The following ideas and concepts are not mine. They come from two long time professionals in the note business, Lawrence Tepper and Tom Henderson. I hope my words do justice to their teachings.
My old Webster’s New Collegiate Dictionary provides a definition for the word “myth” as follows: “A person or thing existing only in imagination.” In other words, it has no basis in reality.
The #1 myth that many noteholders are convinced is true about their note is that their $100,000 note is equivalent to $100,000 cash. This is simply false. I am holding a note in my hand right now, and the first line reads “In installments as herein stated, for value received, the undersigned promise to pay…
Promise To Pay! A note is not cash. A note is not a bank CD. It is a promise to pay cash over some period of time. Since the payment is not guaranteed, there is uncertainty about repayment of this debt. This uncertainty creates risk. The risk may extend to the terms of the transaction, such as – inadequate downpayment, inadequate interest rate, poor collateral, poor paperwork/documentation, etc. The risk escalates if payments have been consistently late or missed. A notebuyer must be compensated for all the risks associated with a particular note, and does so by demanding a higher yield on his investment. This in turn results in a discount to the seller.
An interesting analogy to note discounting is winning a lottery. Let’s say a lottery claims that the jackpot is $5 million, Cash Value $3.15 million. If you win, your option will be to receive the $5 million over some period of time, say 25 years at $200,000 per year. The jackpot is not $5 million cash today. Or, you could choose to receive a cash option today of $3.15 million. The cash option represents a 37% discount from the advertised payout of $5 million.
So, the choice for the winner is $3.15 million today or $200,000 annually for 25 years. In selling a note, the seller can choose a lump sum of cash today or a promise to get monthly payments over the remaining term of the note. Most people understand this analogy.
The world of Seller Carryback is like the Wild, Wild West. Sometimes a seller will ride into town, act as the new Sheriff, create a note, and then be humbled by some tough hombre who has been there and done that. Blogs and Newsletters like mine are designed to help educate sellers before they ever climb on the horse.
