- What are the different types of borrowing available and what can a bank finance?
- What loans are available to help a partner fund equity in the firm?
- When should we use an overdraft, and when is it better to use a different type of borrowing?
- How much money can the firm borrow and how can we increase this?
- Will any personal information I provide be confidential, or will the other partners be able to see it?
- What credit checks will the bank carry out?
- What does a bank consider when assessing a financing application?
- How does a bank charge for borrowings?
- What are the arrangement fees?
- What other costs might be associated with borrowing?
- How much interest will the bank charge and how can we reduce this?
- Are there any differences in the rates and fees for sole traders, partnerships, LLPs and limited companies?
- What are the advantages and disadvantages of a fixed rate versus variable rate?
- Can we agree limits on how high or low a variable rate could go?
- Are interest-only loans available or will we have to make regular repayments?
- What options are there for delaying repayment of a loan?
- What options are there for delaying draw-down of a loan?
- What lengths of loan term are available?
- Will we have to provide any security and if so how much?
- Do we stand a better chance of funding if we are willing to provide security?
- How much scope is there for negotiating a better rate, lower fees or other improvements to the terms of a loan?
- How long does it take to agree financing?
- How many loans can be in place at any one time?
- Will we still face costs if the finance never goes ahead?
- What happens if we never use an agreed overdraft facility – will it cost us anything and will the facility be taken away?
- Can we be charged for early repayment of a loan or overdraft?
- How often does a bank review lending facilities?
- Are there rules on how we spend the money we borrow?
- Will any financial covenants apply?
- How can we refinance existing debts?
- Are we tied in to our existing lenders or can we switch banks?
- Do I have to be an existing customer to obtain funding from a bank?
- What differences can I expect between specialist lenders who understand the legal sector and more general lenders?
- What are the advantages and disadvantages of using a finance broker?
- How will it affect our business borrowings if the firm wants to change its legal structure?
- What typically causes a law firm to borrow too much money and get into difficulties?
- When in trouble, should a law firm delay VAT repayments or bank repayments first?
- What happens if we miss a loan repayment?
- What financial information should we give the bank if we are facing financial difficulties?
- At what stage will a bank ‘call in’ a loan and security?
- Can I obtain finance to cover my firm’s tax and VAT payments?
- Can I obtain finance to cover my firm’s professional indemnity insurance costs?
- Which banks provide litigation finance?
David Newbury, a Lloyds Bank Commercial Banking relationship director who specialises in the legal sector, answers the most common questions he is asked by firms about obtaining funding from a bank. (1 July 2019)
1. What are the different types of borrowing available and what can a bank finance?
As a bank we can finance the majority of your business needs. Cashflow and working capital is usually provided through an overdraft facility. Asset purchases such as vehicles, IT, machinery and equipment are done using asset finance. We can also fund Professional Indemnity insurance premiums, and in some instances tax payments, through an asset finance type of funding facility.
Property purchases (and moves and refurbishment costs), partner equity, inheritance tax and business acquisitions are funded using traditional business loans. Small firms that lack suitable security may be eligible for a guarantee under the government-backed Enterprise Finance Guarantee scheme.
2. What loans are available to help a partner fund equity in the firm?
Partner equity loans are available to both new equity partners wishing to buy into a law firm and existing partners wishing to increase their ownership share.
These are personal loans, made in the individual’s own name. The affordability of the loan is therefore assessed against personal assets, income and expenditure.
Interest-only loans have a maximum 10-year term. Other capital repayment options and interest options are available, usually for a maximum term of 25 years. These must be repaid before the expected retirement date of the partner.
Partner equity loans are usually unsecured and are supported by an indemnity from both the individual and the law firm confirming that, should the individual leave the firm, the partners’ capital account will not be paid out before the bank loan is repaid. An annual review will be held to confirm that the partner continues to hold equity to meet or exceed the loan facility, which is achieved by reviewing the law firm’s financial accounts.
