Philippa Jones takes a look at why it has become harder for those in the fi t-out industry to obtain credit, and looks into some of the options presented.
The 2007/08 credit crunch originally started in America and quickly affected global markets, including the UK economy.
The crash was the product of defaults in the once buoyant sub-prime mortgage market. The fund shortages which followed resulted in UK businesses being forced to make sharp economic choices because interest rates rose as a way to compensate lenders for taking on additional risks. A well-known casualty of the credit crunch was the UK bank Northern Rock.
Parties in the construction industry were forced to make strict commercial decisions owing to a restricted supply of credit. Today the effects of the credit crunch are slowly easing. However traditional credit has become more diffi cult to obtain from leading lenders such as banks who have become overly wary of lending funds to individuals and corporations.
Fortunately, alternative providers have recognised the needs of the market and sought innovative fiscal ways of providing credit whilst maintaining low interest rates.
How the fit-out industry is viewed
So how do credit providers view the fit-out industry?
Recently banks have become less willing to loan to the fit-out industry. This has opened up a market for alternative lenders to provide competitive lease fi nance for entire fi t-out projects ranging in value from £1,000 to £10,000,000 on repayment terms between one to seven years.
Such lending agreements are termed ‘asset fi nance’.
Credit options available to members’ clients
Generally businesses who want to carry out fit-out works to their commercial premises will choose one of three options:
1. Paying cash out of capital reserves.
2. Borrowing a bank loan.
3. Leasing the fi t-out project which is ‘asset finance’.
What is asset finance?
The asset finance industry is worth an estimated £32billion a year in the UK and is growing at a rate of roughly 5% per annum. While nearly all companies will lease something in one way or another (vehicles, mobile phones, even coffee machines), an ever-growing number of businesses are funding their fi t-out projects with asset fi nance which has led to an increase in suppliers offering fi nance options.
In simple terms, the funding arrangement involves an asset fi nance provider (lessor) purchasing the asset on the business’s behalf, therefore shouldering the upfront costs of the fitout, and in turn the company (lessee) agreeing to lease or rent from the finance provider for regular usage payments.
Asset finance is suitable for all business structures including limited companies, sole traders, limited partnerships and public limited companies.
The term length is determined by how long the lessor is willing to allow for repayments to take place. This is usually calculated on the acceptable level of risk and profit/interest allowed by a particular provider.
What drives choices?
Borrowers’ choices can be driven by factors such as:
1. Significant tax benefits: Leasing products such as office furniture during a refurbishment project can make the repayments deductible against taxable profits in the year the expense is incurred.
2. Fixed payments for accurate budgeting and forecasting: Unlike other methods of finance such as floating rate loans and overdrafts, when leasing, payments are fixed for the duration of the lease period. This allows the parties to budget efficiently with certainty.
3. Getting the right solution today. By spreading the cost of a fit-out project over several years rather than through a lump sum, parties can obtain a solution that fully meets their needs now in a flexible manner, rather than being restricted by their capital budget.
4. Preserving future borrowing power: Leasing means parties preserve their existing bank credit lines, without compromising future working capital, allowing them to draw on credit in the future.
5. Turnkey funding: Fit-out and furniture costs can form part of the lease from planning to design, partitioning, ceilings, furniture, flooring and more.
How the process of getting credit has changed
Ultimately, changes in the market place have shown traditional lenders such as high street banks and financial institutions are less willing than they once were to lend to the fit-out industry. As a result of being unable to secure funds using conventional methods, many businesses have decided to draw down on cash reserves to finance projects.
Asset finance has established as an alternative method available to parties wishing to complete a fit-out project. Various non-traditional providers offer leasing options to the construction industry
depending on needs.
Legalities to consider
Parties evaluating their finance options should consider:
• Any tax benefits to be gained from their financial arrangements
• The effect of the economy fluctuating on interest rates
• Risks associated with ownership and
• The repossession rights in the event of default.
This article is intended to give a general overview of possible credit options available to clients of FIS members and does not constitute financial advice in itself. As with any financial product, members should obtain independent legal advice before choosing credit options.
Advantages and disadvantages of using cash to fund fit-outs:
• All assets bought belong to the company from the outset.
• Once paid, there are no ongoing repayments to budget for.
• Depreciation deductions can be considered on assets.
• Annual investment allowance (AIA) can be claimed to the value of £200,000 per financial year.
• The cash flow can be left vulnerable by tying up capital in assets that tend to depreciate quickly.
• AIA does not allow parties to offset payments against taxable profits.
• Limited budgets can restrict the scope or quality of the fit-out.
Advantages and disadvantages of a bank loans to fund fit-outs:
• Parties can plan repayments over the term (usually between one and 10 years).
• Repayments can be tied in with the lifetime of the assets purchased with the loan.
• There is no requirement to give the lender a percentage of the profits.
• This option is not very flexible. For example, parties may be charged for repaying early and may have high interest rates associated with overdraft and commercial loan products.
• Risks are posed if the loan is secured against personal property or assets repayments are subject to fluctuations in interest rates.
Considerations when leasing to fund fit-outs:
1. Monthly regular payments can be planned as part of expenditure, along with rent meaning the costs can be spread in line with the investment return which improves cash flow.
2. Borrowers can decide the term and frequency of payments according to business needs, typically a lease would be spread over three to five years, thus it is not a short-term arrangement.
3. Agreements can cover all costs, including design and build, furniture, fittings and equipment.
4. Fixed payments are easier to budget for and allow accurate budgeting and forecasting.
5. ‘No-deposit’ options can protect cash flow as there is no need for an initial deposit, enabling borrowers to redeploy valuable working capital elsewhere for greater investment return.
6. This option preserves parties’ borrowing power with traditional bank loans/overdraft facilities.
7. There are tax advantages. Often repayments can be offset against profits.
8. Cashflow issues throughout the term may result in parties defaulting on repayments.
Philippa is a solicitor with law firm Womble Bond Dickinson. Philippa assists with, and advises on, construction and engineering dispute resolution and has experience of a range of disputes including contract disputes under the major standard form contracts as well as disputes relating to payment, delay and defects.