Financing for diversifying your food and drink offering

It cannot be denied that Scotland is a food, drink and tourism hotspot in 2022. With its natural resources and long history of food production, Scotland has always been recognised as a home of great produce - however it has been the outstanding innovation and diversification which has grown the industry in recent years and which continues to shape it as a destination for food tourism. 

When it comes to starting a new food and drink enterprise, a key component in being able to invest is appropriate financing. It is important to understand the implications of entering into finance arrangements before taking the leap into a new offering, particularly where the new enterprise is a diversification which is supported by an existing and established business. Here, we explain a few of the legal issues which might be involved, and common things to consider.

The Loan

If you have an existing loan or overdraft in place and are considering diverting these funds to your new enterprise, you should consider whether this is permitted. Most loans have a purpose for which the funds can be used, and funds cannot be used for other purposes without the consent of the lender. It is also common to see a restriction on a change of business or a substantial change in assets, and a restriction on lending funds to other legal entities. You should consider whether the new enterprise is a significant deviation from the business in place at the time the loan was originally offered and discuss your intentions with the lender if you have any concerns.

Where taking a new loan for the purpose of a new opportunity, there are also a few areas to bear in mind:

1. Who is the borrower?

If you have multiple legal entities within your food and drink business, it is important that the entity likely to use the loan is the borrower under the documentation. This is particularly important in the context of diversification if you have set up a new company in order to ringfence the new enterprise. It is not uncommon for a loan to be provided to a "parent" company, or to another company which is under the control of the same beneficial owner, which has more established assets and income. A disconnect between the borrower and the person using the funds may have consequences in terms of accounting and tax treatment, as well as in the event of legal enforcement, which should be fully understood before any loan is taken.

2. When can the lender ask for full repayment?

Any loan must be repaid and usually there is an agreed schedule of regular repayments, and a final repayment on the end date. However, it is important to always check the additional events of default or termination events. These are the circumstances in which the lender will be entitled to call for repayment in full. These terms may not be in the loan agreement itself, but within the detailed terms and conditions which are provided alongside the agreement. It is common to see "cross-default" provisions which should be carefully considered in the event of a diversified business. A "cross-default" is where an event such as insolvency or failure to pay debts in another related entity (such as another company under common ownership) can cause a default for the borrower.

Guarantees

If you are asked to grant any guarantees, you should always take advice on how this interacts with any lending or security being given, as guarantees can have unintended - and sometimes undesirable - consequences. Guarantees are effectively a promise to pay on behalf of the borrower. This means that any entity which signs a guarantee can find itself in the same position as the borrower by way of a simple notice from the lender. Usually there is no requirement for a lender to exhaust enforcement options against the original borrower, and they can choose to enforce a guarantee instead of pursuing the borrower for its own debts, if they feel this is likely to be the most efficient way to ensure repayment of sums due.

Guarantees are also "supported" by any security granted by the guarantor in favour of the same lender, whether this is granted at the same time as the guarantee or not.

Security Documents

Loans can be secured or unsecured. It is common in the context of new enterprises for the loan to be offered against the strength of existing streams of income and/or existing assets. You should consider any and all documents given to a lender by your business – whether by the borrower or any guarantor – to ascertain which assets are given in security and for which lending. In particular, be aware of the following:

• Are the securities "all sums" securities? This is a standard position but means that security is not linked to a specific loan, but to all sums due by the relevant [borrower or guarantor] [debtor] to the lender at any time now or in the future.

• Are there any assets you do not want the lender to access? If so, you should be wary of giving floating charges or debentures. Consider ringfencing those assets and take advice on how best to do so.

• Have you already granted security in favour of the lender – and is the lender relying on security over assets other than those currently under discussion? Always consider everything which is in play – whether you are signing the document now or have signed it before.

• Does the borrower or provider of security have lending or security in place already with another lender? Are the lenders relying on the same assets, and will both lenders be happy to share in security?

Dealing with financing arrangements for a business which is diversified or in the process of diversifying is complex. This is particularly due to the many income streams and multiple legal entities. While the above will give some indicators of things to consider, each circumstance is individual and it is important to consider your position and take advice when entering into legal documents.