281:Board Chats: How Successful Clubs Manage Debt

Speaker 1: 0:01

Hey everyone, welcome back to Board Chats here on Private Club Radio, brought to you by our amazing friends Concert Golf Partners' boutique owner-operator of Private Golf and Country Clubs nationwide. If you, your club, a friend's club, is looking for recapitalization, set up a confidential, very easy phone call with Peter Nenula and see if there's a good fit, head on over to ConcertGolfPartnerscom and the rest is history. But on this episode we are talking about debt. We're diving deep into debt and in this episode we are chatting with Joe Ably and David Duvall of Club Benchmarking. We dive deep into various topics, including debt management, financial planning for clubs, clubhouse project financing and insights into club benchmarking. We talk about the difference between good debt and bad debt, emphasizing the importance of planning cycles and crafting items that favor the club. Joe and David also highlight the risks of variable rates and the advantage of fixed rates, while stressing the importance of transparency with members about the cost associated with debt. We also explore clubhouse project funding, discussing the process of seeking outside capital, the importance of transparency in the process and the dynamics of competitive bids. To wrap it all up, we talk on the trend of long amortization periods and their impact on private clubs. I hate that word, so let's dive into board chats with Joe and David of Club Benchmarking. What's good debt, bad debt, too much debt? Let's just start the conversation.

Speaker 2: 1:39

A lot of clubs use debt. A lot of clubs use debt somewhat poorly and with gifts that are in trouble is when they take out debt that they can't extinguish from what I'm going to refer to as planning cycles. What we see is clubs typically undertake major project or center projects every five to seven years, and then the energy bills again and they take on something else. The problem is, if you haven't extinguished the debt from the first group of projects by the time you get to the second, you're really hamstrung. That future administration that's going to try and do something more. So we like to see relatively short amortization periods, certainly less than 10 years. Less than seven is probably preferable. And people debt isn't a magic source of capital from some third party. It's just an advance on member assessments, member payments. It's all member money, no matter how you slice it. Yeah, so planning cycle when we have preferred terms. We definitely favor using some sort of RFP with a number of banks where you can kind of shape the terms of the deal. The rate comes out and everyone will be fairly competitive about the rate. The terms is where you can really make or break it. Some of the terms we like to see no prepayment penalties, a limit on closing costs and any kind of environmental reviews. You don't want them to go crazy Along those lines. A negative pledge which means you agree not to put any debt senior to the bank. Debt is preferable to a mortgage. It's much easier to amend later on and it usually results in a less stringent environmental review. We like to see fixed rates. Rates can go crazy. We're coming out of a long period of relatively low rates. We're into a different environment now, probably in one not normal period ahead. But clubs don't do well with the variability in rates. Typical thing when the rates are going up it's not working so great in the economy. It's when you start to see members fade and it's not a great time to have your payments increasing. So we prefer to see fixed rates. Not a real fan of swap agreements. They have their place in the world of finance but they're typically more complicated than most boards and clubs can deal with and difficult to get out of. Everyone seems to have their debt immunizations longer than their planning cycles when they're trying to get people to think about that a little bit more. Balloon payments are a big issue in the industry that boards. They want their project set to get passed and they minimize the payments by having very long immunization periods that may have a balloon payment due in seven or 10 years with no real provision to pay that off. I guess my honest point, before turning it over to Joe, which you'll add a lot more color to on this.

