Last time, I shared the private lender’s approach and gave an example. In order to broaden more on this approach i will use this medium to share another example. It is my hope that a lot of us will learn how to use this approach to our advantage.
In this second example, I used private lender with another method. This is the scenario and I’ll paint a picture. I was on a project to purchase a property. The purchase process was such that even if you have all the money, you should not drop it at once. You drop what is called a commitment fee for that type of transaction first and that is to show seriousness so that other necessary due diligence can be done before you are required to now make the other payment.
Now, this property purchase was going to be worth for example, 200 million and we needed about 10 million as the commitment fee. From here I will go to the very next method because I will use this example as well to explain because I used that method here with this private lender. Now, if all you were able to raise on your own is for example, 6 million, you are short by 4 million. For the private lender, the challenge is that the interest is usually high so you have to look at it vis-à-vis what you stand to gain to make sure that it is worth it otherwise you will use another method.
In going after private lender to raise this money, we asked ourselves a few questions. When we go after private lender to raise this money, the balance 190 million, how are we going to get it? Since we sorted out in our head how we were going to make a difference, we then asked ourselves, what are we going to make on this transaction. At the end of our exercise, we felt that we would be able to make 50% of this total sum as our gain on the transaction. Let’s say we are expecting to make 30 million net income after every other expenses have been taken care of except the cost that we are trying to consider here.
One of this situations happened to us during the boom time of share market when everybody thought they can double money in the capital market. You know there was a time everybody thought they were a stockbroker or stock analyst, analyzing everything for you but when the market crumbled, the people who are stockbrokers are the people who remained there. The people who still survived it are the stock brokers. The other ones, they are gamers. What I mean by that is they game the stock market, not that they are stockbrokers. At that time, if somebody wants to borrow you money, the options he has are much. He will consider “If I put it in capital market, what is the kind of return I’ll get,” and it was almost not impossible for someone to actually think at that time that they will get 100% easily and we needed this money to be in our hands for us to be able to pay it back comfortably only after two years fully. So what did we do?
What we actually did in this kind of example was, to go to the market to raise this, we promised 100% flat per annum and we said two years meaning we are going to pay as interest, 8 million at the end of the day because 4 million is going to come as interest because it is 100%. This is how we structured it. We said we’ll pay interest in the first year, in eighteen months, we’ll pay half of the principal, then by the twenty-fourth month, we pay the balance half and the other interest. What we said was that we’ll pay four in twelve months, we’ll pay two in eighteen months, then we’ll pay six in twenty-four months. Total that we are going to pay is 12 million. That is principal plus interest. Principal 4 million, interest 8 million. Now you’ll say wow, this is huge but you see, that’s why I said I will use examples so that you will know the scenarios you are going to use which method.
8 million is huge as interest over borrowing 4 million but for us at that time, this was the consideration. If we don’t get that 4 million, our ability to earn that 30 million in the same two years may be in jeopardy. It’s like, “Do you want to earn 30 million or do you want to use your 6 million to do another business that you will not have to pay 8 million on?” and maybe that business eventually you will earn 4 million in two years because if you pay 8 million out as interest really, what have you lost? Thirty minus eight, you are left with twenty-two. 22 million versus 4 million in terms of return on investment on your efforts in two years, which one will you go for?
So, the considerations are different. It’s not just the absolute sum in terms of what you will pay back as interest that you will look at. You need to look at the scenarios. You use that approach; private lender approach. And like I said, a private lender need not be a corporate body. In this particular case, we used a number of people because we’ve used this scenario in a number of our projects usually and we’ve used individuals, we’ve used corporate bodies as well and in terms of the people we took the money from, the common factor there is that the interest is always steep but it’s money you can get with a snap of your finger with little questions asked, with less formality.
The kind of purchases we’ve funded this kind of money with are not purchases the banks will even listen to you about, not to talk of asking you to bring documents. In the case of this one, if you should write them that you need money for it, the paper, they will take it and fling it through the window because they are not transactions that are bankable in that sense. Banks have the limit of risk that they want to take. As a business, you choose your risks well. An individual may be able to go with you more easily in such transactions than a regulated financial institution and so we decided to use them. You may also choose this method, if you are buying property that requires such huge capital.
I will be discussing another approach to buying property in the next series which should be out on Friday. Stay blessed.