3. When should we use an overdraft, and when is it better to use a different type of borrowing?
Overdrafts are traditionally used for day-to-day cashflow requirements (‘working capital’), so you can pay your suppliers while you are waiting to be paid by your clients (‘outstanding debtors’).
If you are planning an asset purchase (such as new vehicles or IT equipment), or an office move, a term loan is more suitable. You can then make regular, scheduled repayments and match the term of the loan with the life span of the asset being purchased. This preserves your working capital cash to use for the day-to-day payments.
4. How much money can the firm borrow and how can we increase this?
Your firm’s track record will make a big difference to how much you can borrow, along with your financial planning, financials, management accounts and cashflow forecasts. Robust, positive evidence in these areas will support your finance application and help you to achieve the maximum finance required.
There is no set formula for the level of funding each firm receives, as this largely depends on the evidence provided.
Equity loans and property purchases for legal firms can be as much as 100% of the requirement –although lenders are unlikely to invest significantly more than the partners’ own equity in the business. Likewise, facilities are unlikely to be provided if drawings exceed profits.
5. Will any personal information I provide be confidential, or will the other partners be able to see it?
All personal information is held confidentially and will not be shared with any other partners. Any loans to an individual will be held in that person’s own name and will only be visible to that individual.
6. What credit checks will the bank carry out?
All borrowing is credit scored, subject to authority from the borrower. It is likely the bank will use multiple credit reference agencies. The assessment will consider an individual’s credit rating and check for any defaults and county court judgements (‘CCJs’) as well as confirming the registered address(es) for last three years.
7. What does a bank consider when assessing a financing application?
The firm’s business plan, the latest three years of financial results, up-to-date management accounts, bank statements for the past 6-12 months, aged debtors and creditors, and personal asset, liability, income and expenditure statements are all considered.
Of course, a good track record goes a long way to support any application.
8. How does a bank charge for borrowings?
There are a number of ways you can be charged for borrowing. Overdrafts, the interest on which accrues daily (based on the level of facility used) and which is paid on a monthly basis, is one of the most common. Loans tend to have one-off arrangement fees and then ongoing interest fees.
9. What are the arrangement fees?
Arrangement fees are usually charged for overdrafts and loans. The amount depends on the lender, with fees charged as a percentage of the amount borrowed: a typical fee for new borrowings could be 1.5% of the amount borrowed, whereas the fee for a renewal may be closer to 1%.
In the case of a loan, the fee can be added to the loan rather than being paid at the outset.
10. What other costs might be associated with borrowing?
If you are buying a property alongside valuation fees, bank security fees, and your solicitor fees to pay, you will need to insure the building before the loan can be completed. It’s always recommended that you also consider insuring any key people in the business.
Some lenders charge an application fee. This is usually deducted from the arrangement fee once you draw down the loan. If you decline to take up the funding after it has been agreed the fee is not reimbursed.
Many lenders also charge exit fees and early repayment (or ‘breakage’) fees, so be sure to ask about these at the outset to ensure they are explained. Early repayment fees are likely if you opt for a fixed or capped rate.
11. How much interest will the bank charge and how can we reduce this?
Lenders will have their own set interest rates which may differ depending on the reason for the loan, its risk rating and its term. Ask what the rate is and how it might be reduced and have comparisons from other lenders ready. For example, it could be the case that if you shorten the term, the rate drops slightly. Or if the loan is secured differently, the rate drops.
Overdrafts are charged based on the amount you actually borrow, rather than for the whole limit (calculated daily and charged monthly). Loan interest is charged monthly on the outstanding loan amount.
12. Are there any differences in the rates and fees for sole traders, partnerships, LLPs and limited companies?
No, the law firm’s business structure should not affect the interest rates and fees.
13. What are the advantages and disadvantages of a fixed rate versus variable rate?
Fixed rates are higher than variable rates but give you certainty. So you can budget and forecast the firm’s cashflow knowing that your capital-and-interest loan repayments will remain the same through the term of the fixed rate, even if interest rates rise in the UK.
Conversely, if interest rates drop, you will be committed to the original interest rate. Early repayment incurs a charge (known as a ‘breakage’ fee).
