Fixed assets are those items such as property and plant and machinery which your business acquires with the expectation of retaining and using over a period of years. As such they can be regarded as a business’s investments rather than working capital. Therefore funding for these long-term assets needs to be on a long-term basis.

It is important to note that the type of funding follows the use that the business is going to make of the assets, not the type of assets themselves. For example, a plant and machinery dealer will buy a piece of machinery, but this will be to sell it on in the short-term. It will therefore not become a fixed asset on their balance sheet, but will form part of their working capital as it is their stock. Their funding for this machinery will need to be flexible funding based on short-term requirements where the relevant assets will be changing from day to day. The security taken will need to be of a floating charge nature that allows the dealer to buy and sell the item without running to get the lender’s permission each time.

Contrast this with a manufacturer that buys the machine from the dealer. They may expect to keep it for a lengthy period, say three to five years; they can offer a fixed charge over the specific machine as specific security for a specific loan or other financing arrangement used to purchase it.

FINANCING FIXED ASSETS

While you can sometimes raise funding against intangible fixed assets such as goodwill or intellectual property (see mezzanine finance in Chapter 6 for example), or be able to borrow against the value of investments held in other companies, the principal fixed assets which you may need to fund are:

• property; or
• plant and machinery.

While talking about financing such assets it is important to remember that this can be a two-way street in that you may look to raise finance in order to buy such assets; but you may also use the value of such assets that you already own to raise finance for other purposes, such as further investment or to fund working capital requirements.

PROPERTY FINANCE

Some businesses, such as a hotel or a shop, may be based around ownership of a particular property which you may therefore need to buy in order to run the business. Other businesses may not be tied to a particular property, but may still want to acquire or expand the premises in which they operate.

If you want to own rather than rent, but do not have sufficient funds available to buy such a property outright, you will need to borrow money with which to do so, either through your business or through your pension scheme. The normal route to financing will be via a long-term commercial mortgage.

Occasionally your circumstances may mean that you will need to use short-term funding through a bridging loan to finance a purchase.

Pros and cons of buying commercial property

Buying a business property is a major step for any business and needs to be carefully considered. Many businesses see that their likely mortgage payments (on which the interest element will be tax deductible) will often be similar to the level of rental payments for a similar property. They therefore think it makes sense to buy a property, so as to ensure control of their site and not be subject to rent increases or landlord’s restrictions, while obtaining the advantage of any increase in the building’s capital value which might include any future planning gain involved in conversion of the site for housing use.

There are, however, many potential disadvantages of buying a property, as the other side of increased stability is a lack of flexibility. While you could possibly sublet any unused space in buying a property, you will have had to tie up a large amount of your capital in a substantial deposit on the building; funds which you might subsequently want to have available for other use in your business. You will also have a large loan which will need to be serviced over a long period. Also, if your business changes, expands, contracts or needs to relocate, it can be far harder to do so as the owner of a property that needs to find a buyer or a tenant for the business, as opposed to exiting a lease at an agreed break point.

Also many commercial properties increase in value at a much slower rate than domestic properties so the prospects of a capital gain may be much less than you expect, while since you are now responsible for the costs of maintenance of the property, any reduction in the property’s value will directly affect your balance sheet. Do not forget as well that if you take out a variable rate mortgage you will be exposed to increases in interest rates, which can change over short periods of time in comparison to rent reviews which will generally only happen on a five-year cycle.

Existing and developing ownership

Alternatively, you may already own a commercial property and wish to use these services to raise some cash. If you need to maximise the cash raised you can also consider a sale and leaseback arrangement.

In addition there are specialist funding products available for property development and these are covered in detail in Chapter 15.

COMMERCIAL MORTGAGES

A wide variety of banks, building societies, asset based lenders and insurance companies provide mortgages against commercial property. The monthly magazine Business Money gives tables showing the rates and advances available from the main lenders across a variety of sectors and is therefore an excellent starting point for identifying what is likely to be available for your business. These can be the building that you use in the business (known as owner occupied), or investment properties that are rented out.

This type of finance should be readily available in most situations. The issues that the lenders will look at, as with lending to an individual on a domestic mortgage, concern:

• the property’s value; and
• the loan’s affordability for the borrower.

Finance professionals tend to divide lenders in many areas of business into tiers. In the case of commercial mortgages for example, banks and building societies will be regarded as the top tier or primary lenders. Strong borrowers with a record of profitability, good cashflow, a healthy balance sheet and no problems with their credit history (known as adverse) such as County Court Judgements (CCJs) will tend to be able to obtain offers from the primary lenders at low rates.

