The Importance of the Asset & Liability
If a developer wants to put a plan in place for long-term funding (as well as to get approved in the short-term), it is critical to understand the Asset & Liability statements of the Directors right at the outset.
An Understanding of Net Financial Strength
Alongside a developer’s experience and the project viability, a key driver for lending is the developer’s net financial strength (if you don’t own assets we will cover solutions later on here).
Prospective borrowers will be asked to provide evidence that they can support Personal Guarantees (PGs). In development finance, these guarantees tend to be capped and in the region of 20% to 25% of the loan.
Lenders ask for these effectively as extra project contingency i.e. if the economy collapses, the costs substantially jump, or the lender is unable to provide extra funds on top of what was initially agreed, can the Directors come up with a little extra just in case?
Not your standard A&L
Now this is not a bank style A&L, a lender doesn’t need to know what your electricity bill is.
This is a fairly simple property based A&L, listing all the land and property owned by the Directors in the business, along with the approximate values of each and the approximate level of debt associated with each.
A lender is looking for “usable equity” in order to be satisfied that the borrower can support a PG. This is typically defined as around 65% of the value of the asset minus any borrowings (again there is no uniform practice for this). So if the borrower has assets of £1m and borrowings of £650k, there is zero usable equity.
65% is a marker because in the unlikely event of default, repossession and having to sell at auction within 90 days, a portion of the value may be lost.
It is also important to note that lenders often don’t take charges on those properties, although some do if the situation is deemed appropriate. Lenders are merely assessing what is behind the borrower, and taking comfort that in the worst likely case, the project will still complete and the lender will be repaid.
Why is this important?
Firstly, a borrower needs to ensure they can quality for and potentially service the current funding they are looking for. As stated around 20% to 25% of the loan needs to be supported by the net financial strength of the borrower (or guarantors).
Secondly, from a long-term project planning perspective, a borrower needs to understand how many projects they can service simultaneously, should they wish to take advantage of multiple opportunities that come their way.
What if the borrower cannot service a PG?
There are two main scenarios that arise:
In either case, it would be wise to find equity investment that the borrower can make use of to match the likely need, or a loan guarantor for the larger projects.
For equity investment there are a number of commercial channels now available in order to source, so don’t despair if investment is what you need. Various businesses such as crowd funding platforms, as well as private individuals, are increasingly visible and keen to help where needed.
So in summary, whilst development finance lenders do not lend against the accounts and profits of the borrower like a bank does, they do take the net financial strength into account.
Understanding your net financial strength also acts as a marker going forward, for if a developer wishes to grow as many do, making strategic decisions based on the reality of lending will give you a better chance of executing successfully.
Chris Davidson is Managing Director of Discover & Invest Ltd, a specialist development finance brokerage and operator of the Discover Development Finance website.
Chris believes in providing property developers with groundbreaking insights into the marketplace, that will allow developers to make better informed finance decisions, quickly, painlessly and cost effectively.
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