I work with a Finance Broker with specialist products for the property developer.
What we offer is often referred to as “Stretch Finance”; as a rule of thumb guide, that means that the lender will look at the value of the finished product, rather than simply the site value today.
Our role is to arrange the whole “funding stack” of the project; we save time for the developer in terms of locating and putting together up to four or even five lending sources, which ensure the project is fully funded right to the last sale.
The terms used are Gross Development Value, which could be expressed as gross developed value, after the works have been carried out – LTGDV for short.
All this takes us into a world where we are assessing value on something which has yet to exist, and its future existence is dependent on the Developer – ie the applicant – adding value.
It is within that context that we discuss the matter of Personal Guarantees, to set out some facts and try to dispel the fog of mythology which surrounds the matter
How Personal Guarantees Work
This article attempts to explore the issues, get some facts straight, and see why the property developer – early stage or mid stage – should have the question of PG’s high on the list of matters to decide on as part of the application process, and -- most importantly --as part of the overall plan for the company.
This is not the time for an emotional knee-jerk decision, which is what I often hear; the fact is that PG’s impact on the way that funding for the project is tackled from the outset and decisions need to be taken , in the full knowledge of the implications.
Understanding how PG’s can affect the overall structure of the finance, and how a successful outcome can affect the next project in the series in a five or ten year plan, is the focus of this article.
We have established that the eyes of the lender are on the value of the given project – the GDV.
Why do lenders ask for PG’s?
In a nutshell, the lender is relying on the Developer to create that new value – probably not by operating the cement mixer, but by managing the project through contractors, finance control, right through to marketing and sales.
If the Developer is applying for Stretch funding, the implication is that there is little equity, ie cash contribution from the company.
PG’s are required by lenders where the cash contribution from the developer is negligible or slim, and the LTGDV is high – over 50% will almost certainly trigger the PG requirement.
In the past, in cases where there is little contribution to the project – “skin in the game” is the term often used – and the going gets tough – it is all too easy for a Director to decide to walk away from projects.
I had a prospect who was applying for some £15m for a project – he and his business partner were reluctant, to say the least, regarding PG’s. After explaining carefully to him what PG’s are about, it transpired he had done just that, -- walked away from a project -- a decade ago.
I had been wasting my breath.
If a developer does this, it potentially leaves the lender with a half- completed project with no concrete idea (sic) of what has been done and not done – maybe Building Information Modelling will solve that problem one day – the lender is then faced with two sub-optimal alternatives; putting the project into an auction where every bidder will know it is a fire sale, or employing a new company to complete the job – a daunting task for any new CEO.
This would almost certainly mean a shortfall in the cash recouped versus the loan and interest outstanding.
Fund managers have a duty of care to their shareholders/investors to protect the cash laid out; that is the way the business is conducted, end of.
An attitude of entitlement
I do find, in talking to applicants for finance, that there is an attitude of entitlement.
The story goes; I have found a wonderful project, it will be a privilege for a lender to give me the cash required; let the lenders form an orderly queue and I will pick the best offer.
The reality is that the fund managers – be it one of the Challenger banks, a pension fund, a family office or HNWI – has been entrusted with deploying hard earned cash.
The responsibility is towards the investors, large or small.
Duty of care. That is how financial services works in this country.
The fund manager will want to ensure that the King Pin – in this case the Developer – will do what was claimed could be done, and not walk away when the challenges – and there will be many – hang as a cloud over the breakfast table.
Personal Guarantees are the preferred way of ensuring the Developer sees the ship into port, come hell or high water.
I often try to impress that duty of care when I am networking or speaking to clients; all of us who occasionally turn on the TV are familiar with people with smiley faces giving a Victory V sign; widowed ladies looking rather nice in a natty cape; what this represents is the pooled funds of hard-working people who have paid into pensions and savings plans of various kinds over a lifetime.
They trust and require that the fund managers will invest in things – buy things in simple terms – which will bring the returns they expect.
Bottom line; that is what Personal Guarantees are about.
What If things go wrong…
How do PG’s work, and what qualifies?
The family home of any of the Directors is not usually acceptable; put simply there are obvious complications in a worst case scenario.
Property other than the family home is preferred.
Cash is also an option; however, the question could be raised, would it not be a better option to make a cash injection into the project, perhaps negating the need for a PG.
The assets are usually set out in an Assets and Liabilities schedule
Perhaps it is best to bear in mind that the collateral, in the eyes of the lender, represents or replaces a strong balance sheet on a more advanced development company.
The PG amount is not for the full amount of the loan; it can be for between 10% and 25% of the total loan amount; it can be higher if there is perceived risk.
Each shareholder is jointly and severally liable for the required amount, until the loan and interest is paid in full.
That liability continues, irrespective of resignation or sale of shares during that period.
In some cases, there may be insurance facilities available; the cost needs to be factored into the overall cost of financing.
In a nutshell, prior to engaging in a project where the cash injection is less than 50% LTGDV, the matter of what can be put up as collateral needs to be clarified among the shareholders.
What if Directors have no collateral for PG’s?
