Overdrafts and Bank Loans

5. Security

A bank usually wants security to ensure that it is repaid if things go wrong. The bank puts a legal charge over your business or personal assets, which can be sold if you default.

5.1 Freehold or long-leasehold property is often the most valuable security you can provide.

A bank will usually lend up to about 50 to 80 per cent of the value of a property, although other specialist lenders may advance as much as 90 per cent.

• Specialist premises may be valued at less than you spent on them.
• For smaller businesses, taking a mortgage on personal property (and then lending the money to the business) can pay off. Mortgage rates are below business loan rates, there are no ongoing arrangement fees and lenders will advance up to 95 per cent of the property value. Some mortgages have flexible repayment arrangements, reducing your risk of defaulting.Using personal finance to expand your business may be the best option if you would otherwise risk your house anyway.

5.2 A bank may lend up to 50 to 60 per cent of the value of your outstanding debtors (sales invoices). The bank will check:

• How likely the invoices are to be paid.
• How much it costs to collect the debts. For example, collection costs mean that several small debts may not be worth the same as one large debt.

5.3 Equipment, stock and work in progress will only be valued at their resale price - usually what they would fetch at auction.

• Specialised equipment which is difficultto sell, and equipment which becomes obsolete quickly, such as computers, provides little security.

5.4 Directors of limited companies are often asked to provide personal guarantees. (Sole traders and partners are automatically liable for all the business debts.)

Giving a personal guarantee exposes you to serious financial risk, as your personal assets are at risk if the business fails.

• Ask to limit the scope of the guarantee.For example, the bank might agree to a guarantee which is less than the total amount of the loan or overdraft facility.
• Ask to limit the duration of the guarantee.For example, the bank might agree to release you from your guarantee after a set period of time, or once cashflow reaches an agreed target.
• You may want to renegotiate any guarantees whenever you take out a new loan or overdraft facility.
• If any friends or relatives offer third-party guarantees, the same risks apply to them.

5.5 You may want to consider pledging other assets, rather than giving a guarantee or putting a charge on your home.

• For example, life insurance policies, shares and other investments. Alternatively, you may use these as security for a larger and less expensive personal loan and lend the money to the business.