All Can Benefit When Management Firms Put Up Capital
by Jeff Wilder
Reprinted from Advanstar's Hotel & Motel Management Magazine
It's no secret that some hotel properties, partnerships and individual owners are having financial difficulties. These problems often are related to management or marketing and result in burdensome debts, bankruptcy or foreclosures.
Frequently, fresh capital is needed in order to convince financially involved parties to accept common-sense restructuring.
New money, new management and new approaches frequently work wonders in creating a healthy hotel operation. There is usually good potential to increase income and/or cut expenses in order to make a property more profitable.
Today's proliferation of management companies gives owners, investors and talented operators the opportunity to structure interesting deals with each other. These companies should be willing to advance or secure capital in return for long-term operating positions in hotels they want to run.
Fresh capital is used to productively enhance value rather than simply to "buy equity." Let me share several approaches I've used that seem to work well for all sides:
Net Lease- Existing ownership may be trapped: It can't finance because it's not a credible borrower, and it can't sell because of severe economic or tax ramifications.
In a net lease, the management company agrees to advance the needed capital in return for a long-term lease on the business. This allows the new operator to raise fresh equity or borrow on the lease assets to acquire the business. Instead of earning a 4 percent fee- basically "wages for labor" - the management company can create a valuable asset whose profit potential could be worth four to five times the annualized profit were it to be sold in the lease-resale market.
The amount of fresh capital needed to make the deal happen is often substantial. If so, it can be advanced in the form of a mortgage on the real estate so the operator or its lender is well-secured.
This structure gives the operator long-term control of the business, though not the potential real-estate sale or refinancing benefits.
Assuming managing general partner position-
Sometimes, a general partner wants to resign. A new managing agent may agree to take on general-partner responsibilities if he can negotiate from strength with a partnership that may have few palatable choices. Fees to the new manager/general partner can equal basic management and general-partnership fees, in addition to significant percentages of operating and resale profits. (Naturally, the limited partners must agree to the transaction; otherwise, there may be trouble down the line.)
This form of takeover can allow a managing agent to leverage operating skill and some capital into significant ownership benefits.
Entrepreneurial lending-
Here, individuals with ready credit lines advance cash with interest rates tied to the market, in addition to kickers based on percentages of gross income. The loans are usually permanent transactions in which the current owner may pay income percentages via a ground-lease route or some other approach by which percentage payments survive the repayment of capital advances.
The lender has the capability of taking over if necessary. He may realize up to 20 percent of gross room sales over a base-year level and likely has a good investment if it's been underwritten well.
Sometimes, the owner doesn't want to continue managing. The lender may then suggest a managing agent, though it must be strictly an "arm's length" transaction between owner and manager, so that the lender doesn't risk losing its secured position by making equity decisions.
There are a number of other structures that work just as well as those outlined here. The point, however, is this: Capital advances by management companies can be mutually beneficial. The owner knows the managing agent is truly watching the asset because its money is invested. And the managing agent can realistically expect a significant economic benefit for putting its capital on the line.