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Due Diligence Tips for Your Next Hotel Acquisition |
For the most
recent update on this topic, click here By Jim Butler and the Global Hospitality Group® Hotel Lawyers | Authors of www.HotelLawBlog.com January 14, 2013 Hotel Lawyer with the due diligence wakeup call. As an introduction to today's article on due diligence, I would like to reprint a portion of my blog from December 31, 2008: Bernard L. Madoff -- Maybe the Madoff debacle provides the quintessential anecdote. In what is clearly the largest Ponzi scheme in history -- probably involving $50 billion -- one man seduced the elite of the elite in the financial world. Who would think that Henry Kaufman, former Chief Economist of Salomon Bros. would be hoodwinked by a Ponzi scheme for several million? And how did respected institutions like BNP Paribas, Royal Bank of Scotland and Nomura Holdings get tagged for around $500 million each? Or HSBC and other professional investment firms for more than $1 billion each? The answer to these questions is pretty simple: It was a fundamental failure to perform due diligence. I think one commentator at dealbreaker.com recently summed up the syndrome best that became an international epidemic. It was his answer to the question of how someone could trust their entire fortune to Madoff. The answer? Goldman did due diligence in 2001 "no we didn't", "yes you did" and gave them a pass. That kind of sums it all up. No one wanted to say that the emperor had no clothes. No one wanted to do all the due diligence when it seemed like someone else must be doing it. Everyone just "assumed" that it must be OK. Who needs due diligence anyway? You do (on every hotel acquisition)! Here are some tips. Due
diligence tips for Particularly in the context of a hotel acquisition, "due diligence" generally refers to the investigation conducted by a potential buyer of the hotel that is the target of the acquisition. The investigation covers both the physical asset (i.e. the hotel structures, parking, systems, equipment, inventories) as well as the operating business conducted at the hotel facility, and the relevant markets and environment. The purpose of the investor's due diligence is to understand and evaluate the potential investment in the hotel. It is the analytic review of the real and personal property, the business operations and potential of the specific hotel. This effort all seeks to validate the investor's reasons for buying the hotel and to avoid surprises after the purchase has closed. Perhaps the most significant element in the buyer's calculation of a bid or purchase price is the analysis of the potential earnings to be derived from the hotel. To develop the proposed acquisition price, the buyer must make assumptions as to future market conditions and the hotel's performance within that market. These assumptions will be reflected in a discounted cash flow on stabilized operating projections. Thus, a preliminary business plan which reflects assumptions as to physical facilities and condition, management, affiliation and other factors must be developed in order to assess the potential acquisition realistically. Because your bid or purchase price is based upon a calculation of anticipated revenues and expenses, the due diligence process is critical to validate or gain comfort with your assumptions on these cash flow analyses, and to avoid unnecessary surprises. Unforeseen expenditures to replace leaking window systems, replace boilers or cooling towers, demolish a portion of the hotel which encroaches on adjoining property, or meet a new property improvement program from the brand -- these can all play havoc with purchaser's expectations if they weren't anticipated. What are the
biggest complaints from buyers about hotel due diligence?
Because most hotel purchase agreements are written with strong "as is" language, and express provisions that a buyer must rely on its own due diligence, many buyers do not spend enough time focusing on seller representations and warranties. This is a mistake. Regardless of significant disclaimers in the purchase agreement, having a set of properly drafted representations in the purchase agreement by experienced hotel counsel can significantly help flush out critical issues concerning the physical and operational hotel issues that only a seller or its management company would understand. A few buyers may rely upon a seller's representations and warranties in place of their own due diligence plan, but that too is a mistake. A buyer must execute on its own due diligence plan as if the seller made no representations. A fundamental part of a buyer's due diligence plan should be in the discussions, negotiations and tailoring of the seller representations. Even if the seller is unwilling to make a specific representation and warranty on a particular condition, focusing on the issue up front will help frame the buyer's post-signing due diligence. For further information, Seller representations and warranties in a hotel purchase agreement -- What are the big issues today?" from HotelLawBlog.com (November 4, 2012) Some buyers erroneously believe that the indemnification clauses of a purchase contract will protect the buyer. However, indemnification clauses usually are inadequate to protect a buyer from additional costs that could have been avoided with proper due diligence. Indemnification generally applies only for breaches of representations and warranties, and if the seller limits or qualifies its representations and warranties, the indemnification provision may not be triggered. In addition, indemnification is often limited by deductibles, buckets, caps and expiration dates, any of which may exclude indemnification. Further, in many cases, once the seller sells the property, the seller (or selling entity) will distribute the proceeds of sale and may have no assets left with which to pay any indemnification. Finally, even if none of the above limitations apply, the seller may simply refuse to pay the indemnification, and the buyer will then incur the cost of suing the seller to obtain the indemnity. See The hotel purchase and sale agreement -- What is the value of the seller's representations and warranties to a hotel buyer from HotelLawBlog.com (November 9, 2012). While indemnification can have limited value, it is no substitute for the buyer's independent due diligence. Conclusion HOW TO BUY A HOTEL -- Free handbook Until the free handbook on HOW TO BUY A HOTEL is published (expected soon), you can access all the materials on this subject at www.HotelLawyer.com. Look on the right hand side of the home page and click on "Buying & Selling a Hotel." Here are a few of the articles on
the subject
under this topic: __________________________ This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $60 billion of hotel transactions and have developed innovative solutions to unlock value from hotels. Who's your hotel lawyer? __________________________ Our Perspective. We
represent hotel lenders,
owners and investors. We have helped our clients find business and
legal
solutions for more than $60 billion of hotel transactions, involving
more than
1,300 properties all over the world. For more information, please
contact Jim
Butler at [email protected] or
+1
(310) 201-3526.
Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group™. Jim is one of the top hospitality attorneys in the world. GOOGLE "hotel lawyer" and you will see why. Jim and his team are more than "just" great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them. |
Contact: [email protected] 310.201.3526 |
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