Nursery Management: Finance - How tosecure the right terms

Many nursery operators have to rely heavily on the availability of bank funding, both to pursue a range of expansion opportunities and to meet their day-to-day cash requirements.

As credit markets have tightened, nursery operators have found it increasingly difficult to gain access to the funding that they need. By understanding how banks assess lending opportunities, you can maximise your chances of making a successful application for finance.

Allow a lender to understand your business

As a first step, a lender will want to develop a detailed understanding of your business in order to make an accurate assessment of future trading prospects.

Be prepared to talk about the experience and track record of your key employees, and the culture of the business. As an example, if you are trying to promote a people-focused culture, then a lender will want to see evidence of staff satisfaction as well as motivation to deliver a high quality of care within your settings.

You will also need to demonstrate that your business is viable and sustainable in the current climate.

Your most recent audited accounts and Ofsted inspection reports would typically be analysed; in addition, a lender will often ask you for management accounts and projections to be provided.

Be prepared to talk your bank through these documents, setting out the key indicators that drive performance -such as occupancy, staff costs and fee levels - and the assumptions you have made that underpin your projections.

Ensure that these are realistic and appropriately sensitised, based upon the key risks that you have identified within the business.

It is also worth bearing in mind that not all lenders have specialist knowledge of the day nurseries sector. Therefore it is often helpful to provide a view on its outlook within your application.

For example, while occupancy may be coming under pressure as unemployment increases, we should expect to see this being partially offset by parents returning to work sooner and working longer hours in order to meet rising household costs.

A lender will also want to get a handle on the local competition faced by your settings, and understand your unique selling point in relation to these competitors.

Why do you want to borrow?

A good lender will want to determine whether the purpose of the loan is in the best interests of both the bank and your business.

The two most common drivers for borrowing are as follows:

- Funding growth plans/expansion of existing facilities. This is typically provided by way of a loan with a set repayment profile over an agreed term.

- Funding the day-to-day cash needs of the business. This is commonly known as working capital finance, which often arises due to timing differences between collection of funds and making any day-to-day payments required to keep the business trading.

A working capital need could also arise as a result of parents taking longer to settle fees, while certain creditors may also ask for payments to be settled over a shorter time period. A lender would typically look to fund this requirement via an overdraft facility provided for up to a year.

A lender will want to establish that they are not simply funding the trading losses of your business, which gives rise to a substantial risk of default against the scheduled loan repayments.

Set out a proposal for repayment

It is important to set out how you propose to repay the proposed loan facility. For instance, is the loan you are applying for to be repaid from the day-to-day operations of your business, or from an asset sale?

A lender will conduct an assessment of your ability to service both interest and loan repayments. In the case of interest costs, a lender will typically calculate an interest-cover ratio by measuring how many times your business can cover interest costs from its operating profit (profit before taxation and interest).

The ability of your business to meet both interest and annual loan repayments will also be measured by determining how many times the annual borrowing costs can be covered by the free cash generated by your business (typically calculated by taking operating cash flow and deducting dividends/drawings, tax and capital expenditure).

Debt costs can be influenced by a number of factors. The most obvious one is the size of the loan, with larger loans resulting in higher debt costs. With this in mind, you should give careful consideration to the level of funding requested, and whether you are able to generate sufficient free cash to cover the total debt costs incurred.

The margin above the lender's cost of funds also influences your debt costs via higher interest payments. Lending proposals that carry a lower-risk profile will result in lower margins. Low-risk proposals tend to exhibit a modest level of debt against the asset value of the business (commonly known as the loan-to-value), and demonstrate comfortable levels of serviceability against total debt costs.

The term of the lending and repayment terms can also have a significant impact on the annual debt costs. Lending provided solely against the cash flows of the business as opposed to asset values (such as where the nursery settings are leased) would tend to be committed over a shorter term, given the higher-risk profile, which in turn gives rise to higher annual debt repayments.

Good management is vital

Lenders are increasingly looking for tangible evidence that a strong management team is in place at the setting in question.

Try to demonstrate that you are aware of the key risks and opportunities faced by your business in the current climate, and provide examples of actions that you have already undertaken to mitigate these risks as far as possible. One example might be that your nursery has agreed payment plans with parents who are struggling to pay fees on time.

Finally, try to prepare thoroughly for any discussions with your lender. At Barclays Commercial Bank, we have found that businesses that are able to demonstrate a sound understanding of the key financial and operational factors which drive solid business performance put themselves in a strong position to secure additional funding.

- Ian Murchie is a relationship director in the Barclays Commercial Bank Healthcare Team. If you would like to find out more about obtaining finance, please contact Mr Murchie on 07917 504215, or email him at ian.murchie@barclays.com.

VALUATIONS

Courteney Donaldson, director at Christie + Co, provides advice on valuations.

The global economic climate has impacted on the availability of funding across all property classes. This has led to a reduction in transaction volumes, a softening of multiples and a fall in day nursery values, thus highlighting the need for accurate valuations. Formal valuations are not only required for business acquisitions, they are also undertaken when the nursery owners wish to refinance.

The need for valuation expertise has never been more imperative than in the current climate. Any valuers undertaking a valuation of a nursery business, where values are directly related to trading performance, must have a sound knowledge and understanding of the sector.

Nurseries continue to be valued on the 'profits method' and values are driven via a multiple of earnings, or profit. Prior to selecting a multiple of earnings, the valuer must examine income streams, average fee rates and occupancy levels to consider whether the turnover reported by a business is fair and sustainable, or whether the business is over-or under-trading.

The valuer will need to understand the income sources such as nursery fees, NEG income and any one-off grant income payments. Consideration will be given to operational costs such as employee costs, staffing margins, rates, insurance, food, resource purchases and other operational costs. For leasehold nurseries, the valuer will examine the terms of the lease and level of rent payable, so that they may consider whether the nursery is over- or under-rented and the desirability, or onerous nature of the lease terms.

In essence, the valuer is seeking to determine the fair maintainable level of Earnings Before Interest, Taxation, Depreciation and Amortisation(i) (EBITDA) or net profit that the business is capable of demonstrating, achieving and maintaining.

The 'market value' of the nursery business is determined by a multiple which is applied to the EBITDA. This multiple is derived via market sentiment and selected through the examination of sales of other nurseries that are considered to be 'comparable transactions'.

Alongside the selection of a multiple valuer, judgement and expertise is applied. There is a variance in the range of multiples applied for freehold and leasehold nurseries.

During the past 18 months multiples, and hence values, have fallen. However, it is hoped that in the long term multiples will recover to previous levels.

(i)Amortisation is the process of accounting for an amount over a period of time.

For further information, please contact Courteney Donaldson on 0161 833 6924 or email her at courteney.donaldson@christie.com; or contact Mark Wingett on 020 7227 0794 or email him at mark.wingett@christie.com. www.christiecorporate.com.