Thin capitalisation: practical guidance: measuring debt: groups/companies in expansion mode
It is difficult to obtain finance for completely new business ventures. However, third-party lenders may be prepared to tolerate higher-than-normal gearing ratios for a business that is expanding, provided certain conditions are satisfied:
- The borrower must be soundly financed in the first place and able to demonstrate it can service its debts. In particular, it should have a well thought out business plan that includes reasonable and realistic projections for profits over at least the life of the loan, and the underlying assumptions of the plan should be robust. A realistic plan may well have a number of scenarios, depending on the market and economic conditions which may prevail.
- The borrower should have a clear idea of how it intends to reduce the debt over a reasonable period of time, normally bringing levels down towards those of a “steady state” business within three years or so. The reduction may either be by the repayment in instalments of some of the debt or the introduction of more equity, or a combination of both.
Given that third-party lenders may be prepared to accept higher levels of debt where a business is in a start-up or growth or acquisition phase, HMRC will discuss with UK groups the way in which this principle may be reflected in a thin capitalisation agreement.