension investment capital is based on trust and reputation as well as security. It is also very personal because you are asking people to trust you with their hard-earned retirement funds and you must accept the money with that sobering responsibility in the forefront of your mind. However, once you find one pension investor, perhaps an uncle, cousin or friend, others often follow. These people have the right to expect a detailed package of financial information, what the money will be used for, and when they can expect repayment. You’ll want to provide relevant information, whether requested or not, because they are entitled to receive it and you look more professional in the process.

What’s your track record and experience level ? How much of your cash is behind the pension investor’s ? What’s the senior debt level in front of the pension’s funds ? Do you have a written business plan ? Expeditiously answering all these questions will enhance your prospects for success and facilitate providing that most elusive class of funds, commonly referred to as gap financing, from private retirement plans.