Private Money Lending Structure
Hi BP Community,
I've been lending informally for the past couple of years to family and friends on fix-and-flip deals, and I am now looking to formalize it i order to raise further capital and grow a sizable book. After reading and speaking with other lenders, I've found there are a couple of different ways these companies are structured:
1) A close-ended fund much in the nature of a PE/private credit fund, where the operator earns an asset management fee of invested capital (2%) and a servicing fee of the loans in the portfolio that the operator is actively managing (.5-1%). LP gets a 8-10% preferred return and the net-of-fee returns are split 50/50 after the fact.
2) A simple assignment agreement on a per-deal basis, where the operator provides the loan and then assigns it to the end investor, whereby the operator earns a brokering or servicing fee (the end investor earns the interest rate on the note minus a certain percentage fee, and the operator earns the rest).
I'm trying to weight he pros and cons of both, keeping in mind that I value flexibility, discretion in which deals I choose as an operator, and making it super easy for the borrower. Any advice on which fee/legal structure to go with would be much appreciated.
Thanks!
Hi Eric!
First there are a few considerations you need to acknowledge BEFORE you start diving into take other people's capital for lending activities. First, if you have been lending "informally" in the past, I would say get real formal real quick. Once you start accepting capital that isn't your own, you now have a fiduciary responsibility to uphold. Informal goes right out the window. You will also need a good idea of WHAT, WHERE, and WHO you would want to lend to, and HOW you want those deals structured. Are you going to invest in your local market where you live? Do you know the lending laws in that state? What about the foreclosure process? Do you have any key vendors in place that will help with increased deal flow? (think attorney to draw up docs, attorney to handle foreclosure/default situations, vendors to establish a value or do background checks on potential borrowers, a system to securely transmit sensitive information from borrower to lender, the appropriate disclosures in place, an application, etc etc). What market advantage do you have in your area for lending? Are you faster? Go to higher LTV? Lower fees and points? Do atypical construction like container homes for example. These are all things you need to have in place BEFORE you think about scaling up and taking on investor capital.
Now- the other part of your question about the fund model versus assignment process. I would only venture into the fund realm after you have been doing this for awhile or have someone you can partner up with that has been lending for awhile and has a following. The process for a Reg D fund will likely cost about $20k to set up with legal fees for the documents, investor portal set up, if you are going to have a fund admin company that even more than the $20k start up. There will also be ongoing monthly fees associated with the fund, so if you are going to go that route, be well capitalized to get it off the ground, so don't count on the income from the asset management fee to actually be income for awhile. There are a ton of considerations for this option that are beyond the scope of a simple online post, but I will say tread lightly and really think about this option. The fiduciary responsibility it HUGE here.
The assignment agreement can work, especially when you are newer to lending and won't have a ton of deal flow. There are a variety of ways to do this, and if your state allows it you may even be able to fund the loan and then sell the loan to another investor as well.
Another consideration in all of this is not only the capital involved, but the time involved. Scaling up is not always the answer. More of something doesn't mean it is better. The thing I enjoy about private lending for me is that it is a business in a backpack. I can go anywhere in the world and work on this stuff with minimal input from me and it keeps going. I wasn't trying to work myself into another W2 job. As a military spouse I needed geographical and time freedom, so if I can make the passive income number I want doing what I am doing, then why keep going and take away more time from my family and my hobbies? Part of your initial consideration needs to be what do you want your lifestyle to look like? What amount of money are you shooting for monthly? Why is it that number?
Quote from @Alex Breshears:Thank you very much for the valuable insight. Loved your podcast episode and can’t wait to dive into the book!
Hi Eric!
First there are a few considerations you need to acknowledge BEFORE you start diving into take other people's capital for lending activities. First, if you have been lending "informally" in the past, I would say get real formal real quick. Once you start accepting capital that isn't your own, you now have a fiduciary responsibility to uphold. Informal goes right out the window. You will also need a good idea of WHAT, WHERE, and WHO you would want to lend to, and HOW you want those deals structured. Are you going to invest in your local market where you live? Do you know the lending laws in that state? What about the foreclosure process? Do you have any key vendors in place that will help with increased deal flow? (think attorney to draw up docs, attorney to handle foreclosure/default situations, vendors to establish a value or do background checks on potential borrowers, a system to securely transmit sensitive information from borrower to lender, the appropriate disclosures in place, an application, etc etc). What market advantage do you have in your area for lending? Are you faster? Go to higher LTV? Lower fees and points? Do atypical construction like container homes for example. These are all things you need to have in place BEFORE you think about scaling up and taking on investor capital.
Now- the other part of your question about the fund model versus assignment process. I would only venture into the fund realm after you have been doing this for awhile or have someone you can partner up with that has been lending for awhile and has a following. The process for a Reg D fund will likely cost about $20k to set up with legal fees for the documents, investor portal set up, if you are going to have a fund admin company that even more than the $20k start up. There will also be ongoing monthly fees associated with the fund, so if you are going to go that route, be well capitalized to get it off the ground, so don't count on the income from the asset management fee to actually be income for awhile. There are a ton of considerations for this option that are beyond the scope of a simple online post, but I will say tread lightly and really think about this option. The fiduciary responsibility it HUGE here.
The assignment agreement can work, especially when you are newer to lending and won't have a ton of deal flow. There are a variety of ways to do this, and if your state allows it you may even be able to fund the loan and then sell the loan to another investor as well.
Another consideration in all of this is not only the capital involved, but the time involved. Scaling up is not always the answer. More of something doesn't mean it is better. The thing I enjoy about private lending for me is that it is a business in a backpack. I can go anywhere in the world and work on this stuff with minimal input from me and it keeps going. I wasn't trying to work myself into another W2 job. As a military spouse I needed geographical and time freedom, so if I can make the passive income number I want doing what I am doing, then why keep going and take away more time from my family and my hobbies? Part of your initial consideration needs to be what do you want your lifestyle to look like? What amount of money are you shooting for monthly? Why is it that number?
My brother and I are investor/operators in the DFW metroplex ourselves, so we’re excited to dive into this realm more “formally” and aggressively. Competitive advantage is something I’ve been mulling over a lot as well.
Thanks again and I hope to continue the discussion.
