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What About Finance?

What About Finance?

One of the sticking points I see again and again with my customers is finance. Building a new store takes capital and most small businesses do not have the spare cash to pay for a store fitout upfront or are seeking a tax effective solution when funding depreciating assets. The finance option you choose will be based on your financial position and what is right for your business.

As a small business owner, the finances of your business are usually quite closely linked to your own finances. It is common for first time business to be financed by personal capital or personal loans. This allows you to open the doors on your first business but also puts you at a high financial risk if your assets or home are tied to the performance of the business. As your business grows and you open more stores, this problem repeats itself as you need to find capital to open new stores.

I met up with Dane Nicholson from HSS Finance and Xavier Gene from Econex Consulting  to discuss the different finance options available for Hospitality businesses. Understanding your options and when you need to apply for finance will avoid delays in opening your new store.

Commercial Lending

One option for financing your new store is to go to the bank. I have found this is often the first option my clients consider. However, it is generally secured against your personal assets and you cannot be guaranteed that your application for finance will be successful. Your ability to access finance will depend on the risk to the financier. Opening a new hospitality business is considered a high risk for the banks. Because there are more hospitality businesses who open each year to the number that survives, it can be a challenge to convince the bank that your business is a good investment. This is particularly difficult for first time business without a track record of success.

Xavier from Econex Consulting clarified why this is the case. Financing a store fit out is not creating a saleable asset in the same way as building a house. If you borrow $200,000 for a fit out, it is difficult for the bank to recoup this money if you default on the loan. The bank is more comfortable financing assets which have a clear resale value. Usually the bank will ask for other property or assets as security against the loan.

Applying for a commercial loan can be more straight forward for established business and franchises who have a track record of success and can demonstrate to the banks that they have proven systems behind what they do. Even in these cases the application is in the name of the business owner or franchises and specific to the individual site. Working with an experienced finance consultant will allow you to include all the information you need to have your finance application assessed.

Operating Lease Agreement

Because it is notoriously difficult to get commercial loans approved for the hospitality industry, there are a number of other finance options that have been created to fill the gap. A popular choice for hospitality businesses is an Operating lease Agreement.

Operating lease agreements are most commonly used for equipment and furniture. However, some financiers will be willing to cover other areas of your fitout including stainless steel and joinery. Unlike a commercial loan, which is a set dollar amount, an operating lease agreement relates to specific assets.

Dane from HSS finance summarized the basics of an operating lease agreement.

“With a rental agreement, the financier maintains ownership of the equipment, assets or furniture, similar to a secured loan from the Bank. The key advantages to this however include the ability to claim back GST on the payments in each BAS lodgement and claim up to 100% tax deduction on the total payment compared to a Bank loan whereby the interest component is only tax deductible. It also doesn’t secure your personal assets. Essentially this allows you to choose the equipment to want and, rather than purchasing it outright, pay for the use of the equipment as a regular payment. There is usually a term for the agreement and an ability to purchase the assets from the financier and take ownership of the goods.”

The advantage some business owners find with this form of finance is it allows you to keep your capital to get the new store up and running. With some lenders, you may not need to provide a security deposit as you would for commercial lending. This allows you to open the new store and still have the cash you need to pay for wages and suppliers during the first twelve months, which is usually the most challenging time for a new store.

With an operating lease agreement, rather than the bank loaning you money directly, the financier sits in the middle and absorbs the risk. Typically this form of finance does have a higher repayment than a bank loan however has more flexibility and can have tax benefits.

Chattel Mortgage

Another form of finance that may be worth considering is Chattel Mortgage. With chattel mortgage, you select the equipment and furniture that you want to go into your new store and the financier lends you the money to purchase those items. As with a lease agreement, the chattel mortgage is linked to set assets rather than a dollar amount.

The key difference with Chattel Mortgage over a lease Agreement is that you take ownership over the assets. This allows you to claim depreciation and has some tax advantages. Typically, the upfront payment will be cheaper than equipment finance but you lose some of the flexibility as you will be locked into a fixed term contract.

What Do I Need to Apply for Finance?

Finance applications for loans from the big banks are the most thorough, and must contain enough information to allow the banks to assess their level of risk. You may choose to make this application directly to the bank or go through a finance broker or consultant who can assist you with the application process.

As a general guide, your application should demonstrate the experience of the business owner in the hospitality industry and your financial position. The financier or bank is looking to assess their level of risk, make sure the business is viable and that you have enough cash in the bank to support the business through initial setup.

Xavier from Econex Consulting summarized what usually needs to go into a finance application. “If you are making an application to the bank, they will usually want to look at your business plan, financial plan and cash flow forecast for the business. To determine your financial position, you may need to provide your tax records, bank statements and statement of position. You will also to need to show evidence of your contribution and security.”

In your application you will also need to include a heads of agreement for your lease and site information. The location of your site is important to the bank in determining the viability of the business and your lease also contains key information round your lease period and lease amount.

For a lease agreement, the process is usually less rigorous. To start looking at finance, you will need two things: a site and indicative pricing. You will need to demonstrate your experience in the hospitality industry and your current financial position. What the financier is looking to see is that the business is viable. You will still need to demonstrate that you have cash in the bank sufficient to run the business and pay for any parts of the store fitout that do not qualify for finance as part of the lease agreement.

Before you can get finance approved on a rental agreement, you need a breakdown of the equipment costs and the other parts of your building cost that you are looking to finance. There will be elements of your fitout that won’t qualify for equipment finance. It is usually straightforward to finance equipment, steel benches and canopies. Trying to get equipment finance on things like plumbing and electrical is much more challenging. With a breakdown of costs, your financier will be easily able to tell you what he can and can’t finance.

When Should I Apply for Finance?

Timing for finance can be tricky. You will need to have finance approved before your shopfitter can start on site. However, before you can have a finance application approved, you will first need to give your financier a signed heads of agreement for your lease and a breakdown of your fitout costs.

This means that typically you cannot get finance finalised until your shopfitter gives you an itemised quote for your new store fitout. This is usually just weeks before you are wanting to start on site, any delays with finance approvals at this point will push back your store opening as you may be waiting on finance to pay your shopfitter’s deposit.

What is the solution? You can work with your shopfitter and designer to put together an equipment list and budget estimate much earlier in the design process. This budget estimate will only be indicative for your building costs and services. However, it should be quite accurate for your equipment. Your shopfitter should be able to give you an estimate for things like stainless steel benches and canopy. The financier can then sit down with you and look at the indicative costs for opening the new store and how much cash you have in the business.

This initial conversation should give you clarity on the amount you are likely to be able to finance. Starting this conversation early will also make sure you have everything your financier will need to approve the finance. Once you have the final itemised quotes through from your shopfitter, you can then sit down with your financier to run through the costings and finalise your finance approval.

How is the Finance Process Different for Franchising?

Finance applications for franchise stores follow the same general process as detailed above. The key difference is the backing of the franchise does help with your assessment of risk to the financier. In a franchise system, the lender has the confidence that the business will have systems in place, and have head office support for training. There is a level of credibility associated with recognised franchise brands that the operator knows what they are doing and will have vetted their franchisees.

For Franchise brands, the finance applications are still in the name of the franchisee. The franchisor should be able to provide more detailed information about the store costings and cash forecast for the store, however, the financier will look at each site individually as well as each applicant. Some financiers have agreements with particular franchises. However, the franchisee will need to demonstrate their financial position and viability before they will have the finance approved.

 

 

 

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