Property debt repositioning plan could help save small businesses
Some business owners who are burdened with property debt may be able to restructure that debt by transferring it or part of it into their company to alleviate cash flow pressures. Such moves as part of an overall personal and corporate debt restructure can facilitate the survival of the enterprise and preservation of employment.
Small entrepreneurs play a key role in protecting and generating employment. This is an essential ingredient in the overall recovery of the Irish economy.
Many businesses that have weathered a major storm and stabilised their underlying business are engaging with their lenders to agree debt sustainability measures which can cope with the problem of a property overhang.
This overhang is generating, either directly or indirectly, a significant drain on resources in order to either fund the rent or the interest on the borrowings.
This can be by way of direct costs of a lease if the business is a tenant or interest costs where it is an owner/occupier.
A variation on the latter is where the principals of the business are the landlord having purchased the business premises in a personal capacity either as part of a wider portfolio or as part of their pension planning.
This can be an inefficient structure from a tax perspective with the drawings from the business to fund the property borrowings being taxed as income in the hands of the director/shareholder.
What can be done?
So what can be done to address these issues? The subject of rent reductions and lease re-gearing is highly topical at the moment particularly in the retail sector.
A number of high profile retailers have recently sought the protection of the High Court appointing an examiner as a means to restructure their businesses.
As part of the process they have exited unprofitable stores repudiating or surrendering the leases together with negotiating rent reductions on the remaining store estate. This has proven very successful in some cases returning the business to a more stable footing for the future to weather the continued crisis in consumer confidence and spending.
Businesses who are essentially owner occupiers face stubbornly high property costs with few options available to them. The property cost relative to their overall cost base has gotten out of sync with the business model as turnover and profitability have fallen.
It is therefore difficult for these businesses to position themselves for any market improvement and fund growth with a property millstone around them.
Realistic proposals for debt restructuring and a pragmatic lender are a key part of the recovery story in these instances.
The incidence of business owners personally owning the property from which the business operates is widespread. The strain placed on a business to fund the principal's personal borrowings can put the enterprise in jeopardy.
An overall restructure of both the corporate and personal property debt is required and should be discussed openly with the lenders. If a single bank is involved it improves the chances of a successful restructuring.
As part of the restructuring, lenders are commissioning independent business reviews to carry out an assessment of the trading business whilst also instructing valuations to be prepared on any property assets. This allows the lender to evaluate and assess any restructuring proposal presented by a borrower.
The tax inefficiency of substantial drawings subject to income tax to fund personal borrowings is something that should be addressed.
There may be opportunities to move the property and an appropriate amount of debt into the company to fund it directly, receiving a deduction for the cost and reducing the overall salary payments and associated income tax payable on the property owner's salary.
In many circumstances we come across a combination of all of the above and indeed far more complex ownership structures. The banks generally are keen to support robust businesses and are amenable to realistic restructuring plans.
Given the importance of the SME sector in Ireland, the de-coupling of trading businesses from distressed property assets will play a very important part in the speed with which domestic SME's can recover and focus on their core business. Professional and efficient restructuring will accelerate this process.
Declan McDonald is restructuring and insolvency partner, PwC