How to Start Your Direct Lending Business (Lending Investor)
Aside from being an Energy Technology Expert, Marcial T. Ocampo is also a leading consultant in setting up your own start-up business, especially in direct lending — also called lending investor.
The following is a sample business plan for starting your own direct lending business. With today’s global economic crisis, it is important that credit is made available to small businesses with the least inconvenience and costs which normal banks would not otherwise lend for being too small an amount or for being not credit worthy.
On the other hand, traditional investment outlets provide very low returns that individuals with surplus capital placing their hard-earned savings either earn very low interests or risks in stocks and other high-yield instruments.
This article below will hopefully guide you start your own direct lending business.
Please contact the author below for further help in setting up your own direct lending business, including the needed administrative, loan processing and accounting systems.
For a minimal fee, you will be provided with a Sample Business Plan and a Sample Financial Model for a Lending Investor Business.
For a regular fee, you will be provided further with a spreadsheet for a five-year business plan (income statement and balance sheet) that shows the growth of your business to break-even and to profitability.
This model will provide you the minimum new loan releases and minimum capitalization that will provide sustainable operation to overcome the fixed costs of the direct lending business.
BUSINESS PLAN FOR DIRECT LENDING BUSINESS
In the Philippines, there is a great number of individuals and families that could not secure affordable credit because they are either retired already (over 55-60 years old), temporarily disabled (receiving disability pension for about 12 months), or under employed (receiving less than P15,000 gross income per month).
These individuals are therefore exposed to usury and are forced to borrow money at exorbitant interest rates of over 4% per month from pawnshops and individuals wherein they pawn as security jewelry, cellfones, laptops or desktops, motorcycles or vehicles and house & lot titles as collateral. Sometimes, they borrow at 5%-10% a month from individuals lending money for 1-3 months.
It is in this light that this corporation engaged in lending business aims to help them get affordable credit at 2%-3% per month plus fixed charges (3% service fee, 2% collection fee, 1% credit investigation fee, 1% legal/audit fee, 2.5% marketing/referral fee, documentary stamps [PhP 0.30 per PhP 200 PN amount if more than PhP 100,000], notarial fee [PhP 180 per loan] and creditor’s life insurance [PhP 1.55 per PhP 1,000 outstanding balance], all totaling around 8-9% as one-time fixed charges).
This is still much cheaper than their traditional sources of credit. The retired pensioners usually borrow around PhP 2,000-4,000 per month for a term of around 6 to 12 months. For a 12-month term at 2% per month, this translates to a 2.58% per month average interest. On the other hand, salaried individuals borrow from PhP 4,000-8,000 per month for a term of around 3 to 6 months. For a 6-month term at 2.5% per month, this translates to a 3.85% per month average interest.
Experience has shown that once a private employee (SSS member) or a government employee (GSIS member) retires at the optional age of 60 years old or mandatory retirement of 65 years old, the retiree suddenly loses access to affordable credit. This means that prior to retirement, the employee should ideally have saved money and/or invested his savings in some form such as time deposits, treasury bills, stocks, small business enterprises, apartment rental units, etc. in order to have regular replacement income after retirement.
Upon retirement, the retiree suddenly finds himself with little or no savings at all, and therefore, is solely dependent on financial support from his children or relatives and whatever little SSS or GSIS retirement benefits he is entitled. The retiree usually receives a lump-sum payment equivalent to 1-years’ salary upon retirement, and after 1 year of waiting, he begins to receive regularly his monthly pension, the amount of which depends on his last 6-months average salary prior to retirement. The larger the average salary, the larger the monthly pension he receives until he dies. The pension amount also depends on having a surviving espouse and children under 18 years of age.
On the other hand, a retiree with some savings and upon receipt of lump-sum payment finds himself with a large sum of money with little experience in investing such money to provide supplemental cash flow to augment his monthly pension which commences 1 year from receipt of lump-sum payment.
The lending investor business model is therefore an ideal solution to both retirees: that provides investor retirees with 10% p.a. net interest (after 20% withholding tax) income payable monthly, quarterly, semi-annually or annually, and borrower retirees a ready credit facility up to PhP50,000.
