Investment Opportunities; Alternative Investment Strategies
Non-Traditional Investment Opportunities
Investment opportunities exist that can return higher rates of returns than conventional investments. If you are interested in alternative investment strategies, or may be thinking of an “Investment” outside of traditional CD’s, stocks, and bonds, YOU SHOULD TAKE THE TIME TO REVIEW THIS OVERVIEW OF ALTERNATIVE INVESTMENT STRATEGIES. And pay particular attention to our disclaimer. We’ll start with the Disclaimer.
In today’s economy, many successful people are looking for opportunities to improve their returns on cash holdings. Many institutional options are available, including CD’s, bonds, stocks, and other traditional investment holdings. The returns vary with the risks and the investor is constrained by the regulatory environment within which these products are offered.
Alternative investments are available that can achieve higher returns. These alternatives can also result in much higher risks; including TOTAL LOSS OF THE INVESTMENT. The following potential opportunities involve SUBSTANTIAL RISKS and are presented for information purposes only.
In the event that an investor decides to pursue one of these opportunities, he/she should exercise Due Diligence and carefully examine the risks associated with any prospective investment. THERE ARE NO GUARANTEES OR WARRANTIES. Each transaction must be evaluated on its own merits and the investor must evaluate the risks before making their decision to put their money at risk.
ASSET BASED LENDING:
Banks are the best example of Asset Based Lending (ABL). The model is fairly simple, determine the value of the asset in the event of liquidation (foreclosure) and lend money accordingly.
In today’s regulatory environment banks are required to follow strict rules and guidelines in making loans. In many cases, loans are denied due to factors not related to capability of the borrower or value of the asset. As an example, a borrower’s poor credit history(score) would prevent the bank from making a loan; regardless of the ability to pay back or potential of recovery in the event of default.
And therein exist the investment opportunity. A private investor (lender) can make loans without regulatory interference, based exclusively on his/her evaluation of the opportunity. Generally speaking, the loan rate can be increased, but should be within reasonable ranges of current bank rates and correspond to the risks. Additionally, the lender can take additional collateral to secure the investment and create “events of default” that are unique and tailored to the borrower.
One of the downsides of this opportunity is the cost of foreclosure and the legal procedures associated with the foreclosure. And then, once the investor has acquired ownership of the collateral, the asset must be sold. While the investor may prefer to have a performing loan, in some instances, depending upon the value of the collateral, an investor may actually achieve a higher Rate of Return in a foreclosure; but the lender must not be predatory in his/her lending practices.
SALE/LEASE-BACK OF ASSETS:
Similar to an Asset based loan, the sale/lease back opportunity secures itself in the asset. In this scenario, the lender actually takes title to the asset and leases the property back to the borrower; in many cases with an option to re-purchase. The interest, or return, is built into the lease payment and the “buy back” price.
The terms of the sale/lease back are negotiated. In most instances, in the event of default, the lender does not give any credit for payments made and cancels the lease; taking full ownership of the property to dispose of as he/she sees fit.
PURCHASE OF CLASSIFIED (DISTRESSED) LOANS:
Banks are required to classify all loans according to strict rules. These rules often require the bank to set aside cash reserves to cover potential losses on troubled loans; reducing the liquidity of the bank and in some cases impacting the banks cost of capital. Banks pay close attention to classified loans and depending on the number and amount of such loans, the banks will sometimes “sell” the loans at a discount; leaving room for an investor to make a substantial return.
These opportunities tend to be highly risky. The borrower has already been identified as problematic, by conventional banking standards, and in most cases may have been granted special financing terms. On the other hand, depending upon the value of the collateral and the payment history of the borrower, these types of investments can be financially rewarding. An investor must be confident in the value of the collateral, the security position of the lender as it relates to other debt, and the documentation of the loan.
PURCHASE OF ASSETS OUT OF BANKRUPTCY PROCEEDINGS:
Generally speaking, a debtor in a bankruptcy proceeding is subject to the sale of his assets; either by a Trustee or under a “363” sale. Once again, the re-sale value of the asset is the benchmark for consideration.
In some cases, the purchase can be “friendly” with the cooperation of the debtor, or can be independent of the wishes of the debtor. In a friendly acquisition, sale/lease backs are common. If the asset is pledged as collateral, the creditor will often have a controlling voice in the ultimate price of the property; but not in every case. Additionally, unsecured creditors will have the opportunity to voice their objections to a sale and bidding in a 363 sale is open to the public, for the most part.
