How do I finance my management rights purchase?

Published: 12 March 2007.

There are half a dozen banks that have a specific lending policy for management rights. Each bank only has one or two managers that understand and specialise in the industry and some of these people are constantly moving from branch to branch, and from bank to bank. A purchase can easily fail if the bank takes too long in getting the proposal approved or the proposal is put together improperly.
It?s the same as dealing with a non-industry accountant and solicitor, dealing with the wrong professional can cost you. A purchaser needs to source a bank manager or broker who is experienced in the industry. Ask your broker or bank manager how many management right transactions have they completed.

You don?t want to be the first one.

It is important that suitable bank products are used and the loans are arranged in a tax effective structure. For example, there is no point in taking out a home loan for the purchase of the manager?s residence as you won?t legally be able to claim the interest as deductible. The funding is secured against the manager?s unit and the business. There is no need to take additional security if sufficient cash is being contributed.

Management rights is a cash flow business and your income is received on a monthly basis, therefore you need to think about what finance product suits you best. Just because a particular loan has a cheap interest rate doesn?t mean it will suit your situation and may end up costing you more money due its inflexibility.
Other considerations when taking out a loan include:

What is the loan term?
Should I fix the rate and for how long?
Do I have the flexibility I require?
Is there a redraw facility?
What are the ongoing fees?
Is there an offset facility?
Do any penalties apply for early payout or lump sum payments?
What is the bank?s on-going service like?
Should I use a different bank for my other accounts?
What are the set up costs?
Can I claim the interest?
Can I have a limited guarantee?
Do I need a separate borrowing entity?

These days there is strong competition between banks for management rights business so you can get a good deal by checking what options are available. Quite often a bank doesn?t need to offer its best deal to an existing customer as it thinks that customer will remain loyal forever. But, is your bank being loyal to you? One major bank has authorised its managers to discount rates for new customers only, with no discretion for discounts to long- term customers.

How much should I borrow?

The quick answer is ?only as much as you need?. Many of financiers advise that you should maximise your borrowings but remember that interest is still an expense and you shouldn?t be carrying debt that you don?t need. In saying that, there is no harm in having extra funds available in case you need it for another investment. For example, if you could borrow say $600K for a business but only need $500K there is no harm in having the extra approved now just in case something comes up down the track. You will only need to pay interest on the $500K you are actually using.

Most management rights lenders are approving loans of between 60% and 65%.

A purchaser is also able to borrow up to 100% as long as there is enough equity in other property and the business (along with any other income) is earning enough to meet the commitment.

Using a combination of bank and equity finance funding of up to 95% can be achieved without the need for additional security.

You need to factor your upfront costs, or around 5%, when assessing your borrowing levels. The upfront costs generally cover your stamp duty, solicitor costs, bank costs, licences and accountancy costs. Additional monies may need to be allowed for company and trust set ups.

It?s a good idea to speak with your financier or broker prior to looking for a suitable management rights to work out the what price and income range you need in a prospective purchase. Generally the more you are able to borrow, the bigger you can buy, therefore the more you will make. You still have to be comfortable that you can or want to run a large business and, for some managers, choose a smaller management rights for lifestyle reasons.

Do I need to make repayments?

It?s a nice feeling to get your self out of debt but no one actually likes making loan repayments. Historically, being conservative in nature, banks looked for a repayment program on any business lending, as they never trusted a borrower to be able to retain value in that business. This provided a certain level of comfort knowing that their exposure was being reduced. Things are changing and some of the banks are quite happy to lend on an interest only basis in this industry. This comes from a higher comfort level banks have with managements rights in comparison to many other industries.

The question still remains though; do I need to make repayments? Most experienced managers are setting their loans up on an interest only basis as it allows them access to additional funds for further investment and lifestyle.

They have been around long enough to be comfortable with the fact that the business will keep improving in value and the debt doesn?t have to be reducing for their equity to keep increasing.

Why make money if you can?t have any fun with it? Many new managers however like to know that the debt is reducing so they are getting somewhere ?just in case? the business doesn?t improve in value. The key here is to have a bit of flexibility with the loan arrangements so you can choose how much you pay off and if you want to pay anything of at all. The principal repayment on your loans is not a tax deduction whereas the interest component is.

Generally if the management rights has a short agreement the banks will need a repayment program in place initially.

Management rights remain a preferred sector for banks to lend against and the competition is always strong and changing. It will always be worthwhile in seeking advice from others even just to keep your own bank manager honest.
Article by PCS Finance