Speaker 3: 4:38

To provide some color is that clubs, from an operating perspective, generally break you. They don't make much money. We focus in as a firm to guide clubs that you're putting in a magnificent new facility doing more weddings and banquet business is not going to pay the bills. It's generally not profitable enough. F&b is an amenity, not a profits, so that really you have to be very upfront with your members with respect to you know, if your payment is a million dollars a year, then the members really need to be paying an additional million dollars a year to extinguish the debt. One issue on immunization periods and balloon payments most banks don't want you to have a term of any more than 10 years. So if you have an immunization period of 25 years with a 10-year bullet, you get to the end of 10 years and 72% of that principle is outstanding. So that's scary and you're leaving that for two or three boards later because the way boards cycle. We've been surprised when we've done our survey that when we've asked clubs, do you have debt? What are the terms? Do you have a balloon payment? We saw we actually took the yes answers and the no answers went back, went back to audited financial statements or platform where we had them and saw an alarming amount of clubs where they had a balloon payment when they said they did not have a balloon payment when in fact they did. So it's. You know, david, I always like to say club boards don't know what they don't know and we certainly didn't back in 2006. We really did. You know the balloon payment phenomena, if there's a. You know, the federal government programs really did a lot to save the clubs in 2020 and 2021. But if balloon payments are going to be coming due in the next, you know, seven, eight years out, and there's no BRTC out there, there's a problem coming. And to Dave's point, you're not going to be able to have a new aspirational project to redo the clubhouse or to redo the pool when the planning cycle comes along. One small thing that we noticed back to Dave's point on the RFP process banks have certain covenants that they use that are more applicable to private businesses and you do need to make sure that when you're agreeing to terms and agreeing to respective covenants, that those covenants are consistent with what your business reporting model is, because it's very easy to trip over there and it's easy to do. You know, club controllers, club general managers, the CMA train. They have access to club benchmarking. We know the accounting firms out there that are involved. You know you can tailor in a way, but you don't want to get into a position where the economy is a little tough. You trip up a covenant and that is the bank's excuse to then call the loan Well, we haven't seen that.

Speaker 1: 8:05

What are some of the things you know clubs or personnel can do to alleviate that or not come close to that, or you know what are some safety measures to take to ensure that that doesn't happen.

Speaker 3: 8:21

They need to have what we call an integrated, funded, long-term financial plan that goes out in time and shows your operations, your membership, your depreciation, which is a proxy for assets that you're going to replace down, any known aspirational capital projects that you have, debt and debt repayment, you know, consumptions with respect to capital assessments, monthly capital fees, initiation fees. You should just kind of lay it all out, put it out over a preferably ten year period. So then, when you set the covenants, you've set them based upon playing that you have, and I'd ask Dave to kind of add to that.

Speaker 2: 9:06

Just to call up on Joe's point about debt terms and making sure they work with your business model. As we know, in the club world a lot of the capital flows don't move through the P&L or the EBITI line. In many cases the flows directly to the equity section where the banks, if they're working with a printing company or a restaurant or something else, typically start with EBITI for lack of a better term and with some add-backs or subtractions as the basis for figuring out what the debt service ratio or other covenants may be. There we prefer to see clubs start with a change in members' equity, which definitely picks up all of the capital flows, and then you do your add-backs or takeaways from there. But it's an important distinction and not all bankers who don't do a ton of work with clubs would know. To do that the banks may need some educating, but it's one of the things that you put in the RFP to stop the education process. That that's your desired starting point for any covenants.

Speaker 1: 10:12

How do you know, if you have too much debt, or what is too much debt, or what are some you know Tests, I guess, so to speak, that a club can take that, that. Lets them go. Oh, okay, I think we're getting close, or, ooh, you know, this is not a good situation, like what's.

Speaker 2: 10:32

We use a real rough cut high level test of one times dues as a place to kind of say this may be getting to be a bit much, but you know there are exceptions to every rule, so it's not a hard fixed rule, it's just some place. Look Back to answering us in softer terms. You know how do you know you have too much when you're forced to repay debt but you don't have enough capital to pursue your other plans. You probably got too much debt when you can't extinguish it before your next big capital need probably got too much debt or insufficient inflows. Well, I'm yeah and I think it's more. Can you continuously execute on your long-term plans Without the debt hamstringing you? And that's the ultimate testing.

Speaker 3: 11:18

Yeah, I mean, the one thing that we do see is that club takes on debt. They don't have sufficient targeted flows To pay off that debt. They've used that debt to do something really nice to the facility and what they end up doing is then Taking money that they would otherwise be investing in the facility, funding depreciation and Using it to fund the debt at the same time and and this doesn't go noticed by a lot of clubs Well, you do a nice thing to your clubhouse Is an example. Your operating costs are going to go up. You know, as an example. Another particular example is let's say you expand your F&B footprint, so that is more cost. So you're operating costs are gonna go up. Your utilities are gonna go up. The amount of people you have supporting that is going to go up. Your depreciation as expense is gonna come go up, which is which put another way, is that in three, four or five years You're gonna have to start replacing those assets, just to keep it fresh. Well, if you haven't had a dedicated source to pay your debt and you're not keeping up on what we call your obligatory capital Funding, depreciation of funding, a reserve study, you know that that kind of stuff, that that is an indication of a style of a spiral, not a good direct, so excuse me.

