Spring 2004 • Issue 13, page 7

Understanding the Unique Challenges in Operating Hotel & Restaurant Receiverships

By Gemberling, Dennis*

The complex operations of hotels and restaurants – often referred to as the “hospitality industry” — makes even the shortest term receivership daunting for a receiver with little or no experience in the industry. Few other types of businesses “book it, cook it, service it and account for it” under one roof. Add to this recipe for trouble a shortage of qualified employees and seasoned managers, low profit margins and unceasing demands of a round-the-clock operation, and the receiver’s job of maintaining cash flow, generating income and preserving value becomes quite a challenge. It is important for courts and opposing parties to understand what confronts a receiver during a hospitality industry business dispute and what steps are needed to achieve a positive outcome.

Beware - Kids Supervising Playgrounds
A typical manager in the hospitality industry is younger and less experienced than his or her counterpart in other businesses, yet is often responsible for directing a multi-faceted operation generating millions of dollars in annual revenue. A typical hospitality industry manager has multiple duties, such as marketing, purchasing, labor planning, maintenance, accounting and supervising day-to-day operations. Staffing the business is a real challenge. More than 80% of the staff in lodging, resort and foodservice businesses are non-management, are minimum wage or low wage workers, and have limited education. Many are recent immigrants. These factors, along with employee turnover averaging 200%-400% annually, make the need for seasoned management readily apparent.

It is critical for a receiver to assess the capability of the current manager during takeover. Retaining a professional management firm to deal with these complex operating issues may be necessary. This is especially true if the receivership entity is a sizeable business operation, the receiver lacks hospitality industry expertise, and retaining a management firm is not cost-prohibitive. An experienced management company’s fee arrangement is generally 3% to 6% of revenues, plus expenses. An “incentive” or “disposition” fee may also be appropriate if the management firm’s retention contract includes assisting in a sale or transfer.

Hiring a qualified on-site interim manager rather than a management firm may be more appropriate where the entity in receivership is a small, single-asset hotel or restaurant. Such experienced short-term managers are normally paid a salary 25% to 35% higher than is customary for permanent managers, because of their limited availability and the short-term nature of the work.

Minding Money AND Mayonnaise
Hotels and restaurants generate hundreds or thousands of customer transactions daily. Most are paid with credit cards or cash. Watching money and material is critical and “daily” reporting by management must be timely and have sufficient built-in controls and cross checks. The Receiver’s accountant must also understand how cash, sales receipts and product costs flow through this type of business to enable him or her to spot peculiar activity not being properly accounted for. For example, in one recent partnership dispute involving a nightclub, the on-site managers set up separate credit card machines that directed the monies into the managers’ bank accounts - not the account of the owners. It was determined where the missing money was going when spotters were sent in and daily receipts audited. Unfortunately, this was 6 months and $100,000 too late. In another hotel receivership, it was discovered soon after regular inventories were instituted and cost samplings undertaken, that certain food items paid for were nowhere to be found. Later it was discovered that the purchases were transported from the delivery dock to a nearby warehouse instead of the receivership business.

Labor – rather than product costs or operating costs, as is the case in many other businesses – is the single biggest expense in operating a hotel or restaurant. This is a service-driven industry. There is a minimum number of employees required just to open doors, make beds, prepare meals, register and serve customers and account for the day’s income. This employee cost can be as much as 30% to 50% of gross revenues. Higher labor costs also increase related expenses, such as employer taxes, workmen’s compensation insurance premiums, employee meals and uniforms. Payroll must be monitored daily in order to avoid excess spending and must be watched as closely as the cash register!

Many hotels and some restaurants customarily bill large clients on a monthly basis for rooms, meals and miscellaneous charges, creating accounts receivable worth many thousands of dollars. Sales personnel trying to bring in large clients tend to focus on volume and price, paying less attention to good credit management when trying to improve business. A cash shortage problem may be the result of too many ongoing company contracts with airlines, nearby corporations and tour wholesalers. Aggressive collection action on late payers without alienating regular clients will yield more cash to fund operations.

Beds Go Bump at Night - Income v. Value
Hospitality businesses are priced, bought, financed and sold according to income produced, rather than to value of the land, bricks and mortar or fixtures, furnishings and equipment. Industry values are normally determined by applying an income capitalization rate for hotels, or a multiple of the cash flow for restaurants. In a stable year, the industry average capitalization rate for hotels is 11% to 12% and the average restaurant multiple is 2x to 3x.

Since value is directly related to income, how the Receiver operates the business will impact the receivership property’s value. Ideally, maintaining (or improving) profitability will help all concerned where there is to be a disposition or refinancing. If the receivership business is failing but is perceived to be capable of generating a profit with a new operator or brand name, it may be appropriate for a receiver to seek to fund short term losses, rather than close the doors. In one case involving a 110-seat nightclub without debt (or assets worth anything), the fair market value of the lease was $5,000 monthly, with net cash flow in prior years of $100,000. By negotiating an agreement with the building owner to cover losses and eventually sell it at $200,000 market value, this covers the outlay and secures a tenant. In another case involving a mid-market, soon-to-be-branded 197-room hotel, income was increased short term by entering into 6-month housing contracts for construction workers. This gave the receiver time and income to demonstrate future viability. This resulted in a $1,300,000 sale, $400,000 more than the $900,000 distressed appraisal value of the business.

In short, the unique issues implicating management, manpower and money in hotel and restaurant businesses have the greatest impact on production of income and business value. If operated correctly, a hospitality industry receivership can accomplish its purpose, give everyone a good night’s rest and still generate plenty of dough.

*Dennis P. Gemberling is president of Perry Group International, based in San Francisco with a satellite office in Los Angeles. Perry Group has managed, operated and consulted on numerous lodging, foodservice, resort, gaming and club businesses across North America since 1985. Mr. Gemberling has more than 30 years of hospitality industry experience.