Since there is a 20% final tax on interest income which is shouldered by the lending investor company, this translates to a 12.5% p.a. gross interest income which is definitely much higher than what banks provide today: 2.5% p.a. gross interest on savings bank deposits, 4-5% on time deposits, 5-7% on treasury bills, 7-9% on commercial papers. Mutual funds as well as investment-linked life insurance products such as fixed funds, balance funds and equity funds may also provide investment outlet but given the sophistication and stringent age / health requirements, this may be out of reach from most retirees.
Identification of Target Market
The business of the lending investor is most appealing to small business ventures. The entities are usually engaged in the service sector, wholesale / retail trade and manufacturing / subcontracting. The agri-forestry and fisheries sectors may be tapped depending on the location of the business. Being primarily undertaken in rural communities, they are serviced usually by the informal money lenders (“Bombay” or “Indian” national money lenders).
Aside from business persons, the financial requirements of employed individuals in the locality are potential source of revenue. The lending investor may arrange formal agreements with various employers and extend consumer loans to the employees in the form of salary loans, appliance financing or direct loans.
The handling of consumer accounts is more tedious and burdensome as compared to business accounts. However, this difficulty is compensated by its ability to spread the default risk in having smaller but numerous loan amounts.
Lastly, individuals receiving monthly pensions from SSS and GSIS members due to retirement, temporary or permanent disability, and death (surviving spouse or children under 18 years of age receives survivor pension) are also potential clients.
Types of Credit Accommodation
The following are the general types of loans extended by lending companies. This lending corporation will concentrate, however, on salary loan and pension loans.
1) Direct Loan
2) Real Estate Mortgage
3) Chattel Mortgage
4) Market Vendor Loan
5) Assignment of Time Deposit
6) Salary Loan
7) Pension Loan (SSS and GSIS)
There are other specialized types of loan such as car loan, appliance financing, quedan guarantee, housing loan, bridge financing, etc. These labels are coined essentially for marketing purposes and they basically fall under the general types mentioned above.
Sources of Funds
A start-up lending investor such as its predecessor, Winning Edge Lending Investor (WELI), a single proprietorship, started with the following initial capitalization consisting of working capital, donated capital (donated vehicles – L300 van and Honda Civic car), donated software (Real Time General Ledger Accounting System), office equipment and pre-operating costs.
WELI was registered at the DTI last 28 August 2006, and thereafter, pre-operating costs were expended to complete the registration and licensing of the business, procurement of equipment, undertake office repairs, employee training and other incidental expenses. All of these were funded via equity of the proprietor and donated capital for the vehicles and general ledger accounting software.
Advanced rental & deposit to the initial and final location of the business amounted to PhP 46,000.
Office furniture, equipment, improvements and inventories totaled PhP 143,581.
Organizational & registration expenses amounted to PhP 18,115.
Donated capital in the form of vehicles (L300 van and Honda Civic car) and general ledger accounting software were valued at PhP 570,000.
Other pre-operating expenses for salaries & wages, company share of employee benefits, transportation & representation, professional fees, rent & utilities (electricity, water, telephone), security, gasoline & lubes, repair & maintenance, bank charges, and miscellaneous expenses (reproduction, parking) amounted to PhP 159,494.
Including cash on hand of PhP 32,809 as working capital, the total initial capital is PhP 970,000.
