BUSINESS STRATEGY/FINANCE
The New Normal by Michael O’Meara and Loren Picard
W
elcome to the world of
(website lenders are generally
In this approach you take the cash
financial engineering. Allow
referred to as marketplace lenders).
flows coming from the asset and
us to introduce you to the power and
In this world where investors are
direct them to different investors at
simplicity of some basic financial
searching for yield—and not just any
different times. Investors who get
engineering techniques that will
yield, but yield with a risk level they
most of the cash flows earlier generally
expand your business opportunities,
understand—FE can be a market
get less of the interest generated by
allow you to entertain new lending
differentiator and give you and your
the underlying asset and suffer fewer
strategies and help you understand
firm a competitive advantage. If you
losses if there is a default. Investors
that when Wall Street does financial
have the ability to accurately design
who get more of the cash flows at a
engineering (referred to hereafter
different return scenarios across risk
later date typically get a higher interest
as FE), it is what we lay out in this
and return profiles that incorporate
rate than the previous investors,
piece, but with less transparency to
the most sensitive variables to
but in exchange they must suffer
the average investor.
return, you will be way ahead of the
more—if not all—of the losses sooner
average lender who says, “We offer
and definitely prior to the previous
is also about allocating risk. It is also
our investors an 8% return.” Without
investor. This structure is a simple
about risk mitigation.
context and details, investors have no
senior/subordinate structure.
At its core, FE is about leverage. It
When you own a cash-flowing
idea what the assumptions built into
asset, whether a loan or property, you
that 8% return represent (a lot of the
can leverage that asset with borrowed
time there are no assumptions built
money. Assuming the cost of the
into the return quoted).
loan you are using for leverage has a
Let us look specifically at
Structuring a $3 million loan, the basic idea is:
$3 MILLION First Meeting
lower interest cost than the net cash
leveraging debt secured by real estate.
flow (sans principal) coming from the
You can leverage it in two ways. The
asset, then you should expect a higher
first is to put the secured debt up as
return, all things equal, compared
collateral and borrow against it. This
to not leveraging the asset. This is a
is called financial leverage. This is
very popular use for leveraging an
very common and doesn’t take much
can be created between these two
asset, but usually entails much more
to understand other than you must
extremes. Also, the cash flow rules
risk than necessary and in a lot of
read the leverage/loan agreement
are a further layer of complication
cases requires a personal or corporate
very carefully in order to know all the
and can be structured differently
guarantee on top of the loan being
ins and outs of when the leverage is
from deal to deal.
provided as collateral.
due and payable, cure rights, reps and
The relevance to private lenders and lenders operating with a sophisticated website is apparent
18 PRIVATE LENDER
warranties, etc. Another way to leverage the debt asset is called structural leverage.
$2.7 MILLION Senior
$300K Junior
There are many variations that
FE allows for much more complicated structures than a simple senior/subordinate structure. If you ever get the chance take a look at a