Rather than one larger loan, you may want to have two or three smaller loans to provide more flexibility in the future. For example, if your firm is more cash generative than expected and you find yourself in a position to repay some loan early, you can repay the variable rate loan first.
Borrowers can also opt for a capped rate loan (see 14).
14. Can we agree limits on how high or low a variable rate could go?
A ‘capped rate’ loan is designed to give borrowers the best of both worlds, as it is variable rate but that rate cannot exceed a specified maximum interest rate (the capped rate).
In the case of Lloyds Bank, the cap lasts for the first five years of the loan term, after which the loan switches to variable rate.
Like a fixed rate loan, a capped rate loan enables law firms to take advantage of the current low interest rate environment.
Larger law firms taking out larger loans may wish to consider more complex ‘cap’ and ‘collar’ loan products – which all have their advantages and disadvantages, depending on borrowing needs.
15. Are interest-only loans available or will we have to make regular repayments?
This depends on the type of loan – for example, interest-only partner equity loans are available.
Traditional loans for a property purchase or business growth are usually regular repayment loans, but it may be possible to arrange to have no repayments at the start of the loan.
Property development loans are usually interest-only and repaid in full at the end of the term.
16. What options are there for delaying repayment of a loan?
A delay in repayment (‘capital holiday’) may be possible if there is a specific reason for it.
For example, a one-year capital holiday might fit in well with your firm’s cashflow forecast if you are moving premises and have the costs of the move and fitting-out in those first 12 months.
Partner equity loans, if taken on interest-only basis, will require repayment in full upon maturity of the term. This is usually from the partner’s own funds. Sometimes the repayment is scheduled to coincide with the retirement of the partner and with the repayment of the partner’s equity by the firm. In other cases where the partner is remaining in place, the lender may consider extending the loan in some way if needed.
17. What options are there for delaying draw-down of a loan?
Tranche loans, released in stages once certain milestones are achieves, are used for property development. Interest is only paid on the amount currently borrowed.
18. What lengths of loan term are available?
Loans for property purchases have terms of up to 15 years for commercial properties and 25 years for residential ones.
Partner equity loans can be interest only for up to 10 years followed by 15 years of capital and interest repayments.
All such terms will depend on what is being financed and the profile of the borrower (for example the retirement plans of a partner needing an equity loan).
19. Will we have to provide any security and if so how much?
See the set of FAQs on Security for borrowing.
The lender will take a legal charge over the asset being purchased, such as a property, or vehicle, or piece of equipment.
In addition, firms that have incorporated may provide a debenture (a general charge over the assets of the firm, including debtors) and personal guarantees may be provided from the directors or owners of the firm.
Partner equity loans are in the main unsecured, depending on the level of funding requested.
The security required will reflect the risk profile of the law firm and the type and amount of the lending.
20. Do we stand a better chance of funding if we are willing to provide security?
Yes, although security is not always a requirement (with partner equity loans being the obvious example).
If a law firm’s partners are investing their own funds and/or are prepared to provide security, the risk to the lender is less. Not only is there a better chance of achieving the requested funding, the interest rate is also likely to be lower.
21. How much scope is there for negotiating a better rate, lower fees or other improvements to the terms of a loan?
The fees and interest rates of the lenders will on the size and length of the loan and the risk profile of the law firm borrowing the money.
It is always worth having a discussion with the lender, so you understand how changing any of these factors could help you achieve different and more beneficial rates, fees and other terms.
If you have comparison quotes from other lenders, this can also help your negotiating position.
22. How long does it take to agree financing?
Once all the required information has been provided, a decision in principle can be provided within 48 to 72 hours or even sooner. Ask your lender for this timescale commitment.
Additional questions are likely to be raised at this stage, but you should have a clear indication of whether the funding can go ahead.
23. How many loans can be in place at any one time?
Each loan is agreed on its own merits and affordability, so there is no maximum number of loans as such. Multiple loans are possible if the cashflow is available to repay them all.