Advanced Rental & Deposit
2 months deposit rental, Dona Enriqueta 14,000.00
1 month advance rental, Dona Enriqueta 7,000.00
Light deposit, Dona Enriqueta 2,000.00
Water deposit, Dona Enriqueta 1,000.00
Light deposit, Dona Enriqueta (refunded) -2,000.00
2 months deposit rental – Verde Oro 12,000.00
2 month advance rental – Verde Oro 12,000.00
Office Furniture, Equipment, Improvements
Furniture & Fixture (Chairs & Tables) 15,087.25
Office Equipment (Safe, A/C, Ref, Computer, Printer, Fax, Tel, Stapler) 107,000.00
Leasehold Improvements (office repairs) 17,330.25
Initial Inventory – Office Supplies 4,163.50
Organizational & Registration Expenses
DTI Business Name 370.00
SEC Registration 0.00
BIR Registration 2,825.50
Mayor Business Permit 13,520.00
Barangay Clearance 1,400.00
Honda Civic (2001, 10 yrs life) 360,000.00
L-300 Van (1994, 15 yrs life) 180,000.00
General Ledger Accounting Software (2 yrs) 30,000.00
Other Pre-Operating Expenses
Salaries & Wages 25,500.00
Professional Fees (management, accountant, legal, audit) 0.00
Office Rent (Dona Enriqueta, Verde Oro) 69,440.00
HR, Admin, Janitorial 0.00
Company Share (HDMF, SSS, PH) 0.00
Transportation Expense 680.50
Representation & Entertainment (Meals, Lunch, Gifts) 12,940.97
Taxes & Licenses 0.00
Telephone (PLDT Dona Enriqueta, PLDT Verde Oro, Celfone) 10,778.49
Electricity (Meralco) 945.45
Gasoline, Diesel & Lubes 19,120.00
Vehicle Repair & Maintenance 13,494.59
Bank Charges 1,320.00
Miscellaneous Expenses 2,197.25
Cash on Hand 32,809.27
TOTAL Pre-Operating Capital 970,000.00
Additional Sources of Funds
The owner-proprietor obtained additional funds thru bank loan in the amount of PhP 1,795,000 with a term of 5 years payable in monthly installments at a fixed interest rate of 1% per month or 12% per annum.
As a non-bank financial intermediary without quasi banking functions, the lending corporation may now borrow funds / accept placements from a maximum of nineteen (19) individuals / entities at any one time. The funds sourced through borrowings from 19 lenders are not subject to the legal reserve requirement usually imposed on banks which cannot be used for lending activities.
This exemption from the reserve requirement provides the lending investor an advantage over other financial institutions. It allows the lending investor to lend out funds which should have been put in reserve. Borrowing is a productive source of funds for re-lending. If properly managed, it brings incremental revenues and profits without an infusion of additional capital from the owners / stockholders. The ability to raise funds from borrowings is largely dependent on the credibility of the management / owners / stockholders and the public’s confidence in them.
Another source of fund is a combo loan consisting of a 5-year term loan of PhP 1,000,000 with a fixed interest rate of 12% p.a. and a revolving credit line of PhP 1,500,000 with an interest rate of 10% p.a. on drawn amount. This loan is normally secured by a house & lot mortgage valued at 70% of its market value.
Taxes Affecting the Business
Following are the permits, licenses and taxes to be paid and withheld:
1) Renewal of Business Permit due Jan 20, 2007 (Mayor’s Permit, City Tax, Garbage Fee, Sanitary Fee, Building Insp. Fee, Electrical Insp. Fee, Plumbing Insp. Fee, Signboard, Fire Insp. Fee, New Registration Plate/Sticker, Zoning Fee, QCBRD) – PhP 3,707.00
2) Quarterly Renewal of Business Permit due Apr 20, 2007 – PhP 335.00
3) Quarterly Renewal of Business Permit due Jul 20, 2007 – PhP 335.00
4) Quarterly Renewal of Business Permit due Oct 20, 2007 – PhP 335.00
5) Annual Certificate of Registration due Jan 30, 2007 (BIR) – PhP 500.00
6) Monthly Percentage Tax (gross receipts tax or GRT to BIR) – 5% of gross income
7) Monthly Withholding Tax Expanded (to BIR) – 10% of marketing agents, rentals, professional fees (credit investigation, legal & audit fee)
8) Monthly Withholding Tax Compensation (to BIR) – 15% depends on monthly salary bracket and Company Share (employer): Pag-Ibig – PhP 100; PhilHealth – PhP 100; SSS – PhP 575.30
9) Final Withholding Tax (to BIR) – 20% of interest income when interest is paid to investor
10) Quarterly Income Tax Return (to BIR) – 0% to 32% depending on individual monthly taxable income. For partnerships and corporations, 35% on monthly taxable income.
11) Dividends from Partnerships and Corporations –
12) Documentary Stamps Tax (Promissory Note – PhP 0.30 per PhP 200 face value; Real Estate Mortgage / Chattel Mortgage – PhP 10.00 for first PhP 5,000 plus PhP 5.00 on each additional PhP 5,000; Certificate of Placement – PhP 1.00 per PhP 200,00 of face value; Original Issue of Certificates of Stock of Corporations – PhP 1.75 per PhP 200 par value)
Sources of Revenue
The lending investor derives its income from finance and non-finance charges on loans extended to its borrowers. The income consists mainly of the interest, service fee and collection fee and penalty/charges if any.
