Posted by John Behle on November 10, 1998 at 24:40:54:
There has been a lot of discussion about funding notes and using private investors. I am sharing an article I wrote on the subject to help expand and clarify on the questions there have been.
Paper Funding Pitfalls - By John D. Behle
I get asked a lot about using private investors. One of the risk areas of paper is funding notes through private investors. Some educators say do it, others warn you to stay away. Why the controversy and differing opinions? They are looking at different ways of doing things.
I absolutely agree. Don’t broker notes to private investors. Do work with private investors. Sounds like a conflict? It really isn’t. Like many other areas of paper and investments, how you go about something and structure it makes a world of difference.
Selling to the Naive
One of the riskiest things you can do in this business is to broker a note to a naive investor. If it goes bad - you pay. It violates one of the primary rules of investing in notes. “No liability - without Control”. If you have any liability, you better have control. If you don’t have control - don’t do it. Brokering a note to a naive private investor carries this risk. They won’t know how to collect the note or solve any problems that arise. Even if they do something to screw it up - they’ll blame you. So will the courts.
Selling to a Pro
Unfortunately, this can come back to bite you also. I had a call from a troubled new broker one time. He had brokered a note to a local investor in his area. He made a few hundred dollars. He was sued for tens of thousands. He lost. The irony is that it was one of his first deals and the investor had many years experience. The courts still considered the new broker liable.
A few years back an experienced broker even lost out when they sold a note to an institutional investor. There was fraud involved where an un-related broker had dummied up closing statements and a policy of title insurance. I was totally astounded that either party would just accept and rely on the phony documents. One simple call to the title company would have prevented the problem.
Any way, the broker was sued by the “Sophisticated” investor. Bottom line is that brokering notes contains risks. When it passes through your hands a “Stain of liability” remains. You may not be able to avoid having to broker notes as you start out in the business, but you should quickly develop a long term plan of developing “funding” sources and keeping the notes. If I showed you all of the factors involved, lessened liabilities and lost potential profits right now - you would never broker another note.
Many of my most successful students do not broker any notes - yet they buy more and do more deals than those recognized as “Super stars.” It’s funny that some banks, insurance companies and other institutions don’t think we exist and don’t even invite us to their conferences because we don’t broker notes to them. Well, that’s fine. I may make ten thousand on a note I fund when someone else would have made one thousand as a broker. Our portfolios, cash flow and net worth grow every month, while a note “broker” just has a nice job.
Borrowing from a “counseled” investor
You can safely use private investors for your funding as well as institutions. The difference is most institutions want to own the note (they know the profits), where private investors want a good return, but want you to guarantee and manage the note. If I own the note and borrow from the investor (secured by the note I buy), I collect payments, manage the note and pay the investor. Technically it’s not a guarantee to the investor and you want to avoid that term because of securities laws, yet I am signing a note to them with a promise to pay (you don’t get a better guarantee than that).
The investors I use for note funding are counseled and educated about notes, but their real focus is that they are loaning to me or my company with the note as collateral. They have the best of both worlds. A great note and a third party guarantee.
A World of Difference
Here’s an example. I buy a $50,000 note for $35,000 and sell it for $40,000 to an institution. I make $5,000 and hopefully nothing goes wrong to come back and bite me. Not bad for a couple days work and some well thought out marketing.
Or, I could borrow from an investor. I buy for $35,000 and borrow $40,000 against the note. I still make $5,000 right up front. But what if the note pays off in a few months or I improve the note using one of the 117 different techniques covered in my books.
The note pays off for $50,000 and I pay off the investor loan for $40,000 and pocket an additional $10,000. What if I entice them and offer to let them pay the loan off for $45,000? I make an additional $5,000.
Two to three times the profits of the “Broker” and we’ve only scratched the surface. There are so many ways to improve notes that over 50% of the notes you buy will improve within a few weeks of you contacting the payor. It’s amazing how few investors are aware of and profiting from these techniques. Everyone’s been trained to broker to the institutions.
It reminds me a little of the first two times I tried yogurt. No one told me the fruit was at the bottom and I wasn’t all that impressed with the top part.