If you are building a personal finance library, I suggest the following as building blocks (all the links are not affiliate links):

1. The Millionaire Next Door by Stanley and Danko: A book anchored in statistical analysis on how the millions got to be millions. The lessons are not earth-shattering but, if nothing else, a re-affirmation of old world values: hard-work, frugality and modesty are keys to financial independence. A book I tend to pick up every other months and re-read passages.
2. Get Smarter by Schulich and DeCloet: Schulich is a self-made billionaire (mostly in junior mining companies) who shares his money, life and love lessons in small bite sized chapters. A very good thought process book about being a good person, good investor and good entrepreneur.
3. Stocks for the Long Run by Siegel: The bible for stock investing setting out why investing in stocks over the long run will protect your savings and more.  A great guide for exploring the various sub-sets of stock investing (dividend investing, global investing, exchange traded funds etc.). If you are interested in stock investing, a definite read.
4. The 5 Rules for Successful Stock Investing by Dorsey: Another in the fine series of Morningstar publications, this is an extremely thorough guide on how to read financial statements with industry specific metrics to look out for. A word of warning, it is a little technical at times
5. The Art of the Start by Kawasaki: My newest entry. Not a personal finance book per se but have you ever wondered how to turn an idea into a business including getting customers and obtaining financing? Kawasaki, a venture capitalist and former Apple alumnus, gives a refreshing look at starting a business grounded in some real experience rather than abstract MBA-isms.

You will notice from the above list that these are all thought-process books not product books. Even the stock books are about how to assess stocks not which ones to buy. As I have reiterate in this blog, product comes and goes. Its a thought process that will carry you through long term.

Any books you consider a building block of a personal finance library?

Here’s the dirty little truth about interviewing. Even with companies with HR departments, eventually, you have to speak to someone with no training in the formal process of hiring people. The interviewer is just as nervous as the applicants are because, unless it is a skill-based interview (and this is usually vetted before you get to short-list), they are feeling their way through the process too. Me? I am a terrible interviewer. I am always tempted to break out into the Ralph Wiggum “do you like stuff?” line of questioning to fill the pregnant pauses.

I ended up interviewing one candidate and I asked what I consider to be a “I need to fill the blank” question and asked “what do you hate about your current job?” Well, the candidate broke out about how they hating dealing with the public and people in general and then lobbed some racial epithet about a group of customers they deal with. I am not going to repeat it and I am not a member of this group but I stopped dead for 5 seconds and then just started filling in the silence with random chatter. The candidate withdrew the next morning (not sure whether because the position wasn’t the right fit or they realize their faux pas).

The only thought that came to me after this interview is that perhaps interview questions are not meant to elicit the right answers but to weed out the absolute wrong answers and the foot in mouth moments such as hurling racial insults, complaining for 5 minutes about your boss (which happened to another candidate that got cut by the initial interviewer), complaining you don’t make enough money incessantly (huge red light for an employer), you only view the job as a short stay to “better” things etc. etc.

For us mere mortals who do not have Pepsi’s bank account to find (or pay for) good advisors for our own personal finance, small business or life issues, where do we go to build an advisory board (whether formal or informal) to give us the best advice possible and who do we pick to be our advisors?

I know most of my colleagues in the blogsphere are either raging DIY er’s or slanted towards the DIY side but, as someone who’s worth was once measured by the billable hours, you begin to prioritize tasks that will yield you the most bang for the buck and delegate what you do not know or do not have time to know to others. Or, to quote the business saying, sell what you are good at and buy what you are not.  It is very rare to be good at many different things. Take the time to be great at one and then pipe in the talent on other aspects.

Some of you may think: “I don’t have the money to hire advisors!” You don’t have to. You would be shocked how few people are asked to give advice to people on a volunteer basis and how receptive they are to the offer someone who is genuine and eager for advice. I was asked this week to attend a dinner where someone I had not spoken to in over 6 months was canvassing advice on an idea he had. I was honored he actually asked me and said yes immediately. Most people want to help others but are rarely asked; its a sad statement on our society that we think of ourselves as islands on our own and not members of a community. Those who greedily look out for themselves are those who wouldn’t be a good fit anyways. As a caveat though- be reasonable, be respectful and honor their time; there’s a difference between asking for advice and getting someone to work for free (the fine line with me is whether I feel like I am being used then disposed of… we are all human).

The question becomes- HOW do you look for a good people to be your advisors? There are two things to keep in mind. First, I deliberately shy away from putting in my inner circle people on my “payroll” as paid advisors. Certainly, I pay them to do whatever they have to do but for the big decisions in money or life, I ask for their advice but vet it with someone else in the inner circle (except for extremely technical questions of course). Why do I do this? If they are on payroll, their context to you is different; they want to help you BUT as a client whereas a good advisor will help you because they like you as a person; money and professional liability concerns color the advice given (trust me, I was a lawyer…).

The second thing I do is reach outside my immediate circle. It is hard to give honest advice to a good friend- too much politics involved and someone always pulls out the “well, remember when you were 18 and drunk…” card. All of my close advisors have become friends but they didn’t start out that way. At first, they had a sufficient personal distance to give good advice without worrying whether I would be mad at them for their candor and not have beers with them Saturday night. Even after we became friends, we had set the expectation that honest advice should keep coming. One of my best advisors I met completely randomly through an association. In other words, start networking away in circles different than yours where people have experienced success.