It may be financially prudent to have loans over differing time periods and to consider restructuring existing loans with new loans that better match your projected cashflow.
24. Will we still face costs if the finance never goes ahead?
Some lenders may charge an application fee for agreeing the finance, which in effect is a commitment fee. This fee is reimbursed on completion of the finance but is not reimbursed if you decide not to accept the finance. You may have also incurred costs such as valuation fees and your solicitor fees.
25. What happens if we never use an agreed overdraft facility – will it cost us anything and will the facility be taken away?
If the overdraft is not used there will be no interest costs, but you would still pay the arrangement fee when the facility is set up and the renewal fee upon each anniversary.
A discussion can take place before the anniversary renewal to gauge the requirement for the next 12 months and potentially remove the facility.
26. Can we be charged for early repayment of a loan or overdraft?
Overdraft facilities are usually provided on a rolling 12-month basis reviewed annually and are repayable on demand. They are designed to be fully flexible and so do not usually have any early repayment penalties, but you may still be left paying the full set-up fee if the overdraft is later cancelled by yourself or the bank.
Early repayment penalties are charged for some types of loans, such as loans with a fixed or capped interest rate. If the loan is a standard variable product with no fixed/capped term, early repayment penalties are unlikely. Always ask your lender in advance if there are any penalties on any of the loan types.
27. How often does a bank review lending facilities?
Usually a review is carried out on each anniversary of the lending in question.
The lender will ask for up-to-date financial information (financial accounts and management accounts) to check the continued affordability of any loans, or whether an overdraft facility is still at a suitable level.
28. Are there rules on how we spend the money we borrow?
All funding is expected to be used for the purpose for which it was lent to the law firm.
An overdraft is provided to fund day-to-day cashflow. Loans are provided to fund particular assets or growth plans.
29. Will any financial covenants apply?
Covenants are contractual terms that protect the lender by limiting financial risk. For example, a covenant might limit the borrower’s dividend payout ratio, or working capital ratio, or the borrowing of higher priority debt.
Covenants tend to be considered when banks are making loans of more than £500,000.
Discuss any covenants with your lender, to understand how they may affect your firm.
30. How can we refinance existing debts?
Situations change and sometimes it makes sense to rethink your law firm’s finances. For example, you may want to restructure short terms borrowings over a longer period, to ease pressure on your cashflow.
List and summarise all the various borrowings and ask the lenders what it might cost to refinance it. For example, there may well be fees and/or early repayment penalties.
Approach your existing lender(s) and any potential new lenders and see what a refinancing might look like in terms of cost and benefit.
You will need to provide the full list of required financial information, as you would for any funding request.
31. Are we tied in to our existing lenders or can we switch banks?
Switching banks (or other sources of finance) is always an option. In fact the UK leads the world in open banking, which makes switching easier.
Consider any early repayment penalties and the costs of any fees (and so on) for setting up new financing before going ahead.
32. Do I have to be an existing customer to obtain funding from a bank?
No, you do not have to be an existing customer.
But if you take out traditional loan, you will need a loan servicing account with the same bank.
If you require an overdraft facility, the lender will expect to see 100% of the trading of your firm going through that account, to monitor the turnover against the forecasts that supported the initial decision to provide the facility. Dual banking overdraft facilities are not usually accepted, especially if a debenture is held by any one bank.
If you are financing professional indemnity insurance, or tax payments, or assets such as vehicles, these can usually be serviced using your existing bank accounts.
Of course, a bank will always wish to consider providing your full banking requirements.
33. What differences can I expect between specialist lenders who understand the legal sector and more general lenders?
Specialist lenders understand the legal sector, its requirements, and the most suitable finance packages.
For example, finance that reflects the different cashflow timings and capital requirements of medical negligence or complex commercial litigation as compared to more straightforward conveyancing and family law matters.
In the case of Lloyds Bank, its relationship managers in the legal sector team are all Lexcel trained and continue their CPD every year.
