TYPES OF BORROWING

Overdrafts

An overdraft facility is a service provided by banks whereby they allow you to borrow money up to specified limits. They are useful for covering short-term, cash-flow shortages. As well as the interest rate charged on the overdraft, a fee may be payable too. Interest rates tend to be higher than standard bank loan rates, so borrowing using this method over a long term is likely to cost more. Penalties will be charged if you exceed your overdraft limit, which can be costly.

Loans

Loans are available from banks and a wide range of other lenders. Small loans can be obtained on an ‘unsecured’ basis. This means that you are not required to provide any form of security for the loan. If you have a good credit rating, small loans can be quick and easy to arrange and many lenders do not require you to confirm what you will be using the money for.

Larger loans, typically over £ 20,000, may need to be secured against one of your major assets, such as property etc. This means that the lender can sell the asset you have used as security if you fail to repay the loan. Lenders will want to know what the money is to be used for, and require business plans and verified accounts where possible. There will be limits to the amount they are willing to advance you. You may be required to match the amount of their loan with money of your own. Arrangement fees normally apply to setting up your loan.

Many lenders will not be willing to offer loans to fund ingoings for tenancies or new leases, because there is no opportunity of them securing the debt, and there are no verified accounts available.

Commercial mortgages

Commercial mortgages can be used to buy freehold pubs. They are similar to residential mortgages, though tend to carry higher rates of interest to reflect the increased risk to the lender. Like residential mortgages, there is a number of different schemes available and interest rates can be fixed or variable. Mortgages tend to be arranged for a period of between 10 and 25 years and lenders secure the debt with a charge on the property. If you fail to keep up payments, they can use the property to recoup their money.

As well as banks and building societies, a number of brokers can advise you on the options available to you. Set-up fees will be charged on any arrangement and can typically be 0.5–1% of the loan amount. The property will need to be professionally valued and there will be a valuation fee to pay for this. The mortgage may include an early redemption penalty where you would have to pay a fee if you settled the loan earlier than planned.

Lenders will consider loans of up to 70% of the purchase price of the pub, leaving you to cover the balance and other costs connected with the transaction.

Lenders will require 2 years’ verified accounts, profit and loss and cashflow forecasts, and a comprehensive business plan. They also need to have confidence in you personally, and will check your credit rating, assets and liabilities, and track record.

Brewery loans

Brewery loans can be used to purchase freehold pubs. Loans are usually arranged by the Free Trade department of a brewery, and can run for up to 10 years. Interest rates vary according to how much drinks products you buy from them. The brewery agrees to lend you an amount of money in return for you agreeing to sell some of their products. They may require the security of a charge over the property. You pay the full list price for the products you buy from them, and the discounts you earn are used to repay your loan. (As a free trade customer without a loan from them, they would normally deduct discounts from the list price or pay them directly to you, periodically.)

There are limits to how much a brewery will be willing to lend you. A normal limit would be based on the ‘forced sale’ value of the freehold pub. In this case, the brewery may only be willing to advance you up to 80% of the forced sale value of the pub. This being the anticipated selling price of the pub if the brewery had to sell it closed and quickly, to recover their money. Because the loan is repaid through discounts on the products you buy from the brewery, the amount of products you are anticipated to buy also determines how much they will lend you. On average, they will lend £ 300–£ 350 per barrel.

The brewery is mainly motivated by the amount of beer it can sell and the anticipated barrelage will be the primary means of assessing the pub for lending purposes.

Using brewery discounts to add confidence to lenders

Aside from borrowing money from a brewery, their discounts can be used to support loan applications to other lenders. In this case, you would look to borrow money from another source but agree, as part of the terms of the loan, that discounts earned from the brewery would be paid direct to the lender to help repay the loan. This may help to encourage a lender to loan you money where they have some concerns about your application, as it reduces their risk. Similar schemes, where the brewery agrees to pay a contribution towards interest payments from other lenders, have also been used to help raise finance. While such arrangements are not popular practice, it is worth discussing these with your Free Trade representative.

Using equity in your home or other property

Where you have a home or other property that you intend to retain, you can raise money via a residential mortgage arrangement. This will be subject to having sufficient equity in the property on which to secure the loan, and valuation of the property will also be needed to establish this. Decisions to use your home to raise money should not be taken lightly, and professional financial advice should always be sought before going ahead. If you fail to keep up payments, you run the risk of losing your property as well as your business.

There is a number of different ways of mortgaging your home and these are discussed below:

• First mortgage: where you own a property outright, a lender (mortgagee) may be willing to lend you up to 95% of the value of the property. They will secure the loan via a ‘first charge’ over the property. This means they are first in line to recover any outstanding money by repossessing your property, if you default on the mortgage with them.
• Further advance: an existing mortgagee may agree to increase the amount of their mortgage in order to advance you more money.
• Second mortgage: another lender may lend you money via a second mortgage and take a ‘second charge’ over your property. They become second in line, behind the first mortgagee, if you default on your mortgage with them. The second mortgage will be dependent on there being sufficient equity in your home. (See section, ‘Using your property as collateral’, below). The interest rates are likely to be higher than for a first mortgage to reflect the lower security available to the lender. Third and fourth mortgages are possible where there is sufficient equity in the property.
• Re-mortgage: this is where a new lender is brought in to clear an existing mortgage or other borrowings. A new, first mortgage is created over the property and other charges over the property are cleared.

As in the case of commercial mortgages and other forms of loan, there is a bewildering range of mortgage products available and obtaining specialist advice is recommended.

Using your property as collateral

Homes and other property can be used as collateral for other types of borrowing. This is where the property is used as security for a loan. Again, you risk losing the property should you default on payments. To use a property, there must be sufficient equity on which to secure any debt. To calculate the amount of security a property offers, the lender will normally take 80% of the property value, less any outstanding mortgages. An example of this is shown here:

Loans from family and friends

Family and friends are another potential source of finance and many businesses have been supported in this way. The advantages with these sorts of arrangements are that they know you and (it is hoped) have confidence in you and your business plan. Lending arrangements may be more flexible in terms of interest, repayments and security.

Borrowing money from family and friends can cause difficulties too. Relationships can be damaged if you are unable to repay the loan. You may also find that there is pressure from them to become involved in the business, which you may not want.

When borrowing money in this way, it is best to take a professional and businesslike approach. Put any arrangements in writing, confirming repayment details and rates of interest, plus what is to happen if the loan is not repaid, and whether the lender is to have any involvement in the business. Both parties should sign the document and each hold a copy.

Brewery and pub company support for tenants and new lessees

Breweries and pub companies offer a number of ways to assist people wanting to take a tenancy or new lease with them. Purchasing the fixtures and fittings tends to be the biggest expense when taking on a pub. They often offer fixtures and fittings repayment plans to pay for the cost of these over a period of time, rather than up front. Some are willing to spread the cost of these over a period of several years, but will charge you interest for this facility. Others are happy to defer payment for several months until you have established yourself and started building up the business.

There may be opportunities to build up your deposit with them over several months too. They may well allow you to trade on a ‘cash with order’ basis with a small deposit, and transfer you to credit terms once they hold a substantial deposit for you.

Many breweries and pub companies have links to lenders where preferential terms are on offer to new tenants and lessees. These can provide an opportunity to help fund the cost of your ingoing.