Tips for Partnerships by Multimedia AU/NZ

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TIPS FOR PARTNERSHIPS

Partnerships and syndicates explained ‘Be prepared’ is a comment that is thrown around ad nauseam. The only other area that comes close, in terms of general lack of understanding and prudent risk analysis, is off-the-plan purchases of management rights. When the two collide, get ready for fun and games! However, armed with a grounding in the fundamentals, neither opportunity should cause alarm or present unacceptable risk to potential purchasers or investors. The partnership (or investor syndicate) concept is not new, in terms of a group of investors getting together to leverage their combined purchasing power to acquire an asset. Historically, the concept has been used in the commercial property sector and to a lesser degree in the freehold hotel/motel investor sector. Acquisition of going concern businesses by investor syndicates are less common with the management rights industry being a rare exception.

Typically, the management rights partnership opportunity starts with the listing of a large property Positive attributes that might attract investors and working partners include term of agreements, real estate to going concern value ratios, return on investment, return on equity and future upside potential. I am often surprised when I meet existing partnership investors and when I ask about return on equity I get a puzzled look and a shrug of the shoulders. I am also surprised/shocked/horrified (take your pick) to learn that, in many cases, partnerships are formed to purchase large management rights with the working partner having no prior accommodation management or similar experience. For me, the single most critical component of any partnership acquisition is to identify the right managing partner.

Get that wrong and the risk profile of the transaction will rise significantly. I am also a big fan of having everyone on the same page from the outset. When I talk to disgruntled managing partners or investors, the source of concern most usually stems back to the initial set-up and a lack of understanding and transparency through the process. Returns not meeting expectations can also cause some angst, although these are going concern businesses with numerous variables in terms of operating conditions. In my view, no-one should invest in a management rights (or indeed any business syndicate) if the return is critical to meeting debt obligations outside of the investment or the general living costs of the investor. These are discretionary investments in my view and should be treated accordingly. So, a listed going concern, or

Mike Phipps Director, Transaction Management Consultants

off-plan management rights, has been identified and the return on equity numbers look encouraging. In my mind, that’s a return commensurate with risk as calculated on the capital contributed by the partners. Remember, that’s return after interest costs, managing partner wages, relief management, body corporate levies and incidental expenses outside those usually included in a typical management rights profit-and-loss for sale purposes. A suitable working partner has been found and a silent partner investor group have shown interest in the project.

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For me, the single most critical component of any partnership acquisition is to identify the right managing partner

The group would generally engage an accountant, lawyer and finance broker to assist with the transaction, advise on appropriate structures, review risk and potential opportunities, provide finance and return scenarios and coordinate investor group meetings and the equity, offer, contract, partnership agreement and settlement process more broadly.

The co-ordination of the initial assessment, negotiation of purchase price and conditions, due diligence and equity contributions is critical and in our case is undertaken by Transaction Management Consultants PL, a wholly-owned Phippsfin PL and Holmans Accountants consultancy. TMC Pty Ltd liaises with select industry expert lawyers

and accountants via the due diligence process and ensures that only professionals with significant expertise in partnership transactions are involved. Having consideration for budgeted staffing levels and the size of the business, a base managing partner salary will be agreed. This would usually include a cash component plus residence within the manager’s lot together with payment of utilities, body corporate fees and business outgoings. It is important for the partnership to divorce the return on equity expected by the managing partner from remuneration considerations. The two are totally separate and I have seen disputes caused by silent investors failing to recognize that the managing partner’s equity investment return is a reward for capital invested, not for time and effort. Prudent risk management would suggest that debt funding for these projects be limited to gearing levels of 65 percent or less and that limited guarantees be requested when putting the finance proposal together. Of course, higher gearing is available and may be appropriate on a case by case basis. I think it’s also appropriate to consider interest only terms to assist in preserving the return on equity, which would otherwise be eroded by the cash flow impacts of principal repayments. Loan covenants need to be reasonable and, in a perfect world, not give the lender too much leverage in terms of changing the rules post settlement. It’s important to seek finance proposals from lenders who understand these transactions,

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particularly agent companies, unit trusts and increasingly self-managed superannuation fund compliance. While it is not usually possible for a SMSF to purchase a going concern we are seeing an increasing number of investors using SMSF capital via compliant purchase structures. I am not going to go into detail here except to say that under the appropriate purchase structure SMSF investment is possible and the lenders appear reasonably relaxed when dealing with these structures. Obviously, investors need to seek their own advice and ensure that their investment decision complies with Superannuation Industry Supervision Act guidelines. We have assisted a number of syndicates recently and provided potential investors with feedback in relation to likely debt finance structures, interest costs and lending guidelines. We work closely with industry lawyers and accountants to assist clients through the whole process from reviewing opportunities to executing transactions. If you would like to know more about these opportunities we are always happy to help. Simply call or email and we can provide guidance as required. If you are an experienced accommodation manager looking to take the next step we are also happy to have a chat. In closing think about this. If a bank lends a partnership 65 percent gearing at an interest rate of six percent and the partners contribute 35 percent plus costs for a return on equity of 20 percent who is taking the bigger risk for the lower return. Food for thought, I suspect.