Speaker 1: 12:54

So let's say you're seeing the spiral, what do you do? You know you're, I'm, I'm, I'm on the board of my club and I'm starting to see the Spiral coming, the funnels. You know, I the writing on the wall. What are some first action steps, like how do you take control?

Speaker 3: 13:11

So that's it. So I'm not gonna say that this is a good action step, because it is. What clubs tend to do is to refinance the existing debt and and Just kick the problem down the road. You refinance it, you Extend the payment terms, the payment comes down, you know you start doing obligatory product projects by Assessing the members on a piecemeal basis, not based upon a long-term plan, and so it becomes very much ad hoc as opposed to something that has been planned, something consistent with a strategic plan, with a funded long-term financial.

Speaker 2: 13:51

I mean, joe just laid it out in detail there. But you need to have a long-term integrated financial plan and you have to fund that plan, not the individual projects and the short answer at all with those back to, you need more money from the members. I mean that's always the solution and it's a difficult step for forwards to take when some other born kind of passed the problem to them. Now it's there to resolve it and they have to go to the membership for more money. It's the simple answer in the club world. It all remember the end of the day, that's the only money that has any real profit margin in it, or the dues, the capital fees of the assessments We'll take a look at the club over the last five, six, seven, eight years From their audited financials and where the attacks returns.

Speaker 3: 14:41

And what you see in some clubs is they could have taken out debt 15 years ago and that debt never really went away. They refinanced it periodically to, you know, redo the kitchen and then something he went on they refinanced it again to do something else. We we affectionately refer to that as zombie debt Because it never goes away and there's a lot of clubs that that unfortunately, what do you do?

Speaker 1: 15:13

Like you have zombie, like how'd they? What's in? Like what's another state? How do like is it like you said, you can't Do more like events? That's not gonna help it.

Speaker 3: 15:23

I, you know it's kind of like it hasn't happened any. We haven't had a serious economic downturn, you know. It is, as I said, the the government programs Rule lifeline to a lot of these, these clubs, what every club you know. So they bought time. If there's an economic downturn, then you'll see what happens. In the meantime, that the clubs that are on the, you know and these are Clubs that aren't the top clubs right these clubs that are on the lower end that that they just keep rolling the debt around to keep it going. They don't want to tax the members. They tax the members every now and again. They kind of get along and you can tell when you're well in first normally. Yeah, you can actually tell when you walk in.

Speaker 1: 16:22

Go ahead, dave.

Speaker 2: 16:24

Yeah, I was just gonna say you see what?

Speaker 1: 16:26

do, you do.

Speaker 2: 16:26

I mean, at the end of the day, to really break the cycle, it's probably takes an assessment. It's the only way you get back on top unless you've got some sort of capacity in your membership and you get a windfall of new members and, when fall, of new initiation fees. Short of that and that's unlikely and short of that it's gonna come down to, if you really really really want to break the cycle, boards gonna have to Look for an assessment to the members to bring in sufficient capital to hit the reset button so you can plan properly going forward so so, dave, that Peter the Neweller actually connected me with, with Denny and and a lot of what Peter does in his business.

Speaker 3: 17:09

He goes into clubs that are otherwise. You know, have some real bones but have gotten themselves into a dead problem, and then Makes a deal and does pretty well as a result. You know, so you're able to buy for the debt.

Speaker 1: 17:28

Bring in a money and that would probably even just to you know. Do you even start that? You need to start with the education. You have to have a board that is educated in a group that's educated and Wants to take it to the next level and do something about it.

Speaker 2: 17:42

Now Just keep passing the buck and If you get a while educated board like that, you've got to get all of them. We provide that education before they cycle off, because the the next border. You know it's unusual to have that kind of consistency of educated board. I mean, we're big components, obviously, of board orientations and try and pass the wisdom along and Get people up to speed as quickly as possible, but it's a challenge to keep people educated and rolling in the same direction across multiple administrations.

Speaker 3: 18:15

I was gonna say that I'm gonna say what Dave said. We, most of what Dave and I do art is would education and Again, part of that is a survey amongst the board members, which is kind of interesting in and of itself because a lot of them don't have a firm grasp of what is going on in there in their club and these, these discussions. I mean, when Dave and I do these discussions and we do the prep work with the president, the treasure and the general manager, the discussions go on for a long time. It's very conversational when it was oh wow. And then you're in front of the board and it isn't so much us talking to them because it and you know you get into discussion surrounding management of debt, you get into discussion surrounding nominations and Succession planning, which is really a hot issue. You then spend a lot of time conversing about it. The shortboard terms and short office terms are a challenge in the industry For the very best.

