Budgeting for Survival
About 20 years ago, the idea of getting into the “fun
business” was pretty straightforward. The concept of course,
was to locate a site, acquire some key attractions, and let
the merits of the business sell themselves. While the general
principles remain the same today, the way that we get there
has changed dramatically. For starters, the costs of entering
the industry have increased exponentially, with raw development
costs often exceeding $200/foot. This high price of entry leaves
little room for error and demands that every dollar be spent
with an extra degree of care and responsibility.
When Development Budgets Fail
If there’s one thing I’ve learned about the development
of entertainment venues, it’s that the budget is truly
a moving target. The official budget is never really known until
the last coat of paint dries and the site is deemed operational.
What might have looked good on paper two years ago can prove
to be severely upside-down when executed in present day dollars.
Rising real estate prices, changes in market rents, escalating
construction costs, and weaknesses in local economies can all
contribute to cost overruns. When a project gets into trouble
before completion, both the lenders and investors often lose,
as there is generally no marketable product to sell, and often
no capital remaining to access.
Recently my firm has been assisting a regional bank with
a failed entertainment center project. The project, which
was originally budgeted to cost $5. million to build, has
swelled to $75 million and is only 85 percent complete. The
principals have exhausted their own equity funds and the lender
is reluclant to furnish additional capital for completion.
The main culprit appears to be the under-budgeting of construction
and site improvement work, as the original development estimates
had been prepared nearly two years earlier. In this case,
neither the lender nor the developer had anticipated significant
changes in local pricing, nor had the developers re-confirmed
their line item budget prior to construction. In essence,
negative changes in the budget were allowed to mushroom uncontrollably
without a clear understanding of how such overruns would he
funded down the road. Finally, with all bank-issued construction
funds extended, development at the site came to an abrupt
halt.
Tips on Budgeting
When it’s time to establish a project budget, one of
the first steps should be the creation of a protect timeline.
The timeline serves as a benchmark for gauging changes in
economic costs, particularly for projects whose development
length extends more than twelve months beyond the budget’s
creation. A “timeline budget” is intended to accept
cost changes resulting from general economic factors, including
adjustments to the consumer price index (CPI), changes in
interest rates, and appreciation of real estate. Quotations
for the purchase of attractions, ancillary equipment, and
general supplies should be updated every six months, with
confirmations obtained in writing from the appropriate manufacturers
or distributors. Time is the enemy for every protect, as changes
in raw materials and energy prices often affect the price
of just about every other item purchased.
I often hear the phrase “budget high” when chatting
with new developers attending industry seminars. While the
philosophy of doing so would appear sound, a high or inaccurate
budget may paint the wrong performance picture for potential
lenders. Instead, an ideal goal would be to establish a “verifiable’
budget - essentially a budget with backup. All future purchases
would be hard quoted, with the quotes serving as an addendum
to the actual budget. Now, lenders and developers alike can
find comfort in the budget process by reducing the number
of unknowns, and more importantly, the number of cost overruns
that can occur along the way.
To Bond or Not To Bond?
If you intended to build a structure to house your new entertainment
project, chances are that you’ll need a qualified general
contractor to coordinate the details, In the construction
business cost is secondary to follow-through, as a half-completed
project is infinitely worse than the premium price often associated
with a reputable contractor. When a project fails due to poor
contractor execution, theft are often other consequences to
the developer including significant time delays, additional
interest carrying cost, unacceptable jobsite work that requires
remediation, timing and availability of a qualified replacement
contractor, and increased costs to complete the project. That’s
a lot of variables to juggle, particularly when time is working
against you.
One alternative is to insist upon the use of a bondable contractor,
recognzing of course that you’ll be responsible for
the added bonding fee. While the bonding process will add
cost and possibly limit the supply of contractors deemed suitable
for the project, it will provide a significant level of security
to the developer, as contracted costs will remain tied whether
or not the initial contractor completes the job. Bonding the
project may prove to be a requirement of your lender as well,
as few bankers wish to find themselves with a half-completed
project and a non-performing loan,
Two Sets of Eyes Are Better Than One
Creating an entertainment venue budget can be a daunting affair.
My firm routinely reviews budgets prepared by new developers,
and commonly observe omissions and assumptions that might
not prove true in the long run. Most budgets fail to adequatly
account for financing originatioun costs, early stage payroll,
pre-opening expenses (utilities, real estate laws, water and
sewer charges, engineering and for architectural fees), and
legal services. When costs such as these have not been appropriately
allocated in the early stages, the result is often a shortage
of the most critical element — advertising dollars -
at the most critical time. Advertising and promotion might
be the easiest budgeted line item to pull funds from, but
will often prove the most dangerous to the future business
enterprise.
As a matter of course, have your budget reviewed by a number
of parties, including your accountant, industry professional,
and even an experienced entertainment developer. By doing
so, you’lll be better able to access the strong and
weak areas of your plan long before entering the point of
no return. Better still, your financial package will stand
up to the scrutiny of bankers and investors alike and provide
you with a greater sense of confidence as you enter each phase
of development. You only have one opportunity to do it right;
what better place to start than with a budget that works.
|
