In what I fear may be the least anticipated sequel since Sharknado 5, the second part of this blog looks at two real world scenarios, taken from recent transactions in the hospitality sector, that illustrate the flexibility of the BVI’s corporate code and why it matters for investors in this space. Both are based on transactions which we recently completed, but with names and certain details changed to protect client confidentiality.
In choosing an investment vehicle/portfolio holding company, basic requirements for any PE fund are likely to be limited liability, tax neutrality, ease of exit and reasonable maintenance/set-up costs (which the BVI also scores highly on…). While a flexible, modern corporate statute is inherently a good thing, it may not matter so much if there is a straightforward ownership structure with a single class of shares (eg a single wholly owned subsidiary, or even the classic real estate OpCo/PropCo structure).
However, much of the hotel industry is not set up this way, which is where the flexibility comes in handy. The average tourist would have no idea how many of the hotels which they’ve stayed in and which proudly bear the name and logo of an international hotel chain are actually (at least part) owned by a private equity firm (which, as it happens, also own a lot of the major brands too). Although some PE firms have the expertise to manage their own hotel investments, this arrangement can suit them perfectly, allowing them to share the risk, take advantage of the branding, and let the professionals handle day to day affairs (for a fee). It can also suit both parties for the operator/manager to take an equity stake and create a true joint venture.
At the other end of the spectrum, there are the boutique hotel chains, who may only have one or a handful of properties before looking for capital to drive expansion, but who (understandably) want to retain a share in the business and stay true to their creative vision. Again, they might find a PE firm who is happy to co-invest and run the business as a joint venture.
Any time a PE firm (or any fund) is investing in a company in which it will not be the sole owner, a key concern is ‘control’. This can mean many things: day-to-day management, board supervision, shareholder voting rights or veto rights over certain matters. You might think that more control at every level is always better, but having ‘control’ can also have (non-BVI) regulatory, legal or tax consequences which may not be desirable, as in these two situations:
Scenario 1 – Client 1 is the owner of a small hotel chain, looking for a financial partner/investor to come in and provide capital to support the expansion of the business, but wants to retain day to day control. A potential investor is found, but under rules imposed by regulators in its home jurisdiction the investor is required to have a ‘controlling interest’, even though they trust the existing management and are happy for them to have de-facto control.
Scenario 2 – Client 2 is a professional hotel operator/manager. A hotel which they manage (but do not own) is in financial difficulty, and they want to provide a capital injection to prop it up. For various reasons, equity is preferable to debt, but this time, they are keen not to have ‘control’ (for non-BVI purposes related to local land ownership rules and tax treatment). Despite this, the client needs to ensure that their investment is adequately protected.
In the first scenario, the first thing to figure out was what level of ‘control’ was required by the rules that the investor needed to comply with. It transpired that this was a majority of the shares, and the right to appoint a majority of the directors. Client 1 agreed commercially that the investor could have 51 per cent of the shares, but the director point was trickier. We arrived at a solution where investor would have the right to appoint a majority in number of the directors (which right was enshrined in the company’s constitutional documents as well as the shareholders’ agreement) but covenanted contractually that unless certain events occurred, one of their appointees would at all times be a certain, specified individual. Who just happened to be Client 1.
In the second scenario, Client 2 ultimately took preferred shares with a cumulative return and negative (veto) control rights, and a board seat which was in the minority, but with enhanced voting rights for certain matters. To protect their position if it all went pear shaped, Client 2 took a BVI share charge over the ordinary shares (obviously common for debt financing, but extremely rare for equity) and a signed but undated resignation letter for the other directors. This means that if the need to intervene directly reached a stage where it outweighed the reasons to avoid control, they could quickly get to a position where they held a majority of the shares, and controlled the board.
Every JV is different, and these were specific issues that we may never encounter again. We also happened not to act for the PE firm in either scenario (although we’ve sat on that side of the fence on several other deals this year), but we think these two do illustrate the wonderful world of hotel joint ventures and the complexity that can be thrown up. Best of all, from our perspective, they show that working together with onshore counsel it’s possible to use the BVI’s progressive corporate laws to develop innovative, tailored solutions to almost any problem.
So the next time you are kicking back and enjoying the delights of a stay in a fancy hotel, do raise a small drink to the wonders of the legislation in the BVI that allowed the hotel to put the extra olive in your martini glass.