Finance for Short Term Leasehold Property in the UK

This usually, but not exclusively, relates to shops, public houses, restaurants, take-aways and similar, mainly retail type businesses. The underlying leases are short term and generally operate from just a year to 25 or perhaps 30 years with five to ten years being the most common.

The purchase of a leasehold business has always posed a problem for banks as there is no inherent value in the lease itself. If the lessee fails to pay the rent then title will revert back to the freeholder and thus in the event of default there is no value for the bank. Despite this, there is of course ‘value’ for the purchaser but in effect it is within the ‘goodwill’ of the business being acquired. Goodwill is an intangible asset of a trading business. The buyer of a business is often willing to pay for the "good name" of the business in addition to the value of its assets. Clearly, if the lessee has not paid the rent, then being in default at the bank is also likely. The good name of the business will also have been lost and thus of no real value. It is for this reason thank banks are reluctant to lend against a ‘goodwill’ value.

Consequently, the bank will consider this type of lending to be unsecured and thus rather than commercial mortgage finance it will be treated as a Business Loan.

Lenders are unlikely to provide any significant funding on an unsecured basis and thus in the absence of any alternative security, they will look for a very high deposit. Although there is no hard and fast rule most banks will be uncomfortable with lending more than £25-30,000 unsecured and many will do far less than this.

The banks attitude will depend on the sector in which the business operates, the experience of the owner in that sector, the level of cash contribution compared to their level of support and of course the trading performance of the business itself. All of these aspects (and more) will be taken into account when assessing the underlying risk and thus the attitude or willingness to lend. Certain sectors, for example, public houses, are considered to be very high risk since the number of business failures is extremely high in this sector.

The most common form of security (outside of the lease itself) that the banks look to is a legal mortgage [charge] over the owner’s house. This is quite often a second mortgage behind the principal lender (usually a building society). If lending to a limited company it is likely that personal guarantees from the directors will be required.

An alternative now is a loan under the Enterprise Finance Guarantee scheme where the Government will provide a guarantee to the bank for 75% of the loan.

This new scheme temporarily replaces the Small Firms Loan Guarantee Scheme, which has been suspended until March 2010. By that time, the government will have announced plans for the future. This new scheme (EFG) is similar to the SFLGS but somewhat broader. It consists of the following;

• Government will guarantee loans to 75%
• Loans have a lifespan of 3 months to 10 year maturity.
• Businesses must have a turnover of no more than £25m who find it difficult to access finance.
• The value of loans through the EFG will be between £1,000 and £1m.
• Bank fee 1.75%, Insurance premium (payable to BERR) 2% per annum based on the reducing balance.
• Overdrafts can be refinanced subject to the Bank continuing to make an appropriate ongoing working capital facility available – convert part or all of an existing overdraft into a term loan in order to release capacity in the overdraft to meet working capital requirements (subject to usual credit assessment)

It should be noted that just because the government guarantees 75% of the loan this does not mean that the bank will automatically lend 75% of the project costs. The starting point for the bank is would they make the advance if they had security - clearly there must be a positive answer to this question. Certain industry sectors are considered to be higher risk, for example, public houses, and consequently for that type of lending they may restrict their support to 50-60% of the costs. Each proposal is considered and assessed on its own merits.