Before we go any further, let’s make sure we’re working from the same definition of hard money business loans.
For the purposes of this discussion, hard money business loans and hard money loans in general, are typically secured by real estate.
Because the lender is not usually concerned with the application of the funds acquired, I’m further defining a hard money business loan as a source of funds invested into a business operation.
The lending criteria for issuing a hard money loan is primarily focused on the equity held in real estate.
Typical characteristics: 1) private lending sources, 2) short interest terms from one to three years, 3) up front fees on closing, 4) short in duration, 5) use of funds not a focus, 6) limited number of debt covenants if any, 7) interest only payments is quite common, 8) failure to pay results in sale assets to retire the debt.
While hard money lenders have their detractors, they serve a very real and valuable purpose in the commercial financing market place.
Pros and Cons
Pro – The application process for a hard money loan tends to be considerably faster than a comparably sized conventional loan application.
Con – Compared to conventional real estate financing through institutional lenders, the cost of hard money loans is almost always higher.
Pro – In many cases hard money can be lower cost than cash flow financing facilities like subordinate debt and factoring.
Con – Up front fees also add to the cost of hard money business loans which can significantly increase the effective interest rate you’re actually paying over a period of time.
Pro – As a bridge loan, these funds are normally outstanding for a short period of time so the shorter the use, the lower the potential cost.
Con – At the end of the interest term, if an extension is required, but not granted, the loan needs to be paid out in full.
Pro – From a cash flow point of view, an interest only payment, even at a high rate, can still be less strain on the cash flow.
Con – Once you sign up for an interest term, its the same as most fixed interest rate terms whereby there is usually a 3 month penalty for early payout.
Pro – Hard money can also be extended against non real estate assets where real estate is still the primary security in the overall security package for the loan.
Con – If you fall behind with your payments, the foreclosure process can be swift and will typically be as fast as the local jurisdiction will allow.
The basic scenario for considering a hard money business loan is when a business has exhausted its conventional financing sources and is still short money to operate, expand, or just take advantage of short term opportunities.
Because repayment is usually required within a one to three year period, hard money business loans can also be categorized as bridge loans.
If you’re thinking about whether or not to secure a hard money business loan, consider the following points:
>>> Can you generate an ROI? If you have good, profitable business in front of you that you can’t bank because a lack of short term capital, then a hard money business loan may be a solid option.
>>> Do you have an exit strategy? Remember that a hard money business loan is effectively a bridge loan that you’re going to have to pay back in the near future.
If you can’t create a cash flow scenario where full repayment is possible at the end of the loan term, then a hard money business loan may not be a viable option.
>>> What are your alternatives? If your alternative financing options are equity based where you are giving up a portion of the future profits of the business, a hard money business loan can allow you to retain control of the business and keep the related profits.
>>> What’s the impact on personal liability? If your alternative business financing options are high cost and still require a personal guarantee, then a hard money business loan may actually be a better option.
>>> Can you generate enough capital? If a hard money business loan cannot completely address your financing need, then it may not be a good fit.
Sometimes business owners will use hard money to buy time until they can acquire additional capital to meet their entire financing need.
The problem with this strategy is that hard money is not very patient, and if it takes longer to acquire the additional funds than your cash flow allows, the hard money lender will not likely postpone or restructure your debt serving costs.
Instead, if you fall behind in your payments, they will likely realize on their security, which may put you out of business.