Below these there are a range of secondary lenders, typically smaller operators who have a particular specialism or product. Finally there is the tertiary tier of lenders who may deal with cases with significant levels of adverse, or issues about profitability or lack of accounts.

As deals become more difficult, borrowers have to go down the tree to the secondary and then the tertiary tiers where rates become higher to compensate for the increased levels of perceived risk.

Property value

The amount of money you will be able to borrow will be determined first and foremost by the value of the property. While many providers advertise higher levels of loan to value, advances from banks are usually in the range 60% to 70% of Open Market Value (OMV) based on the security of a first fixed charge, where the lender’s charge has priority over any other secured lenders. Through a brokerage you may be able to raise 70% to 75% from specialist secondary lenders, with some on occasions going to 85%, although in practice advances of this level are available only to borrowers with a ‘clean’ five year credit history.

The property value used will normally be the current Open Market Value. When you own the building and are looking to take out a mortgage to raise cash, be realistic about how much the property is likely to be worth. If you have an unrealistic figure in mind you are simply going to be disappointed as the lender will always require an independent valuation before confirming any offer of funds. If the valuer reports a lower figure for the property than you have given in your application (downvaluing) then the lender will reduce the proposed advance accordingly. Where the property is rented out the lender and the valuer will be concerned about the rental income stream.

When buying a commercial property mortgage lenders will usually lend based on the lower of either the valuation or the purchase price, as they take the view that the actual sale price is always the real value of the property, whatever a valuer might say. This can lead to problems in circumstances where you are genuinely able to buy a property at a discounted rate or depressed value, perhaps as part of a larger deal. In some of these situations it can make sense to take out a short-term bridging loan as discussed below, and arrange to refinance again in, say, six months, since once you have owned a property for over six months many more mainstream lenders will then be able to lend based on a valuation rather than the purchase price.

Key issues that can affect valuations, and in practice therefore the speed and ease of raising mortgages as well as the sum available, include the following.

• Whether there are any environmental or contamination issues with the property. These can include items built into the property, such as asbestos often found in older industrial units, or underground oil tanks which may be seen as a threat to ground water, and can be surprisingly expensive to fill in and seal. Contamination issues can obviously also arise from the work that has been carried out on a site. Where heavy industry has been involved the risk may be easy to see, but some can come as a surprise. One site had been used after the Second World War for dismantling aircraft, with the result that part of the site was found to be contaminated with low levels of radiation from the luminous paint used on the cockpit dials. In another case, a paddock in West Midlands was described as fireproof as a result of a history of use in scrapping railway carriages with asbestos brake linings. If such issues (particularly asbestos) occur, at the very least you will be looking at a requirement for a specialist survey to assess the risk and cost involved. This is important as these issues can be real risks to you as a buyer (and to the lender in terms of the value of their security) as the existing owner can be held responsible for the costs of decontamination by the local authorities. So in the worst case you may have to meet the cost of clearing up someone else’s mess.

• Whether there are any party wall issues.
• The area – some lenders such as the smaller building societies will only wish to lend in their local area.
• The type of property and its uses where lenders will differ in the types of properties they will lend against. For licensed premises the breweries offer a range of specialist deals, while there are also specialist lenders in respect of agricultural land.
• The tenure of the property, which can be freehold or leasehold so long as the lease has sufficient length of time to run, which for most lenders means that the remaining term of the lease has to be a specified number of years longer than the term of the loan. Many smaller commercial properties such as rented shops are only held on short leases which mainstream lenders do not therefore regard as providing any meaningful security. But even here some specialist lenders do claim to operate.
• Whether any part of the property is to be used as a domestic residence for you or members of your family, as is common for example with many pubs and shops. Under the new mortgage regulations, loans which take a first charge over domestic properties are now regulated by the Financial Services Authority (FSA) and borrowers therefore need to have had advice from an appropriately regulated person such as an Independent Financial Adviser (IFA). This requirement is limited to properties where over 40% of the area is used for domestic purposes and, as the total area for this purpose can include external spaces such as car parks, in practice many pubs can escape this issue. This regulation can also crop up as an issue on other types of commercial loan if you give a personal guarantee which is supported by a first charge on your home. Loans supported by second charges over your home are not covered by this legislation.

Affordability

Unlike bridging, which is discussed below, most commercial mortgage lending is status lending, which means that it is based on assessing the borrower’s likely ability to make payments in future. Lenders will therefore want to check whether you appear to be able to afford both to service the loan, which means to pay its interest, and to repay the capital borrowed.