Speaker 2: 19:23

When is debt good? It's used appropriately and you know appropriately it's us, as we would have. When you use debt, you have a dedicated source of revenues that doesn't deprive any other affective long-term plan and then you amortize it within a relatively short planning cycle so that that next big wave of projects that's coming along or initiatives you know in five or seven years that that boy can start with a clean slate. We do see clubs that try to convince themselves that you know, the new strength of the system is going to last 20 or 25 years. We should get a 20 to 25-year debt. But that's financing a project, not a plan. And yeah, future people are going to be using this irrigation system. But you used up the last irrigation system and the way this works is every wave of members that come through, every cohort group, every generation, whatever, gets to pay for some log-lived asset that someone else is going to use. It's just part of the club rollout. I just think it's a slippery slope to get on that path. Try and look the repayment term to the asset life, because other assets are going to come along that also need to be financed or undertaken.

Speaker 3: 20:45

So a couple of points. You would ask at the beginning, then, how much is too much debt? And you know the correct answer really has to do with what's in your long-term financial plan. How is it being funded? But one metric that I look at is I look at debt per full member equivalent. And let's say and we see this a lot, let's say you have a club whose dues are $10,000 and that they have debt of $22,000 per full member equivalent. That is too much. And the reason is that if they ever came at point in time where the club did call the law, or if the balloon comes due and you try to refinance it and cannot that debt you know $22,000 per member in theory you'd have to assess. That's too much, you know. So you have to kind of think in the back of your mind If everything went sideways, what is the amount that would be the least painful to members? You know, and you know for a lot of clubs that aren't, that don't have wealthy demographics, hitting them with a huge assessment could be death, right, you know, in fact, the question to Dave on when is debt good? Well, in those situations where you don't want to, because you can't whack your members $15,000 to $20,000,. Taking out debt and having a debt service assessment so that they pay out that assessment in effect over a longer period of time makes sense. I mean at Dave's club. You, you know, when you did it the Charles River several years ago, that was almost the perfect example of what you do. I think it worked well in terms of what did you do there?

Speaker 1: 22:45

So, what was, what was the scenario, what did you do? And then what's the outcome?

Speaker 2: 22:52

Well, we had a long list of projects that I'd say we had gotten behind in capital in the early 2000s. We had a long list of projects to get through. We founded almost all of them internally. How? With member capital and we with two capital fees Through initiation fees. You know it was kind of pay as you go. And when we got to the last big project which was part of the clubhouse or a clubhouse redo, we did need to look for outside capital. But we did follow the game plan that we'll describe today. We put together an RFP, we described the club, we described our financial successes over the years provided on your financial statements, kind of set forth the terms that we were looking for. Again there, you know, no prepayment penalties, minimize closing costs, minimizer environmental reviews and we had numbers around these numbers, what we thought we could reasonably request Negative pled instead of a mortgage. We wanted to fix rate. We wanted our choice between A mortgage style or straight line and amortization. We definitely didn't want a balloon which goes. We definitely didn't want. Not want a balloon in there. We wanted to amortize it over a relatively short number of years, you know, with a fixed rate. Clip made clear we were not looking for a variable rate with a swap and we wanted a true fixed rate. And the definitions were based on the change in members equity, not on starting with the P&M and, and we had 10 banks in the fold Through the process. A couple dropped out immediately but the competitive juices stopped going. And the beauty of running in that kind of a process you know what everyone's telling. You know you go back to each of the groups, say, hey, you know you weren't on board with this term, but we got six banks that are. You know, it's just your chance to stay in the boat. You want to come? You want to stay in the boat or is this your time to say you know it's time to leave? We kept it 100% abroad board, totally transparent. Nine of the ten banks had number representatives. We said you know, this has got to be an aboveboard process, I don't know. And at the end of the day we had two or three banks that came up with the exact terms that we all walk. And then at the end of the day and issue up the rates and they were all very, very close and wrong. So what was a couple of month process? You know? Lots of interviews, lots of banks, but it did work.

Speaker 1: 25:24

What were some of the friction points with the whole process?

