When Purchasing Assets of a Health Club, Plan for an Orderly Succession

When purchasing the assets of a health club, make sure to plan for an orderly succession.

Photo of hands passing a key

Many of the tasks the buyer of a health club must accomplish upon taking ownership will sound familiar to anyone who has moved into a new house or apartment. Insurance must be purchased, telephone and utility services must be arranged, the locks need to be changed. Other important items on this enormous to-do list speak to the specifics of business ownership - open a bank account, obtain all necessary licenses, arrange for electronic funds transfer, print up stationery and business cards, review equipment leases.

The most important task, though, is far more important, far more complicated - and ignored at your peril. You must work with the seller to ensure a smooth transition of ownership, something that requires intensive negotiation, communication and planning skills.

"There are things the new owners can ask the old owners to do to help facilitate the process, and each step in the process raises questions that need to be addressed," says Rick Caro, president of New York-based health club consultancy Management Vision. "Good owners will come in with a checklist and make sure all their bases are covered."

When a transition goes sour, it can only hurt the new owner. After all, in most cases the old owner is selling because he or she is "not a poster child for the industry - they were doing okay or worse," as Caro puts it. It's the new owner who is often left to deal with the member complaints and financial fallout that can ensue.

The new owners of Hamburg Fitness Center and Camp in Hamburg Township, Mich., missed their chance to get the help of the previous owners during this February's transition. The property's 82 acres (six of which serve as the location of the health club) had been operated by the court trustee-hired Southeastern Livingston County Recreation Authority since the former owners' July 2007 bankruptcy filing. This disconnect from the previous owners, as well as the spotty recordkeeping uncovered in the club's antiquated computer system, made evaluating the club's true financial condition difficult. (A bargain-basement price brought on by the real-estate collapse helped mitigate the risk.) It was only after the three new owners (two of whom were members of the club) began repairs and studied the cash flow on a day-to-day basis that they were able to identify a primary source of the revenue shortfall: 740 people who had paid the previous owners for long-term memberships of between one and four years, many of which were found to have been purchased after the company filed for bankruptcy protection.

In a March announcement that the club would stop honoring those prepaid memberships beginning April 1, Tom Rau, one of the three owners, explained it simply: "They have been using the gym at no revenue to us," he said. "Their issue is with the former owner, not with us."

"We had a lot of options," Rau says now. "One of them was to just close the doors, reopen in a month, make everybody pony up the money, and run the club as a totally new operation. But we didn't want to do that to all the holders of shorter-term, three- and six-month memberships."

Anticipating some backlash, Rau and his partners offered an additional 20 percent discount to past prepaid members on top of the 10 percent discount incentive for new members, which he says was accepted as fair by the majority of members affected. Still, the reaction from the outraged minority was swift and loud. Initially hailed as community heroes and "savvy business owners" for their purchase of and investment in the property, the three were subsequently pilloried in the press and online, as a handful of irate members began agitating for a class-action lawsuit.

"We tried to buy just the club portion of the property four years ago, and we approached it the way you normally would, with the purchase price adjusted to reflect the value of the locked-in memberships," Rau says. "But the owner couldn't separate out the club for various legal reasons, and we eventually bought it in bankruptcy court. Ordinarily, it's a fairly simple transaction."

In Caro's experience, many incoming owners fail to fully comprehend certain nuances of even simple-seeming transactions. For example, he notes, there are actually four different classes of people who will give money to or receive money from the club throughout the transition, and all of those dollars will have to be accounted for during the negotiation between the seller and buyer.

Members come in two categories - those who pay monthly dues and those who hold prepaid memberships - and the revenues are typically prorated depending on the time of the sale closing. Dealing with prepaid memberships, Caro says, involves many facets.

"A smart buyer will take into consideration how many months are left on each prepaid membership, and at what average monthly price, and theoretically negotiate dollar for dollar, or something close to it, some kind of offset if he is going to service those people," Caro says, noting that buyers purchase a club's assets but not its liabilities. (The sale of Hamburg Fitness Center and Camp involved the land, building and its contents, and did not include any requirement to honor past memberships.) Caro adds that the buyer's future intentions with regard to capital upgrades will affect the manner in which current members' dues are handled. If members pay $20 a month, and the buyer intends to make significant improvements to the club and charge $70 a month, the value of what the seller considers a prime asset - the current membership list - is likely to be of much less value to the buyer, depending on what percentage of those members he or she thinks can be converted to higher-grade memberships after the sale.

Regardless, Caro says, all of this - who will receive what share of current dues and when, who will repay customers the pro rata share of their memberships that are no longer valid, and countless other permutations - must be spelled out between the parties and communicated to the members.

"What some clubs do is set up a dedicated phone hotline with an answering machine on it so any members with a question about what they're owed or how the transition is going to work can get an answer, and maybe there's an arrangement where the seller accesses the hotline for 30 days, clears up all the questions, and collects accounts receivable," Caro says. "There's going to be some element of the buyer and the seller working together so all the money due goes to the right party."

Similar transactions will take place involving the other two groups of people with a vested interest in the sale - staff members and vendors. Communication with staff is vital, since they too will have pending business with the owners, old as well as new - some staff members will be owed vacation time or incentives, for example, and some will be in the new owner's plans while others will not. A process needs to be put in place for dealing with them all, and it needs to be explained to everyone in advance of the sale. A common scenario has all staff members reapplying for their jobs, so the buyer must have access to all records and a dedicated space in which to conduct interviews and tie up each employee's loose ends.

Vendors, the last group, won't be a large part of the negotiation, since all outstanding bills are the seller's responsibility. But there is still the matter of existing inventory (will the outgoing owner make existing club supplies available to the new owner, and at what cost?) and the future relationship that the new owner hopes to have with the vendor.

"The sellers should send a note out indicating that as of a certain date they will no longer be the owners, so that any bills that come after that date are the responsibility of the new owners," Caro says. "Hopefully, they'll pay all their debts, but you're kind of at their mercy moving forward. If they decide to screw the towel guy or the local printing company that printed their flyers, that's their call, but the new owner may have trouble developing relationships with the same vendors."

Buyers (or their banks) usually insist that a percentage of the sale price be placed in escrow as a contingency to cover certain obligations of the seller that for whatever reason must be dealt with after the closing. "You don't want to have a responsibility of the seller impinge on the future business of the buyer if it can be avoided," Caro says.

Active communication will go a long way toward avoiding the rancor that can develop among members, staff and vendors whose routines (and, in some cases, finances) have been affected by the sale.

But not everyone will be happy with the change. "We wrote a letter that said we didn't know what the total financial situation was, and that it was going to take a couple of months to measure the viability of the club," Rau says. "We told them up front that we'd probably have to make adjustments in the future. When the future came, some people didn't like it. But we're doing fine. We're experienced business guys."