Financing refurbishments

Licensee Bruce Randall is

considering refurbishing

his outdoor area and wants to know if the best way to borrow money is from his pubco in return for a rent rise

I am after some advice about raising money for a refurbishment project. I have a large garden and have yet to install a proper smoking shelter. During the summer I just used an old gazebo type thing without the walls that I use for my beer festival.

But now the winter is coming, I feel I should be doing more for my smokers. I've spent time doing some research and there are plenty of great ideas out there so I want to get in on the act.

The plan is to build a covered terrace out on to part of the garden, complete with heating and lighting - the difference being that even outside there will be a smoking area and a non-smoking area.

I feel that's important because I also want to install some children's play equipment in the garden. We have always welcomed families, but with this ban I feel we could definitely grow that market.

The cost of building the area is estimated at around £50,000 taking into consideration a spot of internal decoration as well.

The pubco is keen to help me out with this and will factor this into my rent at 15%. My concern is - especially with the recent news on the credit crunch and the availability of loans - is this the best and the only way to finance my project?

Also, if this does help to increase my trade - as I hope - will I be hit with another rent increase from my pubco?

Turnover last year at the pub was just over £500,000 and my rent was set at almost £58,000 two years ago and has an annual RPI increase - so it's three years to the next official review.

Any advice would be gratefully received.

Chris Heard director Marlborough Leisure

The sooner you address the issue of the provision of an outside smoking area, the better. Though, as a business, our viewpoint is that the impact of the smoking ban on all but largely food-led businesses is yet to be understood.

I tend to sit on the fence on this matter as I can't fail to look at the long-term trend in California, which has had a smoking ban in public places for many years. Since the ban, they have witnessed a 30% drop in smokers - a significant number and one that suggests the long-term effect of the ban may not be too negative on customer traffic into pubs.

Despite my opinion on the market as a whole, no one knows your business better than you. In terms of raising finance, you are definitely on the right track and lenders would be happy to back your judgment and enthusiasm. It's impressive that your planning is based on observations of your existing trade as well as other comparable businesses.

Practically, provided you have clean credit and banking status, as well as the absence of too burdensome a debt obligation at present, one option would be to look at funding around 75% of the overall project cost as well as a short-term overdraft to mop up the VAT.

The least surprising part of your question is that the pubco is keen (that's an understatement) to fund the project and, to be honest, the answer is a no-brainer. Where you will only pay the bank back once, taking the pubco investment (as they euphemistically call it) route is effectively compound interest as you will be repaying the additional rent on an infinite basis. A further word of caution - the cost is compounded up at each rent review.

Assuming that the £0.5m turnover is ex-VAT and that the lease is on a beer-tie basis, the percentage that the current rent bears to turnover is probably just the right side of average, but you need to try to maintain that edge.

Paul Thompson partner Acorn Commercial Finance

There are always a number of factors to consider when considering any improvement work such as this, the main one being how to maximise profit against expenditure.

There are a few factors that will drive profitability.

1. A loan will eventually be repaid whereas the rent uplift is "for life". If we assume the loan would be 2% over base rate repayable over 10 years, then monthly repayments would be £600. The 15% uplift in rent is an initial increase of £8,700. Ignoring rate increases or future rent reviews/RPI increases, the loan would cost a total of £72,000. The rent option would repay the £50,000 in under six years but

by 10 years the repayment would have totalled £87,000 (£15,000 more than the loan option) and the liability

would still be there and continuing.

2. When the time comes to sell the lease, the value is primarily based on its profitability. A higher rent would reduce expected future sale proceeds, a loan would not affect the valuation as it would be assumed that the loan would be repaid from the sale proceeds. The choice would be between borrowing to build up additional assets or taking the money from the pubco and accruing an extra liability.

3. Additional trade from improvements to premises financed by the tenant is not taken into account at future rent reviews (assuming the landlord's written consent is obtained prior to starting work). The outdoor area is likely to bring in additional drinkers and diners, not just give the smokers an outdoor refuge. If this is the case then the pub company, had it paid for the work, could legitimately increase the rent (at review) to take this additional trade into account.

The benefits of making outdoor space more attractive are varied, but it is always worthwhile maintaining costs at the most manageable level, looking to the future, not just following "the line of least resistance".

Martin Roslyn chairman Pub Accounting Company

You need a decision that will reflect the all-round benefits to you from the actual cost to the potential savings on interest and business-tax allowances. The pubco's offer of paying for the refurbishment and recovering their costs by uplifting your rent by 15% seems a viable offer. This would simplify finances as all payments would be made to the pubco.

However, long-term you need to consider the rent review in three years' time. At present, your rent of £58,000 is 11.6% of your turnover, and paying 15% additionally for the refurbishment would equate to £8,700 per annum. If the new venture increases your turnover to £650,000 then the rent review could increase your rent to £75,000 plus the annual RPI increase and the 15% refurbishment repayment. If the pubco continues to factor in the 15% refurbishment cost against increased rent, then an additional £2,550 per annum would also be increased on the above figures.

Other options to consider would be either a flexible business loan or asset finance, sourced via a financial lender. With a flexible business loan, payments are set from the start, however, some lenders may have a variable rate adjuster. You can claim the annual interest charged as a tax-deductible allowance. With asset finance, the three options are hire purchase, operating lease, or a finance lease. The lender usually secures the finance against the asset and then charges you agreed monthly payments.

In two of the options, the lender retains ownership of the asset but the hire purchase option gives an immediate ownership title. All three options have a variety of VAT, tax capital allowance relief and chargeable interest element relief against business expenses. You need to consider which finance option will be most cost effective, based on a review of the pubco offer of the 15% rent factor, the interest rate on finance lending and the impact on future tax savings.

Bruce Randall's response

I have to say a big thank you to the MA panel of experts for this advice.

My head was firmly on the logistics of the project and it seemed an easy option to borrow the money from the pubco. They were keen to get involved, liked my ideas and said they could help. You don't normally get that kind of willingness from the pubcos, in my experience,

so I am glad I vie