Investment ownership rules make for a healthier purchase

It's always struck me how often ownership disputes lead to operational difficulties, litigation and even induced property sales. This is in addition to the chronic cases of heartburn suffered by all, except the lawyers, during times of financial distress in the investment. These problems often seem to occur because buying groups tend to be more focused on the time-urgent due diligence and finance matters surrounding an acquisition than with a rigorous discussion of partnership governance subsequent to take-over.

The purpose of this column is to mention a few ideas that might improve the governance and ongoing financial health of your next hotel purchase. The two matters that seem to cause the most unhappiness among partners are the challenges that occur when investors aren't aligned in agreement with the policies of the managing partner, and when cash calls are required.

Of course, one of the most obvious ways to finance necessary business needs is an equity capital call amongst the partners, but all too often, no one answers the door when the postman comes with that letter. This situation can cause a lot of stress and disharmony, as some investment partners think it's wise to invest fresh capital in the business while others don't--or won't. Here are some ideas for you to consider when negotiating the issues of decision-making, general partner governance and cash calls in your partnership agreements.

* Decision-making: Generally, a partnership or a limited liability corporation will have a managing partner responsible for its affairs. The power of that manager to make major decisions (sale, finance, cash calls, change of management) usually is accompanied by the need to get a simple or supra-majority vote of the other partners before an important action is taken.

Often, investors feel safer if a voting supra-majority of, say, 70 percent to 100 percent of the ownership group is required before major decisions may be implemented. Often, rather than protecting the minority investor, approval percentages much beyond 60 percent can lead to obstruction by the minority to the detriment of the investment. Speaking from personal experience, an ownership group should be able to make major decisions with the concurrence of the managing partner and 51 percent to 60 percent of the investment group.

* Changing the general partner: Managing partners owe a greater responsibility to their investors than to themselves. However, this basic fact of law somehow gets lost in the shuffle until it's brought up in court, at which time the investment often has suffered great harm. I'd suggest that investors should have the right to replace a general partner if two-thirds to three-quarters of the investment group decides to do so. The general partner may well be entitled to a termination payment for his or her years of service, but that's a subject for another day. The basic point is that a managing partner should be able to be voted out of power.

* Cash calls: Usually, everything goes hunky-dory in a business investment until fresh equity capital is required for business needs and the call goes out for everyone to send in more money. Then, the fur starts flying, the dissembling begins, and the real life immediate needs of the business collide with foot dragging by some of the investors who might be unwilling or unable to meet a cash call. What happens in such cases?

Usually, there is language in the partnership or operating agreement that allows other investors to lend money in, at a reasonably high interest rate, against the non-paying partner's future income stream. I think that is too soft because we must remember that high-risk money is being advanced. I've come around to the point of view that a partner not meeting a cash call on a truly time-is-of-the-essence basis should have his or her back placed against the wall in order to induce quick action, rather than create problems for other partners by not timely contributing his or her fair share. It is the overall investment that is placed in jeopardy, so the noncontributing partner should be made to face a very stiff penalty.

Perhaps the immediate loss of one half of his or her investment each time a cash call is made that goes unanswered would get the attention of a partner slow to send in money when a cash call goes out. I understand that the inclusion of such a clause is an anathema in the eyes of a prospective investor, but it should be explained that a split partnership situation in the case of unanswered future cash calls puts everyone's entire investment at risk. If a potential investor balks at the inclusion of such language, you might want to look for another investor.

hmm@advanstar.com

Jeff Wilder is president of Wilder Ventures LLP, a New York City-based asset management company, and an adjunct professor at New York University. E-mail him at jswilder1@aol.com.

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