Author: Jenny Sargeant
This article was previously published in the May 2017 edition of The Caterer, Licensee and Hotelier.
For those setting up a hotel business an inevitable part is negotiating financing arrangements. Hotel lenders will want as high a level of control as possible over any new hotel business due to the higher risk profile. However, hoteliers need to be aware that giving up too much control can stifle their ability to be responsive to market demands. Whilst not such an issue on day one, this could have a large impact on the business down the line. To find a middle ground it is important to be aware of the following three key objectives for the lender:
Ensuring appropriate security is taken over all assets
Lenders need to take security over all key business assets to ensure that if the loan is called in they can sell the business as a going concern. Lenders will want to take “fixed security” over as many assets as possible. This imposes a high level of control and prevents disposal without prior lender consent. “Floating security” is the alternative to fixed security and is taken over lower value assets which fluctuate in the course of business operations (such as FF&E and stock). Consent is not required to deal with these assets unless an event of default has occurred under the loan agreement. It is important to ensure all assets where flexibility is required are excluded from the fixed security.
Hoteliers should also carefully review bank account arrangements proposed by the lender. Lenders prefer business profit to be paid into blocked accounts (i.e. inaccessible to the hotelier) which is then used to pay the interest on the loan. The hotelier needs to ensure that sufficient working capital is held back from these accounts including funding for its capital expenditure program.
The diligence process that the lender’s advisors will undertake is a very full one as the lender needs to review all assets to assess the risk profile of the business (property title, employment contracts, supply contracts, IP information, bank accounts, booking systems and any management or franchise arrangements). The hotelier can help to speed up negotiations by ensuring information is properly collated and made available to the lender.
Having financial checks and early warning signs of poor performance
The loan agreement will include financial covenants to enable the lender to call in the loan if there are signs that the business is failing. Usual covenants will set markers around the value of the property asset, the trading value of the business and the level of profit and compare these values as percentages against the value of the loan and/or the interest payable.
It is important to be aware that where covenants are breached the lender has the right to call in the loan. Even if a lender is likely to allow a borrower time to remedy minor breaches, this cannot be relied on. It is therefore important that the financial covenants are set at realistic levels at the outset.
Lenders monitor performance by requiring the hotelier to provide detailed business information (usually monthly management accounts). A recent case where two directors were struck off for giving misleading financial information to their lender highlights the importance of ensuring that business accounts are kept in good order and that accurate information is provided to the lender.
Preserving the value of the lender’s security
Covenants like restrictions on lettings and refurbishment without lender consent impose control for the lender to preserve the value of the property asset. However, this can impact decisions a hotelier considers to be key to brand and hotel offering (and not decisions where it welcomes third party intrusion). A good compromise for lettings is to negotiate thresholds under which consent is not required (i.e. level of rent, length of term). For refurbishment it is advisable to agree a regular maintenance program that can be carried out without consent so that only larger projects require lender approval.
Although negotiations between lender and hotelier can be tricky to navigate, ultimately both parties want the business to be successful. Being mindful of the motivators for lenders when entering into negotiations helps to ensure negotiations are solution focused and that the best result possible is achieved for all.
Jenny Sargeant, Partner, Fladgate LLP (firstname.lastname@example.org)