Morgan Allen and Steven Oliver analyse debt and funding for UK independent schools in 2025

 

It goes without saying that the UK’s independent school sector is navigating a confluence of pressures. While demand for high-quality education remains, the financial underpinnings of schools is being tested by the obvious: reduced revenue/falling enrolment following the addition of VAT of fees, particularly at the key entry points; and huge hikes in expenditure as a result of higher employers National Insurance contributions, loss of relief on business rates (for charity schools) from April this year, and for some, the effects of a higher minimum wage.

To add yet further burden, there are inflationary pressures on operating costs, higher borrowing costs and a cautious lender base.

Seismic structural change 

In hindsight, the term ‘unprecedented’ was overused during the Covid pandemic, with the majority of schools having come out of the other side, albeit bruised along the way.

There was a parental flight to quality, changes in teaching methods, and yes, unfortunately, some closures.

Having said that, for some schools the outcome was positive. Income was down during the summer term in 2020 via fee rebates. On the other hand, with reductions in expenditure via furloughed staff and other running costs reduced, some schools saw margins actually improve during that period. The pandemic resulted in little actual structural change, when compared to the current emerging bloodbath.

The current environment for schools truly is unprecedented, with the combined obvious factors having a seismic effect, resulting in interesting behaviours of merger and acquisition activity. For example, schools are now very proactively looking at M&A opportunities (which didn’t occur during Covid anywhere close to the extent they are currently), either hoovering up feeder prep schools to secure pipeline, or charity schools merging into groups, although in some cases, schools may have left the latter a little late.

Additional examples of structural change:

1. Schools going co-educational.
2. Diversifying income by introducing nurseries (sometimes wrap-around day care models) or a dedicated special educational needs offering (which, when done right, has higher margins).
3. Stronger schools with access to funding are embarking on substantial capex projects to expand capacity. That said, these schools are top-tier with waiting lists and can afford to do so. They are spending to survive/thrive. The middle to bottom tier schools are unable to take that risk.
4. Expediting sales of non-core properties and land.

 

In short, the sector dynamics will be totally different on the other side, for those schools which survive.

The cost of capital – higher for longer

Following the global financial crisis in 2008, the UK saw a period of prolonged interest rate stability. The market became used to these incredibly low rates, which helped spur huge asset price increases, especially in property.

Rates began their upward journey from 0.1% in December 2021 and continued to rise peaking at 5.25% in August 2023. So, after nearly 13 years on sub-1% base rate stability, rates went up by 5.15 basis points in 22 months and anyone who had purchased property during the historic lows found themselves breaching loan covenants and unable to service loan interest, which was coupled with values falling dramatically, as investors repriced markets and liquidity.

Debt serviceability – not asset value – became the primary focus for lenders and a source of continued stress for borrowers. While a lender can absorb a higher loan-to-value, not servicing interest is a far more serious matter.

Lenders responded to these changing market conditions by sizing loans based on servicing interest at a ‘stressed rate’ (base rate + margin + market expectations) and this in turn meant some lenders reduced loan-to-value ratios, often capping at 60-65% (although some clearers are still offering up to 70% loan-to-value, but only for the very best performing schools, which don’t need to borrow at that level anyway).

The bad news is that the current market expectation is for rates falling until August next year, before unfortunately increasing. Thus it would appear the interest rate risk will continue to be a key factor for a while, with rates falling less and remaining higher for longer.

Lender appetite

While many lenders remain attracted to the sector and are very much open for business, they are conducting deeper due diligence in granular detail. Schools must demonstrate robust interest cover and cash flow resilience to attract or retain debt facilities.

There is a greater focus on forecasts, rather than historic trading performance. Banks want to see a school’s plan B and even a plan C in a worst-case scenario. Schools will hopefully be able to demonstrate decent headroom and also know how many pupils they can afford to lose before a loan become unserviceable. Is a loss of 20 pupils the tipping point, 30 pupils, or 40 pupils?

Lenders want to see that schools and governors have commercial acumen and foresight, and have a plan in place to know what levers can be pulled immediately, that is, drop an unpopular subject, merge forms etc.

Banks are also undertaking their own internal stress-testing, for example, assuming a surprise interest rate hike and what effect that would have on debt service.

Rising employment costs and pressure on margins

In April this year, employer National Insurance contributions rose and thresholds decreased, adding further weight to the salary bill of independent schools. Given that staffing typically accounts for more than 65% of a school’s expenditure, the financial effect is substantial.

A school with 80-100 staff is now facing six-figure increases in annual labour costs, on top of existing pension obligations and inflation-linked wage settlements. This pressure erodes surpluses and limits flexibility to invest or service debt. Anecdotally, we are aware of pay freezes last year in anticipation of an increase in employer’s National Insurance contributions. It is also in the press that some schools are undertaking redundancy consultations.

Breaching covenants

Schools will be aware that in some of their supplier contracts there are clauses which oblige them to report bank covenant breaches. Lenders are seeing schools request that these covenant breaches are waived, in order that schools are not forced to declare them to contractors/suppliers and worst-case, have to renegotiate existing contracts, which can be time-consuming and costly.

Schools are already flagging to their lenders potential covenant breaches, expected in 2026. The full effects of this new world will not be known until March/April 2027 when pupil cohorts who are currently doing GCSEs or A-levels depart, and when one-off costs such as redundancies will be crystalised, impacting EBITDA (which is surplus before interest, depreciation and amortisation). Again, with the benefit of hindsight, Covid was a mere blip in trade when compared to this unprecedented maelstrom of financial pressures.

In a loan default, lenders can renegotiate the terms of the debt, ask for it to be repaid in full immediately, increasing pricing/fees etc. A covenant breach isn’t necessarily just waived through; covenants are there for a reason. Breaches can be pretty serious, thus if a school anticipates a breach, early engagement with the lender is really important for securing a successful outcome. A head in the sand approach helps neither party.

Covenant breaches will also affect the auditor’s ability to make a clean going concern assertion in the annual accounts, which when published will be there for all to see on Companies House/Charity Commission websites.

Generally, banks are keen to work with schools and help them through this period, rather than see schools resort to more expensive asset finance or third-party funders, which overall aversely affects EBITDA.

Administration scenarios remain school-led, rather than bank-led, as governors are cognisant of their fiduciary responsibilities with their accountants advising on when to obtain the advice of an insolvency practitioner.

Outlook and recommendations

Looking ahead, we see five clear priorities for school finance leaders:

1. Engage lenders early – Begin refinancing discussions well in advance of facility expiry. Alert lenders to potential breaches as soon as possible.
2. Stress-test cash flows – Bursars are already doing this, providing realistic and worst-case scenarios. We suggest also preparing a scenario in which debt/interest covenants are breached. What is the tipping point?
3. Reassess capital strategy – Prepare for lower leverage and a broader lender universe.
4. Focus on covenant headroom – Optimise interest cover and debt serviceability.
5. Invest in forecasting – Lenders want clarity, resilience and credible mitigation plans.

Conclusion

Schools are adapting to a new era of financial scrutiny and tighter credit conditions. By engaging proactively and planning ahead, finance leaders can preserve financial stability and continue to support their educational mission.

In the next issue of Independent School Management, Morgan Allen Property Surveyors will consider some worked examples to illustrate how easily debt has become non-serviceable for previously viable schools.

 

Morgan Allen is managing director and Steven Oliver a director at Morgan Allen Property Surveyors.