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Management rights partnerships – why so different?

Undoubtedly, one of the biggest changes in the management rights demographic over the past ten years has been the boom in syndicate and consortium purchasers Commonly referred to as ‘partnerships’, these buying groups are especially suited to large buildings and a low interest rate environment. Speaking both as a lawyer for partnerships and as a participating investor myself, partnerships provide many opportunities: •

the chance for an enthusiastic/experienced resident manager to operate a building larger than their budget would allow;

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allowing a transition from active manager to silent investor;

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an ability to diversify portfolio risk across different building types and locations;

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if structured correctly, the prospect for investors to use different investment vehicles

The partnership agreement is an integral piece of insurance in minimising the likelihood and cost of a protracted legal dispute if things go wrong such as self-managed superannuation. One of the peculiarities of management rights partnerships is how often participants are current or former operators. This is normally a positive, providing knowledge and advice on hand if needed. However, it can also occasionally challenge the concept of what is expected of a silent partner, with unwanted interference not unheard of. What becomes reality can be influenced not only by the expertise of the transaction management consultant in assembling the partnership, but also through relevant education and advice from the lawyer engaged to assist. Every partnership, the personalities involved, the

building being purchased, and the environment in which they operate, are different. Our knowledge base grows on every transaction without exception, no matter how many hundreds of partnerships we act for. What works, and what occasionally doesn’t, all shapes our approach and recommendations as to how a partnership should govern itself. Our strong transactional volume ensures our advice to partnerships is always cutting edge. Nowhere is this more relevant than in the drafting and negotiation of the partnership agreement. Whether there be two partners or 20, our skillset helps partners turn what could otherwise be a murky sea of unregulated grey into a more friendly legal landscape of black and white. Although it may be

Trent Pevy Director, Pevy Lawyers

destined for the ‘bottom drawer’, the partnership agreement is an integral piece of insurance in minimising the likelihood and cost of a protracted legal dispute if things go wrong. Broadly speaking, these are the rules of the partnership, made by the partnership. Structure, duties, rights, responsibilities, exit strategy and the manner in which profit and losses are dealt with, are all key components. But so too are issues unique to management rights, such as fulfilling the requirements of agreements with bodies corporate, trust accounting and licence compliance, reporting and audit requirements, and documenting the importance an active onsite partner plays in a silent partner’s initial decision to invest and the long term value of the business.

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None of these matters should be taken for granted or assumed. The negotiation of the partnership agreement is the only true time during a purchase transaction where the partners’ individual interests differ – especially that of the active onsite partner and the silent partners. The active onsite partner’s return from not only the investment of its equity but also the investment of its time requires careful understanding to ensure expectations are correctly set and maintained.

Balancing these interests and addressing them early on is a key part of our engagement. It is also one of the reasons why we always favour a face to face partnership meeting well before an acquisition is beyond the point of no return. Aside from assisting the partnership in framing its partnership agreement, we tailor every component of our traditional transaction lawyer role to ensure its relevance to a partnership setting. Whether it be taking instructions or ensuring a partnership does

Specialising in management rights and other accommodation business syndicates

not get bogged down in key dates, we proactively work with the partnership’s other consultants in keeping partners informed and abreast of the strengths and threats to their potential investment. Liaising with the partnership’s prospective bank as to the security it expects to receive from partners is a good example, particularly where banking and approaches to personal guarantees differ markedly. Similarly, the body corporate consent process requires even more planning and flexibility in approach than is usually the case. Armed with findings during the legal due diligence process, we aid our partnership clients in deciding how best to present themselves and their collective structure to body corporate committees and its legal representatives.

Our goal is not just to achieve consent, but to do so in a cost effective and non-invasive manner. It is well recognised that management rights and accommodation industry businesses are the domain of expert accountants, lawyers and financiers. This is magnified further when it comes to partnerships. The foundation to any successful partnership investment is a thorough understanding of both the business and the partnership itself, something we contend can only be delivered by experts operating daily in this space. With personal attention, experience and unmatched accessibility, we welcome the opportunity to navigate a partnership and its partners through what need not be a stressful gauntlet.

AUSTRALIA’S LEADING TEAM OF ACCOMMODATION INDUSTRY LAWYERS Work with the firm that delivers nationwide, industry leading advice on all accommodation based transaction and advisory matters. Helping resident managers and operators to acquire, sell, protect and grow their business through unmatched accessibility and certainty on fees. Phone: 07 5562 6111 After Hours: 0412 092 969 www.pevylawyers.com.au

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