There are a number of terms that are familiar to many in our industry and these tend to just trip off the tongue. However, some words and phrases can seem a complete mystery - especially to first time buyers - and so here are a few terms explained. If you have any others you want explaining, we may even add them to the glossary!
Whilst everybody knows the term 'Freehold', the concept of 'Leasehold' property may be completely strange. What 'Leasehold' means is that the freehold is owned by someone else (the Landlord, sometimes called the 'Lessor') who grants a right to occupy the premises for a specific period (the 'term') with specific conditions of what the person with the right of occupation (the 'tenant', or 'Lessee') must and must not do (the 'terms'), including how much and when the Landlord has to be paid for the tenant's right to occupy the premises (the 'rent'), and when that rent can be changed ('review date') - the document which sets out all this information is called 'The Lease'.
Two further points must also be considered about leases; firstly whether or not the lease is 'assignable' - that is to say that the tenant has the right to have the benefits of the lease passed to someone else (such as the purchaser of the business being conducted from the premises), provided they are suitable to be tenants. Secondly, whether or not the lease may be used as 'security' against a loan.
NOT ALL LEASES ARE RENEWABLE, NOT ALL LEASES ARE ASSIGNABLE, AND NOT ALL LEASES MAY BE USED AS SECURITY FOR A LOAN.
Landlords can be private individuals, local authorities, or property companies. In most cases the tenant will have the opportunity to renew the lease when the term of it expires, either by virtue of an option to renew contained within the old lease, or because the landlord wishes to continue to rent out the property, or because he is obliged to do so because of the provisions of the Landlord and Tenant Act, 1954.
In the majority of cases the tenant will have a right to renew his lease for a further period provided that the tenant has observed all the terms of the old lease. Your solicitor will advise you of the implications of the particular lease you are considering taking, as to whether or not you will have a clear right to renewal on expiration.
A term referring to something tangible that the finance source can hold or have charged to them during the period of the advance.
This can be freehold land or property, leasehold property, valuables, etc. The value thereof must be readily realizable and an allowance is often made by discounting the value to ensure it can be sold quickly to repay indebtedness.
In the event that the borrower defaults on the loan, it is to this ‘primary security’ that the lender first looks to defray the outstanding debt.
A lender will also require the ‘personal guarantees’ of the borrowers - thus they remain responsible for any outstanding debt after disposal of the prime security.
'External security' is that provided additionally to the main or prime security being offered (the business being purchased), such as a house or shares.
Where there is insufficient security in the value of the business that you are buying against the loan that you need, a 'second charge' can be offered on 'external security' - say a house - which already has a mortgage on it. Whereas 'equity' refers to the difference between the market value of the house and the outstanding mortgage (the 'first charge'), usable equity is considered to be 70 to 80% of the value of the property (known as its 'forced sale value') less the outstanding mortgage. Third charges will not normally be considered suitable as additional security.
Thus a house might be worth £100,000 on the open market, but only have a forced sale value of £75,000, if the first mortgage is for £50,000, then equity in the house that could provide additional security for a loan is £25,000.
This is an abbreviation for 'Stock at Value' and often appears in advertisements or sales particulars immediately after the price. It is determined on the day of completion, usually by independent stock valuers, at 'cost price'.
The purchase price is made up, therefore, of either the freehold value or the value of the lease, plus the value of the 'goodwill' of the business, plus the value of the fixtures and fittings: these three together will be the quoted 'asking price' in an advertisement for the sale of the business, and in addition you would buy the stock for whatever its value is at cost on the day of completion.
Loans are normally expressed as a percentage of the price excluding SAV - i.e. you will normally be expected to find the balancing percentage of the price plus SAV, plus purchase expenses, from your own resources (usually without recourse to further borrowing).
Accounts, by their very nature, are historical and do not therefore necessarily reflect the current performance of the business.
When initially viewing a business, try to establish what the turnover and profitability is for a recent trading period, say over the last 12 or 13 weeks (unless the business is very seasonal), and be prepared to accept either the Vendor's word or whatever proof has been furnished (VAT records are usually an excellent source for this information).
You can make further checks in due course when you have had your offer accepted, and in many cases the performance of the business will be checked by an independent valuer, to determine precisely the level of turnover and profitability, as part of the process of the lender considering the loan application.
Clearing Banks often wish to see 3 years audited accounts, which can be a useful guide in terms of trends, but hopeless for assessing the true levels of current profitability.
Remember that it is the normal convention in preparing accounts to show the turnover and expenses with the VAT deducted - so the business' 'takings' (what passes through the till) will normally be higher than its 'turnover' (the takings less the VAT).
Gross profit is traditionally given as the difference between the buying price of a product (or all goods sold by the business) - i.e. what the wholesaler or supplier charges, exclusive of VAT - and the selling price, exclusive of VAT, expressed as a percentage of that selling price.
However in some labour intensive businesses (such as garage repair workshops and hairdressers) wages are often included in the costs prior to determining gross profit.
Thus goods bought for £10 plus VAT and sold in a shop for £15 plus VAT will show a gross profit of £5 - therefore the gross profit margin will be '£5 divided by £15 multiplied by 100 = 33.3%.
Gross profit margin should not be confused with 'mark-up': in the example just given the 'mark-up' was £5 on a cost price of £10, therefore it is calculated as '£5 divided by £10 multiplied by 100 = 50%'.
The net profit of a business is what remains from the gross profit after deduction of the operating expenses.
The operating expenses typically would include rates, electricity, wages, accountancy, insurance, telephone, motoring costs, etc.
Trading accounts will also show as expenses items which are individual to the particular owner - such as finance charges, taxation, depreciation, and owners drawings.
Thus frequently reference is made to adjusted net profit, which is the Net Profit that would have been attained if these personal or individually variable expenses had not been charged.
Please be aware that you are usually only entitled to see the vendor's profit and loss account and not his balance sheet unless you are buying the shares in a limited company.
Goodwill is the element of the purchase price that reflects the 'intangible value' of a business.
One can put a specific value on elements such as the freehold property, or a lease, or the fittings, but it will be seen that these elements alone do not make a business at all, let alone one worth buying!
Goodwill is the value placed on the fact that a business has been well established, has a good reputation, regularly attracts a certain level of trade, and maybe does so over limited hours, etc.
These are the items included in the sale price and required to either display or store the stock or otherwise perform the function of the business (a counter, a till, a frozen food cabinet, an alarm system, a barbers chair, the floor covering, a computer, etc., depending on the trade).
An ‘inventory’ of what is included in the sale is usually prepared as an integral part of the contractual arrangement and unless specified by either the selling agents or the vendor it is assumed that a prospective purchaser will be taking over such items free of any outstanding liability (HP, lease, etc.).
Items that are not the property of the business but are on free or nominal loan from the supplier (often the case with ice cream cabinets, greetings card stands and tights/stocking displays, for example) should be clearly identified.
As this suggests, it refers to the ability of a business to repay or 'service' the borrowing in addition to covering all its normal expenses and generating an acceptable profit.
What is considered an 'acceptable profit' varies according to the size and type of the business involved.
When considering borrowing, from the point of view of both the lender and the borrower, it is essential that there appears to be a clear ability to repay the borrowing within the agreed timeframe, and this should allow for the possibility of fluctuations in interest rates and levels of trade.