As trading starts to recover after the pandemic lockdowns, hotels M&A is climbing the agenda again. Although the sector retains its challenges, agents are reporting a pick-up in buyer interest and would-be sellers who have held tight until now are reappraising their options. This article contains some suggestions on how those that decide to sell, or are considering selling, can optimise their prospects.
Seller key considerations:
- Need for pre-sale reorganisation? If so, carry out well in advance.
- Consider the timing of approaches to key counterparties: manager, franchisor, key suppliers.
- Do the costs of a formal auction process outweigh the likely benefits?
- Is there a case for vendor due diligence to expedite the process?
- Will a locked box structure be appropriate?
- Use of warranty insurance to facilitate a clean break.
- Engage advisers to assist in early-stage planning and term sheet negotiation.
Sellers should begin by considering if their business is in optimal condition for sale. If cracks exist they may ultimately be ruthlessly exploited by the buyer, with the risk of delay, damaging concessions and even price chips. A thorough internal housekeeping process before external scrutiny begins is highly recommended.
Key questions include:
- can the business being sold operate independently from the seller's wider group? If not, consider either an internal reorganisation or offering transitional assistance following completion while the buyer builds independent capacity;
- are assets held by the right company? Most assets can be easily transferred by simple agreement or intra group licences being granted e.g. IP;
- have key contracts or licences expired? It is common in the hotel sector for relationships with important suppliers to be conducted under an informal 'course of dealing' relationship; formalising (or at least explaining) these arrangements will likely reassure bidders. Are all licences needed in place, are they in the right company and do they accord with what the hotel actually does?
- what security/guarantees are in place? Has the target given any guarantees to support obligations of the seller or vice versa? Buyers will expect to buy free of any such security or guarantees..
- are there counterparties that have the benefit of prohibitions on change of control (share sales) or assignment (business sales)? When/how should they be approached?
- if your hotel is subject to a management/franchise agreement, is the owner fully compliant with its obligations? Will a sale involve termination of the underlying agreement or trigger counterparty consent? What are the likely consequences/costs of this?
The answers to each of the above, together with the seller's tax planning, should identify and resolve roadblocks to a deal and point towards an appropriate structure (including whether a share or asset deal will be better).
(Up) Front of house costs
For larger or more sought after assets, or portfolios, a full auction may be undertaken whereas smaller single asset deals may just be subject to a short bidding war on the basis of limited information. At a very broad level, depending on the anticipated demand, doing more work and incurring more cost at an early stage can often drive better outcomes for sellers. But there are no guarantees.
Sellers may therefore wish to consider:
- preparing and allowing interested parties access to a comprehensive data room to facilitate rapid buyer due diligence. This may however put off some bidders by highlighting more risks or exposing the seller by disclosing more sensitive information to bidders than is really needed.
- explanatory notes or due diligence reports ('VDD') by the seller into any aspect of the target (tax, accounting, legal, property) on which the ultimate buyer may rely. These short circuit initial bidder diligence time without bidders racking up large legal costs; private equity are particular fans. The downside is that any VDD (with its own scope, purpose and limitations) is no substitute for the buyer ultimately carrying out its own diligence. Further, VDD costs are often hard to pass on to the buyer and will be fully borne by the seller should the transaction abort.
- a locked box structure instead ofa more traditional completion accounts mechanism. A locked box sets the price at a particular date, with no opportunity for the buyer to price chip post completion. The buyer will get the benefit of profit from the locked box date albeit that if the business is profitable, the seller can negotiate an extra 'daily rate', incentivising the buyer to complete quickly. However, the preparation of a set of locked box accounts will be a significant additional cost whereas the costs of compiling and challenging completion accounts will be borne post completion.
Be careful about getting into bed
Assuming satisfactory interest has been received, a preferred bidder will emerge and they will want exclusivity. Before granting this, the seller should consider:
- granting exclusivity for a short period, with regular reconfirmations of interest and exclusivity terminating if the buyer changes the price or terms or if they fail to keep to an agreed timetable/demonstrate progress;
- whether the bargaining position justifies a deposit/exclusivity fee; and
- engaging solicitors to assist with the heads of terms and exclusivity letter so they can shape the deal and address key legal matters that may be omitted from agent prepared documents.
Checking out without setting up a tab
Traditionally a big area of risk for sellers is warranties and tax indemnities. The landscape here has been revolutionised by the evolution of warranty and indemnity insurance ("W&I"), where the market has evolved dramatically in recent years. This should allow a buyer to obtain a full set of commercial warranties and tax indemnities whilst allowing the seller to walk away with only nominal liability. The vast majority of sizeable hotel transactions now feature W&I, which has a cost but where premiums are trending down. It is a commercial question as to who bears the liability for the costs of W&I but, given the attractions of escaping without years' worth of potential warranty liabilities, an increasing number of sellers (not just private equity and institutions but private individuals/corporates too) are embracing W&I and will seriously consider contributing to the costs of the W&I premium.
This article was originally published in May 2021 by Hotel Analyst and can be found on the Hotel Analyst website.