Financing the entire purchase price of an industrial or commercial property can be a difficult and frustrating task for business owners because conventional lenders will rarely exceed set formulas.
These formulas commonly range between 60 per cent and 75 per cent of appraised value.
Making up the difference can be a vexing problem, particularly when an existing building is cramped or inefficient and new premises are needed to increase efficiencies and stimulate growth to meet revenue targets.
So what are the options?
Beyond leveraging unencumbered fixed assets or arranging a second mortgage from the vendor, the only alternative is to find a lender not bound by strict formulas that can use term funds, either alone or in combination with subordinated debt, or find a private investor that will provide the down payment required to obtain a loan from a conventional lender.
Term loans up to 100 per cent of the purchase price of a new building are usually available, provided the value of the premises and the owner’s equity in the assets of the business exceed the purchase price.
Here is the experience of three owners of high-growth firms in Northern Ontario who financed the entire cost of new commercial buildings. The first company, a light manufacturer in Sudbury, was operating out of a cramped 540-square-metre facility and in urgent need of a larger facility
After identifying a suitable 1,800-square-metre building and negotiating an acceptable price, the owner prepared a business plan which showed that the new plant would allow the firm to double its sales in two years and reduce costs to 10 per cent of the $1.5 million required.
He first approached his firm’s bank, but it was unwilling to exceed 65 per cent of the purchase price. Assets were too low and the company’s debt-to-equity ratio was 4:1.
Other business owners were asked for advice, and a lender not bound by strict formulas was found. The result was a loan package providing 100 per cent financing, together with money for new equipment and moving expenses. It included a term loan for 84 per cent of the purchase price and associated expenses and subordinated debt for the remainder.
The term loan was amortized over 10 years and the subordinated debt over five years. The key to this financing was the owner’s ability to handle the additional debt payments out of cash flow, which strengthened significantly due to the increase in capacity.
The second firm, a mining company based in Timmins needed 100 per cent of the $900,000 required to purchase a 2,700-square-metre building to house its equipment and growing labour force.
Forecasts of long-term growth were strong, and to ensure that the business would have space for further expansion, the owner decided to buy a larger building than was immediately required and rent out the additional space. He calculated that rental income would cover 25 per cent of annual loan payments.
Unlike the first company, this owner was asset-rich. He had the option of borrowing 65 per cent of the purchase price from his bank and leveraging his equipment for the remainder. However, he was worried about limiting his ability to borrow in the future. Therefore, after meeting with a term lender, he negotiated a term loan for 85 per cent of the purchase price and subordinated debt for the difference. He was able to handle the borrowing cost by using the rental income and strong cash flow.
The third company, a high-growth knowledge-based medical service operation based in Sault St. Marie wanted to establish itself in a new market and required 100 per cent of $1,375,000 to purchase a custom-designed 12,000-square-metre building.
The firm had few assets and needed to conserve working capital. Options were limited: either arrange for 100 per cent financing, or shelve plans for growth.
After being turned down by his bank, the owner shopped around and explored the possibility of leasing a facility. The idea was rejected after it was realized that over 10 years the combined cost of leasehold improvements and rent would be more than borrowing 100 per cent of the purchase price.
The financing package eventually negotiated with a merchant banker included a $1,100,000 term loan (based on 80 per cent of the purchase price) in combination with subordinated debt of $275,000. From the lender’s perspective, the deciding factor was the company’s proven track record of revenue growth and strong cash flow.
Normand C. Meunier is Director, Northern Ontario of RoyNat Capital’s Sudbury office.