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The legalities of bank lending

Written by Kate Legg on Friday, 09 December 2016. Posted in Legal

Stumping up the cash required to buy a franchise will often involve borrowing from a bank. But it’s important to understand the commitments you’re making when raising capital

The legalities of bank lending

Unless you’ve won the lottery or have been given a large inheritance, buying a franchise will almost certainly involve securing bank funding. This comes with all manner of legal obligations and minimising the risks you take on requires some awareness of what the bank expects in return.

As a general rule, banks like lending to potential franchisees because the risk of the business failing – and therefore the risk of the bank not getting repaid – is lower than for an independent startup. Having said this, the success of any franchise is not guaranteed and banks won’t hand out wads of cash without asking for some security.

Personal guarantee

Typically, the bank will ask for a personal guarantee from the key people in the business. This will always be in the bank’s standard form with no room for negotiation or amendment of the terms.

The first thing to look out for is whether the guarantee is limited in amount or unlimited. Even if it is limited to a specified amount, the costs and expenses that the bank can charge in relation to enforcement will be unlimited. For instance, this means that if the guarantee is limited to £10,000 the actual amount that you‘re potentially on the hook for will be £10,000 plus costs and interest.

The guarantee will be a continuing security. This means that, once given, it will remain in place indefinitely until the bank releases it. As soon as the loan has been repaid – or if you’re no longer involved in the business – make sure you contact the bank and get written confirmation that the guarantee has been released.

If there’s more than one person giving the guarantee, liability will be joint and several. This means that the bank can choose to sue one, a few or all of the guarantors. The bank doesn’t have to sue each person for an equal share of the amount due.

Some guarantees contain a right of set-off that allows the bank to set-off money you owe against anything of yours that the bank holds. In short, this means that if you have cash in a personal account with the bank and you owe money under the personal guarantee, then the bank could take your cash to pay off the money you owe. In reality, the only time the bank is likely to use the personal guarantee is if there’s no money in the business. However, it’s important to note that the bank doesn’t have to bring a claim against the company before claiming against you personally.
Moreover, ignorance is no defence. If you don’t understand any clauses in the guarantee, ask your solicitor to explain it.

Taking charge

The personal guarantee gives the bank the right to sue the individual guarantor for money owed by the company. However, this is of little value if the person giving the guarantee has no assets with which to repay the bank. As a result, personal guarantees will often be supported by a charge over the guarantor’s home. In a worst-case scenario, if the company can’t pay and the individual guarantor has no other assets, then the bank could enforce the charge over their home to recover the money due.

If the family home is jointly owned by a married couple but the guarantee is only being given to one spouse then the charge will only relate to their share of the house. If there’s already a mortgage on the house, then the bank’s charge will be second in priority behind the existing mortgage. This would mean the bank security is effectively the share of the equity that spouse has built in the property.

Bet your assets

The bank may also take a charge over the company’s assets. This is called a debenture or charge. If a personal guarantee is being given, then it’s worth making sure that the bank also takes a debenture or charge over the company’s assets. This is because if things go wrong, the debenture moves the bank up the priority list in terms of who gets paid first. As a result, this makes it more likely that the bank will be paid by the company and so less likely that it will have to enforce the personal guarantee.

Tips for a successful application

To finish, here are my top tips to make sure your application for funding goes through smoothly:

  • If the bank has a franchise team, use them. Franchising is a niche area and it will be helpful to apply to people who understand the industry.
  • Make sure you thoroughly understand the business plan you are presenting at the application. Don’t rely on any plans or projections given by the franchisor. Instead, do your homework and verify your own figures.
  • Don’t be disheartened if the bank turns you down. The franchise teams at the bank work closely with franchise networks and may have access to information that you don’t have. If the bank turns you down, try to find out why.

Allow plenty of time. The process of applying for funding, having the application approved, getting the documents issued and completed and funding being made available always takes longer than you think.

About the Author

Kate Legg

Kate Legg

After more than a decade advising other business owners, Legg has recently fulfilled a long held ambition and become one herself. Now the founder, director and CEO of Komerse, a legal practice specialising in commercial law and franchising, Legg is clearly practising what she preaches.

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