Introduction
The Bank of England is expected to continue cutting the base rate towards zero. The projected spread between LIBOR and the base rate is set to decrease from 160 to 60 basis points by March 2010. These factors would traditionally have meant borrowing would become cheaper.
However the problem for most businesses is not the “cost of money” but access to it. With lenders’ criteria being drawn very tightly it is fundamental that potential borrowers do what they can to maximise their chance of obtaining funding.
Borrower Actions
- Update the business plan to demonstrate:
i. achievable profit and turnover
ii. proposed application of funds
iii. cashflow requirements
iv. ongoing insolvency
v. repayment strategy
vi. management expertise - Identify and value assets that can be offered as security
- Agree commercial aspects of the deal at the start and record these in heads of terms
- Allow sufficient time for the process, including lender due diligence on the business
- Consider what currency funds should be borrowed in and whether hedging is necessary
Lenders’ Requirements
A lender will typically use a relationship manager to lead its negotiation with the borrower. The lender will be aiming to maximise its short term remuneration through charging arrangement fee(s) and to achieve medium to longer term return(s) through charging a margin over the base rate or LIBOR. The lender will seek a security package that will usually have a value well in excess of the facilities extended.
Three current issues are discussed below: greater security, tighter covenants and increased currency risk.
Greater Security
A business should check what charges are registered against it at Companies House and elsewhere at the start of arranging new borrowing. Any existing charges will need to be released or integrated into the revised security package agreed by all the lenders. This can be achieved by the lenders agreeing a deed of priority between themselves.
Asset based lending has become a more significant type of lending during the “credit crunch”. It involves the valuation of various assets owned by a business including real property, plant and machinery, stock and even intangible assets and as intellectual property rights. The lender then lends a percentage of the market value of the assets.
A lender will require the right to periodically revalue the security provided. If the value of the security falls below the agreed amount the lender will have the right to demand additional security from the borrower or insist on repayment. The lender may also seek a cross guarantee between various group companies.
Tighter Covenants
Covenant-lite loans have been withdrawn. Loans now include more onerous information, non-financial and financial covenants which provide greater protections and more triggers for lenders. A borrower therefore needs to ensure that its financial criteria, borrowers and assets remain within the limits agreed with the lender at the outset.
A borrower should still try and negotiate the type and extent of the financial covenants which usually include interest cover, net worth, debt/equity or gearing ratios. The two most problematic covenants, which are most frequently breached are net worth and interest cover and their inclusion should therefore be resisted.
Increased Currency Risk
If a borrower’s customers pay cash, or it makes payments to suppliers, in a currency other than sterling, then it should consider which currency to borrow in. It should also consider making appropriate hedging arrangements.
It should be noted that term loans now typically include provisions for a situation where the UK adopts the Euro in place of Sterling. These provisions put the financial risk on the borrower.
This article may contain information of general interest about a current issue but does not constitute as legal advice.
Keith Dempster is a Partner in the Corporate and Commercial Department at Kerman & Co LLP. If you have any enquiries in relation to corporate matters, please contact Keith on 020 7539 7081 or by email at [email protected]
