We have both been businessmen, financial professionals and financiers over the course of our careers, so we are very familiar with the use of debt in a corporate setting. As it turns out, even that considerable knowledge and hands-on experience did not prepare us when we took on the role of private club board member. We found out quickly that we had a lot to learn about the use of debt in the private club setting.
There is a common thread between the two environments—in either setting, debt is unforgiving and must be used judiciously. This is particularly true in the club industry where short board terms, inadequate leadership succession planning, limited orientations and frequent management turnover can frustrate the consistent implementation of plans.
In the club world, once debt has been introduced into the cost structure, it demands a disciplined approach to governance and financial management across multiple administrations. The costs are fixed and sit at the top of the annual payments to be made. When it comes to debt, clubs must consider the amount to borrow, the amortization period, the lender with whom you will partner and the fees and costs in addition to the interest rate. Missteps and oversights can hamstring future administrations in their decision-making options and in doing so commit the club to a protracted downward spiral. That said, debt used judiciously can be an effective financial tool in the private club setting when the following financial best practices are applied:
- Develop a long-term financial plan for operating and capital funds that supports strategic, facility and reserve plans. Build the plan forward in rolling increments of at least ten years. Update it annually and communicate the plan to the membership as part of your annual meeting.
- Segregate and meticulously manage distinct capital and operating funds. These are two “checkbooks” that must be planned for and managed separately.
- Fund the plan, not a project. Plan your funding to ensure the success of an all-inclusive long-term financial plan that will include multiple projects over time. An integrated financial plan projects operating and capital funds simultaneously.
- Establish and plan capital levies (initiation fees, capital fees, special purpose fees, transfer fees, etc.) that equal or exceed annual depreciation (or the long-term needs projected in a reserve study, if available), any deferred maintenance plus transformative aspirational capital spending. If debt is to be employed, be sure there are additional provisions in the plan for a source of funds to extinguish the debt. Normal annual CAPEX needs do not go away. Members must be willing to pay more to get more. The costs cannot all be placed on the assumption of new members and inflated census counts.
- Limit debt amortization periods to no more than 10 years. Anticipate there will be another major project coming along in 7-10 years and position that future administration to face that project with a clean slate. It is important to remember that capital needs are nearly insatiable and maintaining, updating, and transforming the facilities to meet changing tastes and requirements of new and existing members is “Job One” for the board. Club leadership is characterized by long days and short years. Plan ahead!
- Understand your debt capacity. How much would your members spend if asked to pay through an assessment? Debt should not disguise that underlying decision.
- Run a competitive RFP process to acquire the best rates and most appropriate terms. The debt package will have long term ramifications to the club that must be well-understood up front.
For clubs that are considering debt as a component of their capital mix, we offer some lessons learned through our combined experiences in the worlds of corporate and private club finance:
- Seek a fixed rate loan without a SWAP agreement. SWAPs are complex and can increase closing costs and be difficult and expensive to unwind.
- Avoid prepayment penalties.
- Minimize closing costs.
- Negotiate a negative pledge in lieu of a mortgage. It will save closing costs, appraisal, legal and other fees that can otherwise reach six figures and may be less contentious among members.
- Limit the scope, cost and ramifications of environmental reviews and be aware that any surprise findings may need to be addressed even if you do not go forward with the loan.
- Amortize the loan over a period of no more than 10 years and avoid balloon payments.
- Be sure Debt Service Coverage Ratios are based on changes in Members’ Equity or Unrestricted Net Assets, not the more typical above-the-line operating income used by lenders in non-club settings.
- Do not forget to consider the annual costs of the operating accounts. This is especially important in periods of ultra-low interest rates as banks levy all sorts of subtle fees to counter those low rates. Provide potential lenders with six months of recent statements for all accounts they require on deposit and have them project the associated fees.