Speaker 2: 25:28

and this goes back a little ways. For me there and this would have been 2013 is friction Shut the time, actually some of it. I had a long-term planning committee with several bankers on board and they thought we were being too aggressive in the ass. You'll never get that. You'll never get that. You'll never get that and, as Joe alluded to, I Spent my career in finance and the venture capital world and I was used to kind of this multi-point Negotiation thing where you're kind of sitting in the catboard seat, you know whatever was telling you, they don't know what anyone else is telling and you just use that kind of knowledge as a lever in the process and I ask people do you want to stay in the process? You want to know, right that I club a very attractive credit question. So we had a lot of people engaged and I know two years later, when I got more involved up here in Vermont and we ran the same process and, I think, ended up with equally strong terms. So there's a process to it. It's not just going back to you are and then Incumbent bank and say what can you do for us? That's very rarely how you're gonna get your best deal and it's often gonna mean a change. I guess I should mention that on a change, most of these banks that do provide you with some debt Also want to tie up all your other accounts and capital, or at least the majority of it. And, as we saw earlier this year, single bank risk is a Initial. You don't want to have. So as you enter any of these arrangements, you want to make sure that your funds are Invested in US treasuries or invested in some sort of well. A spread out the other touches a number of banks and a lot of things have these so you don't expose yourself to single bank risk. What else are they gonna say on that? and when they take over your operating accounts. It's an important. They charge differently. You bet your banks they can charge differently for your fees, compensating balances, whatever on your disbursement and operating accounts and it's worth having them out. What's this really gonna give me a last six months or 12 months worth of bank statements and ask what would this have cost and to manage this banking relationship and and that can vary greatly some banks will give you all these services. Some banks charge heavily for it. I Guess the other thing I learned in all this is oftentimes the small Regional banks are benefits for clubs in the large national banks. They're not, as I'm eager to negotiate, they are 3200 page loan documents, so any Trends you are seeing.

Speaker 1: 28:10

Well, I think it's it's fairly common out there, but anything you you know words of advice, any Trends you see, worries.

Speaker 3: 28:20

I. I think the trend towards Lianmitization periods and balloons is unfortunately gonna hit the wall.

Speaker 2: 28:28

That's certainly the CPA firms see that coming and worry about it. We see it and worry about it on in clubs, Maybe on to it already, but certainly when we highlight it and the rate resets and variable rate loans trying, you know, all of a sudden Swap agreements, you know you think sad to come down again. Yeah become an issue? I don't know. Balloon payments, refinancing at a higher rate for an asset that everyone thought you paid off? I don't know.

Speaker 1: 28:57

Is there is probably like, is there a way to be proactive about it? So you know, I'm on a board of a club, I'm seeing we, we have the balloon, like hey, you know I, I want to make sure that our club stays. You know relevant and again, you know working, how can I approach my club or my board, say, hey, listen, I think we have this. What you are we looking at thing, that what are some Steps like? How do you at least start that?

Speaker 2: 29:25

One step would be to start collecting additional fees that would be available when the balloon comes to, and not just waiting for that moment of truth.

Speaker 3: 29:40

And and I'd say secondly, dave and this is it's really a big thing huh, president, needs to get in front of the membership, be transparent. Put that long-term financial plan up on the screen so that everybody sees, so that members know what's coming and why, irrespective of whether two presidents ago, when they entered into this, they weren't as transparent about it. You've got to be one way or another. The members are going to have to get involved. I Mean what I found personally is the more you've got in front of members, the more you showed them, the more you were transparent, and I'm talking about architectural drawings, bar right that they feel included. They get to ask the questions and you get the support. I Hear too much, dave, and I don't know if you hear the same we're. You know the board decided they want to do something. The bylaws state that you have to get membership approval. They don't tell the members they were transparent. They try to ram something through the membership and they lose a vote because they were transparent. I Think transparency and clubs is like right, just huge. And it doesn't matter for what you know, it's even for for one club that we're doing work for. You know, the recommendation was you got to get in front of the members and they said alright, so what should we talk about? Well, they're just finishing a reserve study. And I said well, you know, if that there's an update, there's the financials, and she go over the reserve study with a membership, just so they understand how much it cost just to keep this place going on a year after year basis. Members don't know that, right? No, like that. They don't know so transference.

Speaker 1: 31:37

If you, your club or club you know might be interested in some recapitalization, head on over to concert golf partners calm to learn more. That's concert golf partners calm. Make sure you check out plenty of our other previous episodes of board chats where we dive deep into the world of private club boardrooms. Catch you on the next episode. You.