So; a good project has been identified; however there is no collateral suitable to put into the Assets and Liabilities schedule for the lender’s requirements
If the Directors and shareholders decline, or cannot, put up collateral for PG’s, this needs to be established before taking on a project, and the financial implications down the road need also to be taken into consideration.
There are two main routes we can offer.
The first is for less experienced developers.
The e first of these may be to ask us look at those of the “Challenger banks” which do not require PG’s.
In the UK, most of the lending for relatively small property development projects is offered by what are known as the “Challenger banks”, rather than the High Street banks.
The best Challengers offer – of course – the best rates – and the best rates are reserved for developers with a good track record and balance sheet.
I often get emails into my inbox from competitors with the headline “Best rates guaranteed”.
I chuckle as I read these claims and ask; To who? For what project? Does anyone seriously think the first-time developer with five units to construct is going to get the same “Best rate” as the Developer giants?
There are a handful of lenders in the market place which will take on project funding without PG’s.
Those few that do also have very specific criteria as to the type and level of project they are prepared to fund.
Perhaps most importantly, the rates will inevitably be higher than the lenders who do.
That higher rate – which is not negotiable, and, yes, I had a prospect who tried to do that – needs to be factored into the whole cost of the funding for the project; put simply, it is going to cut down the profit margins and raise the question; is this project worth proceeding with?
In addition to less favourable rates, there will be clauses in the small print; these will vary from offer to offer.
In my experience, many applicants either do not read the clauses in small print, and/or do not take on board the implications; these clauses usually apply to overrun and cost issues, and can slice hard into profit margins if the clauses are invoked.
In a nutshell, a loan or JV without PG’s may be possible, but the financial forecasts do need to take on all the implications and overall cost of finance for the project. If the project is delivered on time and in budget, in spite of being less profitable than might otherwise be the case, it could be a stepping-stone on to the next project; ; lenders welcome repeat business.
The second may be an option for experienced Developers
It may be worth considering a Forward Funding route.
Forward Funding is available from a number of our sources, including pension funds.
In a nutshell, the fund will deploy all the cash required for the project, the site acquisition costs and the build costs.
The issues of debt and equity no longer apply, nor do PG’s.
The fund will own the project during the development phase and post completion.
The developer takes a percentage of the costs as recognition for bringing in the project on time and within budget – the percentage being some 10-12%.
The advantage is that, with a large project, this puts cash on the balance sheet, as well as adding to the all-important track record.
When sales prices of residential properties are good, this could mean less profit than might otherwise be expected; when times are more uncertain, the fact that the units are effectively pre-sold is a bonus.
Forward Funding may be a good solution for an experienced team wishing to take on a larger and prestigious project but with insufficient collateral to support a solution comprising a combination of debt and equity.
How PG’s can operate in practice
Assuming PGs are offered and accepted – there is no formal lien as a matter of course, assuming the lender has accepted the schedule of Assets and Liabilities – and the project proceeds, what happens if problems arise and there are cashflow issues?
The first port of call is to discuss with the lender, and the contingency clauses in the Terms and Conditions may be called on.
The lender will want the full story, which is why management accounts need to be fully up to date at all times – with clear accountability the contingency amount will be released
Once that amount is utilised, the developer may be able to ask for more – this should not happen, however we are facing uncertain times – if leveraging allows.
After these avenues are exhausted, the lender could ask for liquid assets from the developer, by realising liquidity from the assets previously approved.
Right at the moment, what we are seeing from lenders is a preference for slightly higher contingency amounts – going up as far as 10% of costs rather than 5%; and seeing those factored in even though it may mean a reduction of the projected ROI.
Personal Guarantees should be considered as a means to an end; the long- term aim should be to establish a balance sheet and /or cash contribution to projects in the future which will mean that they are no longer a part of the requirement.
Some Directors may wish to emerge among the big players; the demand for affordable and social housing in the UK is massive; others may prefer to operate in their local area where they know the demographic and feel comfortable. That is individual preference, we can arrange a suitable funding stack in either case.
We would see each application, not as a one off, but as a part of a series, as with experience a company can take on projects of increasing size and prestige.
As industry professionals, we recognise that lenders themselves like to have a relationship and repeat business applications. Put simply, it makes life easier for them; the due diligence is complete and the trust is established. Fund managers have nightmares like the rest of us.
In addition, while It is a well-known fact in the construction industry that there is a shortage of labour at the present time; what is less well known is that there is a also a shortage of Company Directors capable and willing to take on the responsibilities of medium to large scale property development.
If the Directors are able to offer Personal Guarantees, this enables us to take the application to a wider range of lenders with competitive rates for that particular project and sector.
If no collateral is available, there are two main choices; specifying a lender which does not require PG’s; this may be the only route for smaller projects; or, in the case of larger projects, Forward Funding may be a good long-term policy.
Although both of these routes mean potentially slimmer profit margins; it can be a route to a better balance sheet and, importantly in the long term, that all important track record, which gives us more scope with regard to the lenders which we can approach.
A good track record is the way to the fund manager’s heart.
Property developers preparing to make applications for funding should, as a matter of course, consult a qualified solicitor, who specialises in the sector.
Company Directors who are looking at developments in the residential, commercial and leisure sectors and would like an initial discussion regarding the funding stack, please email firstname.lastname@example.org