Their starting point is to look at your last three years’ accounts to check whether you have had both reasonable trading results and reasonable stability over this period. They will therefore be looking to see whether you have had:

• an overall profit in total over the three years;
• an upwards or downwards trend in the profit or loss over the period; and
• any catastrophic trading results in any one year.

If your business demonstrates a reasonable level of stable profits over this length of time the lender will be looking to move to the next step, which is to check that the level of profit is sufficient to cover the payments required. To do so the lender will usually arrange to add back into your profit and loss account a number of items such as depreciation charge, any interest charge on loans that will be replaced by the mortgage that is being taken out, and sometimes part of the directors’ remuneration, so as to assess the business’s underlying ability to generate cash with which to make the payments, and the ratio of this cash to the likely payment level. If you are applying for a loan through a broker they will normally request detailed information about your business’s costs in order to prepare a credit application (sometimes simply known as a ‘credit’) to put into lenders with this type of analysis already done.

Businesses with adverse histories

It may be, however, that your results show an overall loss over the period, or insufficient profits to meet mainstream lenders’ normal affordability criteria, or a catastrophic loss in a recent period, or perhaps you simply do not have accounts going back far enough to give the required history as you may be a start-up or relatively new business. While this means you are unlikely to be able to borrow from the mainstream primary lenders, such as banks and building societies, there are reputable second-tier lenders who will provide commercial mortgages on a self-certification basis of £50,000 to £2,000,000. This means that rather than the lender establishing that you are likely to be able to make payments by comparing your results with their standard criteria, you and normally your accountant will be required to sign a form confirming that you believe you will be able to make the payments. Since this is obviously a riskier proposition than lending to a business which has a clear track record of profitability, rates for such loans tend to be higher than more mainstream borrowings, but at present only by say 2% a year.

These lenders will also accept clients with significant levels of adverse credit who are assessed on a case-by-case basis. Again, to cover the increased level of perceived risk these lenders will load the interest rate, but at present often only by say 1 % a year.

So, while at the time of writing a strong borrower with a good credit rating might be able to arrange a commercial mortgage at say 1.5% over base rate, a business with no accounts that would have to borrow on a self-certification basis might pay 3.5% over base rate, rising to say 4.5% over base rate if it also has a history of CCJs or defaults on loans.

Since this type of secondary lender expects that borrowers then go on to generate reasonable profits, and will look to refinance at lower rates with more mainstream lenders, they will also often have early repayment penalties built into their contracts. A typical example might be a 5% repayment penalty in the first year, falling by 1 % a year.

Since borrowers dealing with these type of lenders often need quite flexible facilities, some of the lenders offer a variety of terms which can assist in budgeting for payments, including:

• fixed or variable rates of interest;
• initial interest only periods of up to three years to keep the first payments to the minimum;
• loan periods from ten to 30 years;
• the value of loan can be increased (assuming there is sufficient security and all payments have been met) once the arrangement has been in place for six months.

You can use a broker to obtain a no obligation, initial offer in principle of funding subject to valuation, usually within 24 hours. So if you are looking at raising finance you can obtain this type of offer by contacting your finance broker, or by photocopying the form in Figure 10, which is supplied by Creative Business Finance, and faxing a completed copy to the number shown.

Buy to let portfolios

Buying properties in order to rent them out has become a mainstream activity over the past few years, helped by the ever increasing availability of specialist buy to let loans based on the rental income that can be obtained from a property, even if it is not currently let.

The same principles apply as for normal commercial mortgages other than the following.

• On valuations, the valuer will be interested in establishing the market rent of the property, particularly if it is currently vacant.
• On affordability, lenders will be looking for either the existing rental income or the valuer’s estimate of market rental rates to give typically 125% cover of the loan payments at either the expected or a specified flat rate of interest on the loan.

Loans available run up to 25 years with a rate fixed for up to three years.

You may, however, have a portfolio of investment properties, which can be either commercial or domestic buildings that are let out to tenants. These may have been acquired at different points and using different lenders. Whilst this may mean that you have obtained good individual loans, typically on a buy to let basis for domestic properties, it can often mean that you have a fragmented approach to financing your portfolio. This can often then limit your ability to borrow more money against your existing holdings with which to expand your portfolio.

It can therefore make sense to try to consolidate your borrowings with a single lender, as some of the specialists in this field can provide you with a pre-approved line of funding, using the security available across the whole of your existing portfolio at up to 85% loan to value, to provide you with a forward buying facility with which to acquire properties. The lenders providing this type of service can cover portfolios of up to and above £5m, either for individual clients or limited liability companies, with no limitation on the number of properties involved.

The information the broker will need to explore whether there is scope for generating this type of facility is summarised in the form in Figure 11.