Partners in funding
4 January 1997
The 1990s have seen a considerable change in the financial performance of professional partnerships. Historically, lending to partnerships and their partners has been relatively safe and during the 1980s partnerships benefited. However, the recession of the early 1990s caused a number of partnerships to experience difficulties, with the result that banks have reassessed their lending criteria.
One area of change has been the increased need to consider the aggregate financial position of the partnership and its individual partners.
For example, with smaller firms of up to 20 partners, banks are likely to look closely at the partnership and the partners' borrowings as a whole. With larger firms these factors are more likely to be considered separately.
In viewing the aggregate position, the asset and liability profile of the firm and partners is considered; in some cases, individual partners are required to produce a personal balance sheet. When looking at a partner's personal balance sheet, consideration is given to mortgage commitments in comparison to the value of underlying assets, as well as to the level of capital loans to the firm.
Banks which deal with the affairs of a firm will invariably offer better terms to partners who choose to be looked after by the same bank.
One particular problem for banks in lending to partnerships is the inconsistency of partnership accounts. As partnerships are not required to have audited accounts, there is some flexibility in how the accounts are drawn up. The bank, therefore, has to consider the figures in the accounts with greater care.
Typical areas of inconsistency are matters such as work in progress valuations, goodwill, debtor provisions and the provision for taxation. All these elements may have a significant effect on the firm's balance sheet, producing widely varying results from the same set of figures.
A large number of professional practices have historically been funded by bank overdrafts partly because such lending has been seen as good business and facilities have been easy to obtain. This service has been combined with banking arrangements for clients' funds held by the firm.
There is often scope for fluctuating bank overdrafts to be partially or wholly offset against client funds, for interest purposes only, subject to the rules of the partnership's statutory body. Thus the bank overdraft facility can appear to cost the firm very little.
In practice, in most firms holding client money the position is more complex, with a requirement to account to clients for interest on some accounts. This can result in a complex banking operation and may involve little or no interest being paid in respect of the overdraft.
A number of banks have tried to simplify these arrangements by reducing their involvement in operating client money accounts. Some banks have a facility which enables the partnership to manage the client accounts itself.
Banks are increasingly recognising the longer-term nature of professional partnership's borrowing facilities and may provide these funds by way of loans of up to 10 years or more at rates which differ only marginally from the overdraft rate.
These loan facilities may be more secure than the potentially "repayable on demand" overdraft facilities, so the result should be additional stability and confidence for a practice. This needs to be compared with the normal borrowing position of a corporate business where such longer-term finance is more common. In some cases it may be possible for longer-term borrowing to be provided on an interest-only basis.
Other factors affecting the size of facilities available to a partnership and its partners are the number of debtors and the amount of work in progress outstanding; typically, banks will take into consideration up to 50 per cent of these figures.
Banks will also look at the level of drawings and tax provision where they would expect these, in aggregate, not to exceed the current year profits. In addition the partners' individual capital accounts, current accounts and other reserves, as well as the historic finances of the business, will be reviewed by the lender.
Finally, while this article mainly concerns businesses which are borrowing money it should be noted that banks are always keen to assist firms where funding is not a problem.
They offer facilities such as treasury management, client fund management as well as the regular banking facilities required by most business. In addition, long-term loans, usually on an interest-only basis, can sometimes be provided to individual partners for partnership capital purposes to maximise tax relief.
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