34. What are the advantages and disadvantages of using a finance broker?
The advantages are that finance brokers have relationships with multiple lenders and will be aware which funder is most likely to support the requested finance. They will also know what information is required by the lenders and can prepare the lending request on your behalf.
The disadvantage is that you may have to pay a fee to the broker (although some brokers will get their fee from the lender and not the borrower, leaving your costs the same).
You should also ask yourself who you wish to build the relationship with: the broker, or the lender. This will depend on whether you wish to secure future facilities with the lender, or whether you are likely to look for support from a range of lenders.
35. How will it affect our business borrowings if the firm wants to change its legal structure?
Borrowings are likely to remain unchanged if you are moving from a sole trader or partnership to a limited liability partnership or limited company.
The change will be in the security provided. An LLP or limited company may be asked to provide personal guarantees and a debenture (see the Security for borrowing FAQs).
36. What typically causes a law firm to borrow too much money and get into difficulties?
There are many causes that can lead to difficulties, which include (but are not limited to):
- Financial mis-management, such as poor cash collection, poor cost control, or poor cashflow forecasting. Sometimes firms fail to reduce partner drawings when cashflow is squeezed and the firm clearly requires more working capital.
- A trading downturn, perhaps caused by a recession, or the departure of talent, or the arrival of strong new competition.
- An over-ambitious property purchase, or the loss of a subtenant.
- A merger or acquisition that goes wrong, perhaps because the management and fee-earners are distracted, or talent leaves, or savings are not realised.
- Over-reliance on one or a small number of clients, perhaps when a key client demands lower prices or moves its business to another firm.
37. When in trouble, should a law firm delay VAT repayments or bank repayments first?
If a firm gets into financial difficulties, it pays to take professional advice early. There are a host of factors that will influence what the best course of action might be.
Talk to your bank and to your creditors and see if there is scope for delaying payments. If you have previously shown that you can overcome cashflow problems, or if you can demonstrate your ability to service a new arrangement in the long term, you may be more likely to receive support.
There may be less flexibility with HMRC, which has a duty to collect the VAT owed, but this will largely depend on your history in making payments on time or sticking to a previously agreed payment plan.
38. What happens if we miss a loan repayment?
As soon as you know that your firm is going to miss a loan repayment, contact the lender to discuss the situation. If it is a short term cashflow problem, provide the evidence of WIP and debtors that will provide the necessary cash. You can then agree a schedule to clear the loan arrears.
If you choose not to contact the bank and the loan arrears increases, you can expect the bank to start formal recovery proceedings.
39. What financial information should we give the bank if we are facing financial difficulties?
In this situation a lender would require the same level of financial information as requested when agreeing the initial lending; latest financial accounts, up to date management accounts, WIP, debtors, creditors. You should explain the reasons behind the difficulties, together with your proposals for correcting the position.
40. At what stage will a bank ‘call in’ a loan and security?
Clearly it is in the interests of all parties to avoid calling in the borrowings and the security for those borrowings, so every potential solution should be considered. For example, the law firm may be passed to a special support unit, to allow the bank to provide additional support.
If the firm is in arrears and it is clear that the situation is deteriorating, formal recovery proceedings are likely to begin. Any security that has been given to the lender will be considered as a means of repaying the money that has been borrowed.
41. Can I obtain finance to cover my firm’s tax and VAT payments?
Yes, some lenders will provide funding for tax and VAT. Tax funding tends to be part and parcel of bank lending, whereas VAT finance tends to be from specialist lenders in the market. Be aware that interest rates for specialist finance tend to be higher.
42. Can I obtain finance to cover my firm’s professional indemnity insurance costs?
Yes. In the past, borrowing for these costs was provided by funders who were linked to the brokers and insurers, whereas such finance is now available from a wider range of funders. It is worth discussing with your bank as part of your overall funding requirements.
43. Which banks provide litigation finance?
Litigation can last years, so litigation finance is a specialised type of finance provided by funders whose own balance sheets are designed to cater for long term lending. Of course, these funders are highly selective when it comes to which firms — and in which cases — they will be willing to lend.