You’ve got to Have Some Skin in the Game! (September 7th, 2010)
This is a term I hear on a regular basis from lenders, and it makes perfect sense. It is the common answer to the numerous 100% financing requests I get. Its meaning is simple, in some shape or form a borrower needs to have more than simply a good idea invested in a project. Many borrowers can’t wrap their heads around this statement because they look at their financial projections and their bottom lines are always large profit margins, however, in the immortal words of a lender whom I will keep anonymous, “it is a lot easier to cash a cheque then write one!”
When someone requires funds, the mind sets of a borrower vs. a lender are completely different. Granted, both are looking towards the future, the borrower wants to payout at maturity and so does the lender; but this is where the similarities end. The borrower is typically using “future value” to calculate their return, while the lender is looking at “present value” to calculate their risk. So it comes down to opportunity cost, the lender is putting up money at a risk for a future return while the borrower is accepting money at present for future risk. In order, for them to meet in the middle, both have to give up something; in the present the lender is giving up cash, while the borrower is giving up some form of security. If one of these variables are missing then the equation is incomplete and therefore “dead”.
Without some sort of investment into a project, technically, the borrower has no real risk. If the project goes belly up or if they simply get tired and decide to walk, the lender is left with a property that he or she must liquidate. Essentially, when a borrower has something to lose then they are less likely to walk away from a project when the going gets tough, their investment acts as an anchor.
This is not to say that 100% financing is impossible, because it is. But something somewhere needs to be provided by the borrower to anchor them to a deal. The bottom line is both the borrower and the lender are seeking to improve their financial situation, but both of them need to risk something in order to earn their expected return…without it the deal is dead!