The rest are payable accounts since these are pass-thru charges for creditor life insurance, documentary stamps, notarial fee, credit investigation fee, legal & audit fee and marketing & referral fee. Since the cash out is less than the amount collected, there are residual incomes from these payable accounts.
SSS Pension Loan (3 – 12 months term, PhP 500 – 50,000 loan)
The loanable amount is from a minimum PhP 500 to 2,000 per month for a total of approximately PhP 25,000 for a 12 month loan. The interest is 2% per month, no creditor life insurance as the retiree is older than 55 years old (maximum age to be insurable by Insular Life), PhP 180 notarial fee per loan application, one time 3% service & processing fee, one time 2% collection fee, one time 1% credit investigation fee, one time 1% legal & audit fees (based on loan amount), and one time 2.5% marketing & referral fee (commission to sales agent based on loan amount less interest). Maximum age of pensioner is 70 years old, except for case-to-base basis for pensioner older than 70. The co-maker should be the surviving spouse or dependents since the pension may be inherited or transferred to dependents upon death of pensioner, though at a lesser amount.
The borrower receives the net loan proceeds which is around 67% of the loan amount after deducting the interest and one time fixed charges.
For a SSS Pension Loan, the following is an example loan computation:
Salary Loan (1 – 12 months term, PhP 1,000 – 50,000 loan)
The loanable amount is from a minimum PhP 1,000 to 10,000 per month for a total of approximately PhP 50,000 for a 6 month loan. The interest is 2.5-3% per month depending on credit risk (nature of job, employer, co-maker), creditor life insurance of PhP 1.55 per 1,000 loan value if employee is less than 55 years old (maximum age to be insurable by Insular Life), PhP 180 notarial fee per loan application, one time 3% service and processing fee, one time 2% collection fee, one time 1% credit investigation fee, one time 1% legal & audit fees (based on loan amount), and one time 2.5% marketing & referral fee (commission to sales agent based on loan amount less interest).
The borrower receives the net loan proceeds which is around 75% of the loan amount after deducting the interest and one time fixed charges.
For a Salary Loan, the following is an example loan computation:
Costs and Incomes from Loans
The income derived from a SSS pension loan is shown below. For a 25,000 gross loan amount, the collection is 16,715 while the cash out is 3,940 for a net income of 4,345 or 17.38% of the gross loan over a period of 12 months.
The income derived from a SALARY loan is shown below. For a 50,000 gross loan amount, the collection is 12,557 while the cash out is 5,227 for a net income of 7,330 or 14.66% of the gross loan over a period of 6 months.
The total lending costs are a summation of the following cost items:
1) Operating Expenses – personnel, repairs & maintenance, etc.
2) Bad Debts Expense – allowance for doubtful accounts
3) Cost of Borrowing – interest paid on placements / borrowings
4) Economic Cost – opportunity cost representing the earnings of your capital invested, for example, in the money market, where it will earn without going through this whole exercise, and
5) Gross Receipts Tax – monthly percentage tax of 5% of gross revenue (interest + service / processing fee + collection fee + penalties / charges)
Year 2007 Clients
As of 2007, a summary of clientele borrowings is shown below:
The average SSS Pension Loan amount is PhP 13,311 for 3-12 months term.
The average GSIS Pension Loan amount is PhP 12,923 for 6 months term.
The average SALARY Loan amount is PhP 14,501 for 1-12 months term.
The PDC Loan amount is PhP 29,154 for 1-12 months term.
Profitability – Financial Model & Feasibility Study
Illustrated below is a Financial Model from a Feasibility Study prepared for a small lending investor business. Numerous assumptions have been made to simplify the scenario. The picture may vary depending on what parameters to suppress or highlight. Truly, there are endless what ifs. It is presented only for illustrative purposes and possibly as a guide to those who wish to prepare their own detailed feasibility study.