The Court has authority in certain circumstances to sell the asset free and clear of any and all other liens. In those circumstances, the investor becomes the owner free and clear of past mortgages.
REAL ESTATE INVESTMENTS – SALE/LEASEBACKS AND LOANS:
Real Estate opportunities are unique. Generally speaking the value of the asset can be determined. Depending on market conditions the asset can be sold timely. And most investors are generally familiar with how real estate transactions are handled.
Often, businesses will have substantial equity in their real estate. An astute investor can buy the asset at a less than market price and lease-purchase the property back to the original owner. The investor gets an income stream and is protected by the value of the asset. The business(or owner) gets his need cash infusion and buys back his property over time. If the business fails, or payments are not made, the investor owns the property and can evict then sell the real estate property.
LENDING TO BUSINESSES – START-UPS AND CASH STARVED COMPANIES:
As previously mentioned, Banks are limited in their ability to fund loans to businesses that do not meet strict underwriting principles. Many times, a business can support a loan but can’t be funded due to the underwriting requirements.
The tight regulation of the banking industry has “tightened” credit availability to many small businesses. In years past, small businesses relied upon banks to fund their cash flow, their inventory, and the equipment purchases. Today’s regulatory environment presents many challenges to small entrepreneurs and creates opportunity for private investors to take advantage of the need for capital by small business.
In these situations, a private lender is often appreciated by the borrower; making the private lender a priority. In addition to typical collateral, the private lender can further secure themselves in additional assets owned by the company and/or by the owner of the business. Generally, these types of loans return a higher than market rate with terms negotiated.
TAKING EQUITY POSITIONS IN A BUSINESS:
Taking a an equity position (buying stock) in a company can provide the highest financial reward. Conversely, the investor can lose 100% of his investment; and that happens often.
There are a number of factors to be considered when contemplating an equity position. A fundamental issue is “Control” of the business. Even with majority ownership, an investor can be limited by the bylaw of a corporation and certainly develops a fiduciary duty to the company and his/her co-owners. Secondly, management is a serious consideration. If the business wanes, does the investor have the time, experience, knowledge, and desire to take over operations? And thirdly, not finally, is the company’s business model sound?
In order for the investor to recover his investment, he must either sell his interest or receive compensation in the form of dividends or some other mechanism. Often, investors will take a minority position and tie their repayment to a % of sale, profit, or some other measurable indicator. As a minority investor, caution is the operable word; a diligent review of all corporate documents is necessary and those documents may need changes to protect the minority partner.
In all instances of equity investment, an investor should conduct a thorough Due Diligence investigation of the operations and the financial condition of the company by an independent third party. The investigation is usually proceeded by the signing of a Letter of Intent(LOI) which outlines and summarizes the purchase terms. Upon satisfaction of the findings of the Due Diligence investigation, the investor will execute final documents to become an owner of the company; with the advice of legal counsel.
COMPETENT ADVICE NEEDED:
If a private investor wants to pursue any of these alternative investment opportunities the investor should rely upon competent advice from professionals with experience. In addition to a professional who can locate these opportunities, the investor should consider the use of a Financial Analyst(different than a planner or a CPA) and a good business attorney. These investments can be complex and should be built around sound business practices.
There are groups of “Angel Investors” who make these types of loans or investments. But even Angel Investors know that the business must be viable and the legal documentation must be thorough. These groups, and others like Private Equity Groups, conduct serious Due Diligence investigations and hire competent attorneys to prepare the final documents for execution. The days of the “Hand Shake” deals are in the past; unless you want to subject yourself to serious risk.
A person considering non-traditional investment must cautious, deliberate, and exercise good judgment in evaluating not only their return but their risk. THE ENTIRE INVESTMENT CAN BE LOST. As many stock brokers advocate, NEVER INVEST MORE MONEY THAN YOU ARE WILLING TO LOSE. These types of investments and or loans should be considered as “highly aggressive” investments where the risks are extremely high; the returns should correspond to the risks.
Even with the risks, many investors are finding opportunities to earn substantial returns in these non-traditional investment opportunities. Careful review, thorough evaluation of the transaction, and establishing favorable terms are essentials to a successful investment.