There are now more than four million self-employed people in the UK and this number is rising rapidly, but many lenders remain cautious about granting commercial mortgages to start-up companies because of the high degree of risk associated with them.
According to the latest figures from business information provider Dun & Bradstreet, the number of businesses going bust increased by more than 15% in the second quarter of the year. A total of 20,164 businesses failed in the first half of this year and most of these were due to bankruptcies among smaller companies. It is, therefore, not surprising that lenders are cautious of lending to business start-ups as the risks to themselves, and indeed borrowers, are greater.
Fewer than half the major commercial mortgage lenders are prepared to lend to start-up companies, as they either feel that it is too high risk, or they do not have the capability to monitor how the borrower is performing. Graeme Taylor, head of commercial lending at Skipton Building Society, says: ‘As a building society we do not operate a business current account, and without this there is no way of monitoring their business projections. The first time we would know if there was a problem would be when the direct debit bounces.’
However, the key problem with commercial mortgage lending for start-up businesses is that lenders have very little information to assess whether it is a viable proposition. If a prospective borrower already owns a business, the lender can see how they have performed, but if they do not there is little for the lender to gauge the risk by and, therefore, it is harder to find mortgage finance. Richard Farr, marketing manager at Sun Bank, says: ‘Start-ups are a different proposition to other commercial mortgages. When you are assessing the risk of someone who has never been in a particular business sector before, rather than looking at someone’s past performance you are looking at completely different things. You cannot go back and look at their previous history.’ Despite this, there are still a number of factors, such as having prior experience in the business, that can aid first-time commercial borrowers in getting a loan.
Andrew Turzynski, senior business manager at First National, adds: ‘We would firstly look for some experience of the business the prospective buyer intends to get into. For example, if they want to set up a pub or a care home we would check to see if they had run one before, or whether they had taken courses in managing them. Sometimes if an individual has already got experience in another industry and have proved they can do it, it is easier to start again.’
But with or without prior experience all potential borrowers will need to provide a detailed business plan which projects outgoings, overheads and expected profits, as well as details of how the loan will be paid back. Brokers should advise clients that spending time on this can greatly increase their chances of securing a commercial mortgage.
Steve Nightingale, marketing manager at HSBC, says: ‘In a commercial proposition there is no guarantee about anything, and because the borrower’s ability to repay is important, the business plan is very important and has to stand up to close scrutiny.’
In addition, lenders may also commission external business appraisals, where the value of the property and the business is assessed, and an indication is given as to what the profitability will be. Turzynski says: ‘We generally do this if the applicant has got a business plan but no experience, because their expectations are sometimes wildly adrift of the likely reality. But while lenders sometimes commission business appraisals the borrower will still have to pay for them. However, the borrower does not always need to go and get one before they go and see the lender, which can save them money.’
When lenders are looking at the viability of commercial loans, many use a credit scoring system in a similar way to residential loans. Mortgage brokers can be invaluable to clients who want a start-up commercial mortgage, if they can anticipate all the likely queries of the lender before this stage and make sure that answers are provided.
One common credit scoring system referred to by lenders is known as PARSERS. This is an acronym for the different areas regarded as important by commercial lenders. The P of PARSERS refers to the person and how much the lender knows about them, whether they have a clarified track record in the business, and how well the business plan has been researched. It also refers to the purpose of the loan, such as whether the borrower wants the debt capital to buy a property, to use as a deposit, buy equipment, promote the business or conduct research.
The A stands for the amount that is being requested. The lender will want to know how much the client wants to borrow, and whether is it a reasonable amount, too much or too little. It also stands for affordability. The business plan needs to set out why they need the amount they are asking for and also explain how it will be repaid.
R is for repayments. Business plans need to include primary and secondary repayment sources. This will detail where exactly they are going to be getting cash from for the repayments and also include something tangible for security. S is for secuirty. Is there something available as security and is it a suitable proposition for the lender?
The E is for expediency. Is there an expedient reason for the lender to provide the money? The lender is a business too and will want the loan to be profitable. This is linked to the next R, which stands for remuneration and how much will the deal generate for the lender. And finally S is for services. What additional services will the borrower require to ensure the deal runs smoothly, for example insurance and critical illness cover. If the borrower includes as much of this information as possible they will increase their chances of success.
However, even if the business plan does include this information the lender may not always provide mortgage finance because they may still find the risk too great. If this is the case there are still a number of options available and the client may still be able to find finance.
Brokers could advise clients to take out a business loan or remortgage their residential property, but it is worth bearing in mind that some lenders offer innovative features on residential mortgages which could save the client a great deal of money. An example of this is offered by Mortgage Express.
Roger Hillier, product development manager at Mortgage Express, says: ‘On all our residential mortgage products borrowers can come back to us after the loan has been set up and borrow the difference between their initial loan and 80% LTV. The money can then be used for any purpose as long as it is legal. So they could use it to help set up a new business, or even as part or all of a deposit towards a commercial mortgage.
‘But as soon as they go over 80% LTV we are more restrictive about what they use it for. It is a secured loan and forms part of the main mortgage and as such it can be much cheaper than the average loan.’
Rod Murdison, proprietor of London-based IFAs Murdison & Browning, says: ‘Commercial mortgages for start ups can be hard to get unless the borrower is willing to put up some security themselves. The maximum loan to value available is around 70-75%, which means they still have to come up with a 25% deposit. And where is this going to come from unless they try to borrow against their own house?’
If this is not possible, all is not yet lost as lenders are much more likely to provide a commercial mortgage if the applicant has a few years of trading experience. If the client can rent a property initially, they will be able to build up the account history needed for a commercial mortgage.
Murdison says: ‘A lot of lenders still encourage new businesses to rent property for a few years and come back to them when they have a few years worth of accounts behind them before they will agree to a mortgage.’
Taylor agrees: ‘Most commercial lenders are prepared to lend to those with a proven track record because they are then looking at quality business.’
While it may be quite difficult and time-consuming to arrange a commercial mortgage for start-up companies, brokers can greatly enhance the chances of success by ensuring the lender receives as much information as possible. But, as the number of self-employed workers continues to increase this is not a market that can easily be ignored.
Lenders who lend to start-up businesses
AMC 01264 334 747
Barclays Bank Local branch
Clydesdale Bank 0141 248 7070
Co-operative Bank 0345 213 213
Farming & Agricultural Finance 0800 225 567
First National Commercial Bank 020 8861 1313
HSBC Local branch
Hampshire Trust 01329 234 294
Lloyds TSB Local branch
NatWest Bank Local branch
Newbury Mortgage Services 01635 555 700
Northern Rock 0191 522 3700
Royal Bank of Scotland Local branch
Triodos Bank 0800 328 2181
Ulster Bank 028 9027 6150
Vernon Building Society 0161 429 6262
W M Mann & Co 0141 248 4936
Yorkshire Bank 0345 034 567
Source: Business Moneyfacts