Starting your own private lending business can be an exciting time. While it is not uncommon for investors to eventually expand into private money lending due to the benefits and given that legally almost anyone can be a private money lender, it is no wonder there is growing interest in this industry.
When creating a private lending business for the first time, there are always legal considerations to consider and seeking straightforward advice from the outset can ensure you aren’t faced with negative implications in the future.
Here are some easy and useful tips to consider in setting up your own private lending business.
1. Name your business and identify your business structure
Consider the name and type of business carefully. Some of the biggest mistakes first time private money lenders make during the preliminary start-up stages is spreading themselves too thin.
Consider business structures and whether you intend on being in a partnership, joint venture, trust, company or initially start off as a sole trader . Each business structure has its own pros and cons.
2. Identify your lending model
Having a clear vision and end goal in mind is necessary for understanding the lending model you will use, which includes considering the following:
- Micro-Lending which are small loans for example: personal loan for a wedding, property renovation, or other personal needs.
- Bridge loans known as short term loans pending the arrangement of larger or longer-term financing, for example purchasing a new property while selling a current property.
- Peer to peer lending allows borrowers to borrow money directly from another investor cutting out the financial institution as the middleman.
- Micro-credit which is an extension of small loans, for example, credit purchases made through stores, app, or the web for a limited amount of price & products. These are paid in instalments even without interest.
- Large lending often used for larger commercial business loans, construction lending, mezzanine finance and property loans.
- Asset backed lending which is the lending backed by collateral.
Please note that loans that are given predominantly to a borrower for personal, domestic or household purposes, including residential property investment (and not business purposes) will be loans governed by the National Credit Code (NCC) which has more stringent protections offered to the borrower when compared to a business loan. Apart from this requirement, there are other requirements to be met for a loan to be a NCC loan.
3. Credit licensees- Australian financial services licences (AFSL)
Engaging in credit activities requires you to have an Australian credit licence or authorisation to conduct a financial services business from the day you start your business. Strict penalties apply to persons who unlawfully engage in credit activities.
An AFSL authorises licensees to:
- provide financial product advice to clients;
- deal in a financial product;
- make a market for a financial product;
- operate a registered scheme;
- provide a custodial or depository service;
- provide traditional trustee company services;
- providing credit under a credit contract or consumer lease
ASIC assesses applications for credit licences as part of their role as regulator of the consumer credit industry.
Applicants should be aware that the licensing process is a point-in-time assessment of the licensee, not of its owners or employees.
Having the right business insurance policies in place, tailored to your business, assists to protect you should something go wrong. Business insurance includes the following:
- Business / office insurance- provides cover for your business’ premises and contents, against loss, damage or theft and offers protections against financial loss caused by an insured interruption of your business.
- Public liability insurance- ensures you are not financially responsible for the costs of a legal claim should a third party get injured or suffer property damages.
- Professional indemnity insurance- protects against legal costs and claims for damages to third parties which may arise out of an act, omission or breach of professional duty.
5. Evaluate potential clients and risk return
Risk-taking is common in business and it is critical calculate the risks involved prior to making an investment. Often private lending involves what is known as “parking” money, known as passive investments in huge commercial projects like retail shops and apartments. Such investments require a lot of capital, and private lenders must consider covering the expenses should the borrower default or legal proceedings are initiated to recover the money. Otherwise, lenders could end up in serious debt that can damage credit worthiness.
6. Verify the facts and numbers
Having the “ideal” client with a steady financial background and credit rating means private lenders can take steps to avoid dubious deals from fraudulent people. Remaining “afloat” often involves assessing and mitigating these risks by applying the correct checks and balances during the preliminary client assessment process. Sometimes, the deal is just “too good to be true” or the prospective borrower may not be competent in accounting or obtaining proper advice. Thorough assessment is always necessary and always conduct the necessary due diligence depending on the circumstantial facts of the borrower.
7. Learn the subject matter
Successful private lenders always understand the investment / project and are very familiar with the types of deals in any industry. Being familiar with a particular industry is important for better understanding the investment.
8. Seek good quality legal and financial advice
The set-up of a private lending business can be a lengthy and confusing process that can sometimes mean private money lending isn’t for everyone. If something goes wrong with the deal, you could incur large losses or end up being sued. Therefore, it is important to consider the pros and cons of opening your own lending business and always seek quality professional legal advice so that you understand the legal requirements of setting up. You should also seek good financial and accounting advice to understand the financial planning and tax implications which may arise in undertaking the venture.
See Part Two of our Banking and Finance articles for private lenders – What type of licence is required for a private lender?
Two of our senior lawyers and firm principals Meghan Warren and Kristy Muhlhan have over 23 years of experience between them in banking, finance, commercial and construction industries. For tailored legal advice and guidance please contact either Meghan or Kristy via phone on +61 3 9833 8588 or email our team here. Find out more about our Banking and Finance legal services here.