Venture Capital Hard Money Loan
A hard money loan is a specific type of funding found in the real estate market. There is a close connection between venture capital funds and a hard money loan because of some shared common factors.
In the real estate business, a hard money loan refers to a specific type of loan that is made using an actual piece of property as collateral. The loan is generally made at a much lower LTV (loan to value) ratio than a traditional mortgage loan and at a much higher interest rate. Also, the value used in calculating the LTV will generally be a “quick sale value” rather than a traditional appraised value. The quick sale value assumes a sale made more rapidly usually within a one to four month time frame. So, what is the connection between venture capital and a hard money loan?
The hard loan typically comes at a much higher interest rate than a mortgage loan. There is no escaping the salient fact here that the purpose of the hard money loan is to bail out a property holder in trouble. The nature and conditions of the hard loan are such that if alternative funding was available, it would be used. The hard loan is often the loan of last resort. Many hard loans are made to land owners holding commercial properties and operating some type of venture on them. They are anxious for funding to reverse some problematic trend and restore profitability to their venture.
An examination of the typical hard loan deal would usually reveal some sort of inherent risk to the lender. This explains why conventional financing is no longer and option. It would be unlikely anyone would deliberately seek a loan at a higher interest rate. It is the inherent risk that justifies the higher interest rate and explains the lower LTV ratio. However, it is this same risk and the higher return on investment that attracts the venture capitalist to the hard money loan arena.
One of the factors that make a venture capital type hard money loan attractive is the possibility of value added funding. The venture capitalist making the hard money loan does not want to see the land owner fail and be forced to sell the property. Although the low LTV provides some foreclosure protection and most hard money loan lenders assume a first lien position on the property, this is still not the way to make money. It merely provides some risk protection. Still, venture capital that produces no return on investment is venture capital losing potential income. The lender wants to see the loan recipient turn things around and repay the loan at the higher interest rate.
Hopefully, this turn around and repayment takes place in a relatively short period of time. To this end, the venture capitalist is likely to make available the managerial and financial expertise to the property owner, perhaps, even a networking collection of connected firms able to guide the property owner into a turnaround position of stability and profitability. In an ideal transaction, this turnaround becomes a win/win result. The property owner has weathered a financial crisis and the investor has made a short term and substantial return of investment.