Whether you’re a budding entrepreneur with a new restaurant concept or an established hotelier with expansion plans for an already thriving business, there’s one thing in common – the requirement for capital. The tough economic climate has caused a sharp decline in lending, particularly for smaller businesses. Pitmans LLP takes a look at some of the funding options available to the hospitality sector.

Whilst the economy is slowly but surely recovering, many hospitality businesses consider that the time is ripe for expansion. However, banks are generally not lending as much capital as they used to, partly due to concerns over customers ability to succeed in a tough economic market. According to a study carried out by accountancy firm RSM Tenon, in 2012, 47% of hospitality and leisure businesses turned to alternative sources of finance for expansion.

Debt Finance:

Banks have not stopped lending entirely. Traditional lending from banks is generally still available if you have a good idea and a strong existing business. New lenders are also setting up in the UK often with a focus on particular markets where sector knowledge allows lenders to better analyse risk.

To combat the increasing difficulties for hospitality businesses of obtaining bank finance, in August 2012 the Government launched its Funding for Lending scheme. The scheme offers low interest loans, of 0.25% per year to banks to encourage more lending at cheaper rates. The scheme will allow hospitality businesses with an annual turnover of up to £50m to access loans with interest rates one percent lower than those outside of the initiative, with some providers also offering fee free borrowing. The scheme has recently been extended until January 2015.

Private Equity and Angels:

Although private equity houses have attracted a fair bit of criticism in recent years, there are still many good funds looking for places to invest. Although going the private equity route will lead to some control in the business being relinquished, businesses will typically gain plenty of expertise, with a representative of the fund usually joining the company board.

The business angel networks are also a useful source of funding.  With interest rates on cash savings being so low, private investors are pooling resources and investing in growing businesses.  A hospitality business has the twin benefits of a potentially strong brand and a roll out opportunity for growth and as such can be an attractive proposition for investors.

Enterprise Investment Scheme (EIS):

The EIS is designed to encourage individuals to invest in smaller, higher-risk trading companies by offering a range of tax reliefs to individuals who purchase new shares in those companies. EIS relief is available where a qualifying company issues new shares. The purpose of issuing these shares, and any others issued at the same time, must be to raise money for a qualifying business activity. In order to benefit from the relief, the relevant shares must be held for at least three years after issue or, if later, three years after the company begins to trade. The relief consists of an initial 30% income tax saving and exemption from capital gains tax when the EIS shares are disposed of.

Personal Finance:

A more risky and small scale method of funding is simply through the use of personal loans. New restaurant owners Jason and Sophie Coolbaugh raised £30,000 using three credit cards to set up a Mexican restaurant in Westminster, after being rejected by the banks. The business is two years old and now debt free and the Coolbaugh’s are expanding their workforce and business. Many small business owners also turn to friends and family to raise finance.

Equity Crowdfunding:

Crowdfunding has emerged as an innovative entrepreneurial way of raising capital over the internet. The principle is simple; raise required levels of finance through a high volume of small scale investments from people who like your ideas and are prepared to back them in return for some form of incentive, such as discounts. Crowdfunding allows the business to raise its profile and generate a great deal of support early on whilst allowing customers to directly benefit from the business’ growth.

The first crowdfunding website, Crowdcube, received FSA authorisation in February this year and many more websites are now starting to operate in the UK. Independent crowdfunding schemes are also a possibility. BrewDog, Scotland’s largest independent brewery, raised £2.2 million through their ‘Equity for Punks’ online scheme in 2011, making it the world’s most successful independent crowdfunding programme to date. Now with 7,000 investors, it is the fastest growing food and drink company in the UK. In need of further capital to fund expansion plans, it has just launched the third phase of its crowdfunding programme with the hope of raising an additional £4m.

Conclusion

The banks have been, and are always likely to be the first port of call for hospitality businesses seeking funding. The Government’s Funding for Lending Scheme provides an incentive for banks to lend to businesses in the hospitality sector on more favourable terms. However, in a climate where raising funds for commercial projects through business angels or traditional lending from banks remains challenging or in some cases, simply unachievable for entrepreneurs and existing small to medium sized businesses, more innovative mechanisms to raise capital need to be found. Crowdfunding in particular has proven to be a success in raising large sums of money quickly, particularly for start-up businesses.

Courtesy of Institute of Hospitality July 2013