Questions

What is a fair rate of return on a $70K investment?

My girlfriend managed the third-ranked Allstate agency in the Midwest in 2014 and is pursuing opening up an agency herself by July 1, 2015. She needs to have $70K in the bank at the time of signing. My parents are reaching retirement and will be investing the $70K. What is a fair way to calculate the return for my parents? My parents are approaching this as an investment and will want to see some sort of return. What should they expect? Thanks in advance!

5answers

The rate of return should compensate for level of risk your parents are taking on by making this investment. You could look at it on a scale - risk free would equal the rate of return for US Treasury Bonds (Current 30 Year rate is 2.68%) and move up from there to unsecured loans like credit cards that start at 12%+

You parents are investing into a small business (historically very few make it more than a couple years) with little recovery value (If your girlfriend can make a go of it and gives up the value your parents would get if the agency is liquidated will most likely be pennies on the dollar). This puts it in the higher risk category in my option. I would say the rate of return has to be at 8%+ to compensate for the risk they are taking on (remember they have to pay taxes on the interest they receive as well so their effective rate of return will be much lower depending on tax rate.

You may want to ask yourself if you want to tie your folks retirement on the success of your girlfriends business. Worse thing that could happen is her business fails and you have an unemployed girlfriend and parents that can't afford retirement.


Answered 5 years ago

An agency is an instant cashflow model business.

Ugly to scale due to logistics of a team and the mess of being in a client-service business model.

But easy to rapidly monetize.

Make a phone call. Close a client. Collect the cash. (Yes, that's a bit over simplified).

Your girlfriend shouldn't grab a dime from anyone before locking in her first client.

An agency can be entirely self-funded and there's little reason to pursue funding.

After she had generated her first $50,000 in clients (for example), she can supplement growth with debt financing.

And, in no way, is the idea of your generous, retiring parents investing $70,000 into a first time business owner, when statistically most businesses fail ... a good idea.

Fair rate is a flexible concept.

If I was lending out $70k, I'd want to see 3x $210k back as a minimum. Irregardless of whether that is "fair"... it would be the minimum (for illustrative purposes) where the process of the due diligence and contracts and parting with $70k liquid in trade for a "maybe" $140k gain would be of interest.


Answered 3 years ago

I have both started a business of my own and leveraged it's success to purchase another company. Your girlfriend has the expertise to understand the challenges that starting a new agency will bring.

Fundamentally, what is more important than the rate of return for your parents is the extent to which there is security on the funds. If they are nearing retirement replacing this $70,000 in principal may not be an option for them if it is lost.

Does your girlfriend have a solid business plan that is realistic and demonstrates an ability to service the debt's principal over a time frame that is acceptable to them?

A standard business loan would seek repayment over a five year period with an interest rate of approximately 6%, assuming you quality.

The key difference with borrowing from family and all private lending in general is that the length of the loan is often shorter as there is a desire and need to actually be repaid in full.

My advice would be to have your girlfriend show your parents a detailed business plan, highlighting expected revenues and expenses and what efforts she is going to undertake on the expense side to guard as much of their investment up front as possible. She should offer a repayment plan on a timeline that is acceptable to them and affordable to her and offer an interest rate of between 6-8% and some security to ensure that even if this venture is no successful, they will be repaid.

I have arranged approximately $250,000 in vendor take back financing (private loans) for ventures I have been involved with over the last two years and have a good understanding of the details for both parties in these types of arrangements. The highest interest we've agreed to is 8%, with asset backed security for the lender and the longest term we've negotiated is 3 years.

Because this is your parents, you should be able to do better I would expect, but a five year repayment with a 6% rate would seem reasonable to me for both sides.

If you have any follow up questions, let me know.


Answered 5 years ago

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