1) Initial Capital – PhP 970,000 + PhP 1,000,000 = PhP 1,970,000
2) Debt Capital – PhP 1,795,000 at 10% p.a. net (12.5% p.a. gross)
3) Lending Rate – 4.59% per month blended rate (2% SSS pension loan – 50%, 2.5% Salary Loan – 40%, 3.0% Salary Loan – 10%)
4) 95% Lending Efficiency – 5% bank balance (not lent out)
5) 98% Collection Efficiency – 2% bad debts (not collected)
6) Advanced Rental/Deposit – PhP 46,000
7) Leasehold Improvements – PhP 143,581
8) Organizational Expenses – PhP 18,116
9) Other Pre-Operating Exp. – PhP 159,494
10) Donated Capital – Vehicles – PhP 540,000
11) Donated Capital – Software – PhP 30,000
12) Working Capital – Cash – PhP 32,809
13) Paid-Up Capital (25%) – PhP 1,000,000
14) Operating Expenses – with a provision for escalation
a) Salaries & Benefits – PhP 8,000 x 13 x 2 (5% p.a.)
b) Rent & Security – PhP 6,000 x 12 (10% p.a.)
c) Utilities (Light, Water, Telephone) – PhP 4,000 x 12 (10% p.a.)
d) Advertising & Supplies – PhP 2,000 x 12 (5% p.a.)
e) Professional Fees – PhP 15,000 x 1 (5% p.a.)
f) Permits & Licenses – PhP 4,000 x 4 (5% p.a.)
g) Miscellaneous (gasoline, allowance) – PhP 30,000 x 12
15) Type of Organization – Corporation (32% corporate income tax)
16) Gross Receipt Tax – 5% of gross revenue (interest + service/processing fee + credit investigation fee + penalties/charges)
The following tables show the simple financial model of the lending investor business given the above simplified data.
SAMPLE FINANCIAL MODEL FOR LENDING COMPANY
The list of assumptions is as follows:
The projected Income Statements for the next 5 years is shown:
The projected balance sheet and funds flow are shown:
Finally, the cash flow statement is shown, and when compared to the initial project investment (equity & debt) provides the project IRR of 12.50% p.a. and a project payback of 3.97 years. When the cash flow is compared with the equity investment (51% equity share, 49% debt) only, it provides the equity IRR of 34.99% p.a. and an equity payback of 2.90 years.
After everything has been said and done, the bottom line to profitability is judicious management. As much as possible, equity capital should be used in order to maximize returns and minimize interest cost on placements and borrowed funds. While interest to be charged to clients must be competitive, it must also be sufficient to generate spreads in order to cover the cost of borrowing money, fund the various expenses and provide extra income for the lending investor owners / shareholders. If raising interest rates is not an option due to stiff competition, raising the lending portfolio would be a better alternative to meet both fixed and variable costs of your operation. Also, cost control should be exercised to avoid costs overcoming income from operations.
Managing Credit Risks
Extra care also must be exercised in lending to individuals to ensure that creditor default risks are minimized. Sufficient collateral and co-makers with repayment capacity should likewise be carefully examined so that only deserving borrowers are provided with loans that could be repaid in full as they mature. Before approving a loan, a credit investigation is undertaken to verify information provided in the loan information sheet. Before releasing the loan proceeds, all the credit and loan requirements are complete, duly signed and notarized and the security / collateral in the company’s possession.
Raising the loan portfolio is best accomplished by undertaking a targeted marketing effort. Fliers may be distributed to tricycles drivers, jeepney drivers where prospective SSS Pensioners may travel to their respective homes as well as distributing hand bills / fliers to prospective pensioners and salaried individuals.
Huge streamers announcing PENSION LOAN with complete contact details is also encouraged. A sales agent recruitment campaign shall also be undertaken regularly to ensure a continued pool of dedicated sales agents who will assist the borrowers in complying with the loan requirements.
The equity investors and directors as well as staff shall endeavor to promote the well being of the Lending Corporation and also conduct marketing drives to connect with Pensioners as well as Salaried Individuals who wish to avail of its credit facilities and convince their employers to sign Memorandum of Agreements (MOA) on providing loan facilities to their trusted employees. The MOA will ensure proper and timely collection of monthly amortization in an efficient manner.
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Marcial T. Ocampo
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