WHO do you look for? The standard answers in personal finance and entrepreneurial publications is to focus on skill-set. Find a lawyer, an accountant, a tech person etc. etc. I find this to be generally bad advice. Remember that good advice is about solving problems and no one skill-set has a monopoly on that. I know literally hundreds of lawyers; I can count on both my hands the true problem solvers in that bunch. Getting a lawyer on your advisory board means nothing if all they do is tell you the 18 ways you can’t do something rather than the ways you can. As another example, some of the best financial advice I receive are from various bloggers many of whom I have never emailed or spoken to and, as far as I know, most do not have the multiple designations a “professional” investment advisor has. They figured “it” out about money and write passionately about it.

Instead, I take this approach on finding who would be good advisors:

1. Find someone who has achieved success in life multiple times. I leave the definition of “success” to you but the key is that they were successful more than once (once is an accident; twice is a pattern). It takes a lot of hard-work, dedication, savvy and street-smarts to be successful- not necessarily a lot of degrees. Someone who has been successful displays these characteristics. The other factor is that if this person is a “level” or two about you, it can motivate you to reach upward.
2. Find problem-solvers. Sounds simple doesn’t it? But think about work when the you know what hits the fan. How many of your co-workers start pointing fingers, complaining, panicking etc. I bet you its a lot more than those who take the bull by the horns and just fix the problem. You ask for advice because you have a problem. You don’t want people to tell you all the things you did wrong, how the situation will only get worse etc. You want some possible solutions to mull over. I have an advisor who has that all-knowing but humble Mom quality to her. Her advice always starts off with “well, why don’t you try this….”
3. Find people who you relate with. You want differ viewpoints but you want to be able to relate to the person too on a personal level. Most of my advisors share a similar context as I do (grew up in hard-working, middle-class families that stressed education). There is something to be said for sharing the same set of life values even if we all come from different viewpoints.

WHEN do you meet your advisors? Depends on your personality. I hate formality and small talk. Most of my “meetings” are not really meetings but casual situations where I start a conversation. For example, I play poker with a lot of guys who are successful in their respective fields. Before we have too many beverages, the quality of advice given on business and personal situations is astounding but no one ever thinks of this as an advisory board meeting in the conventional sense of word; in fact, my advisory board is not so much a board but a collection of people who I speak to regularly. Find a situation which suits you best. The key is to keep the dialogue going.

WHAT do you talk about? Anything at all. Be honest and open. That is the only real rule of asking for advice. Lawyers always ask their clients “is there anything else you need to tell me?” to ensure their advice captures all available information on hand. BE SURE TO LISTEN THOUGH and not to shoot down the idea immediately out of hand.

It can be tough to find some true, faithful and prudent advisors. But its well worth having them in your life. Good luck.

• “I would like you to loan me a lot of money based on the fact I am nice/the business idea is great but I will put no money in it myself.” Lending is the management of leveraged risk (remember that lenders have lenders too so they are leveraging themselves). The best way to mitigate lending risk is to make sure the borrower shares in the risk by putting in their own money (aka “skin in the game”). If you put no skin in the game, you are telling the lender you have no confidence in yourself or the business (put your money where your mouth is). Even a token contribution from a borrower with little assets goes a long way to showing a lender you are willing to share the risk. One of the few situations I know of where the borrower doesn’t have to put any meaningful skin in the game is the 40 year mortgage and these are walking car-crashes for lender and borrower alike.
• “Sorry, you have the wrong lender…” Make sure you target the appropriate lender. This sounds patently obvious but not all lenders are built equally. The quick and dirty on loan sources are:

• Credit Unions: Good for personal and small business loans; not the best source for larger commercial loans
• Banks: They like loans where there is a lot of collateral. For example, historically, mortgages or commercial real estate and RSP loans. Like unsecured lines of credit and credit cards. Hate student loans, small commercial loans (unless backed by the government). Each bank also has their specialty.
• Private lenders: Typically, higher risk borrowers with sufficient collateral (a 2nd mortgage on an appreciating home or rental property).
• Angel investors/venture capitalist: High flying businesses which have the chance of going public.

• Bad Attitude. Lenders are people too. You may look great on paper but if you have a bad attitude, there is a disincentive to lend money to you. If you are difficult to work with now, and the money hasn’t been even loaned, what happens if you fall behind on payments? I know lenders who may have rejected a borrower but because they had a good attitude, actively helped them find another lender.
• Unreliability. Your parents were right. If you keep moving jobs, cities and spouses (!?!), you look like a flight risk and less likely to get a loan (not to mention all the neighborhood gossip your parents have to deal with arising from your fickle ways).
• “I need cash quick” Total red light for a lender. Why do you need cash so quickly- who or what are you running from?

Good luck with obtaining a loan.

I find that the reverse logic applies with investment advisors and financial planners. Everyone wants to see them when the markets are up. Buy this. Sell that. Long this stock and throw me some funky financial products please. But what happens during bad times? I find that, in my circle of contacts anyways, there’s a distinct chill that occurs. People don’t want to call their investment advisors about anything other than to get them to put everything in cash. This seems strange to me. In good times, a trained monkey could probably pick enough stocks to make money but, in bad times, shouldn’t the trained and paid professionals navigate you through down markets to minimize damage?

I know there’s a lot of skepticism about the effectiveness of investment advisors and planners; some justified and some not. However, I am known for my catch phrases and one of them that applies in life should also apply for personal finance: don’t judge people when things are going right, judge them when things go wrong.

If you have a good investment advisor or planner, now is the time they will shine. If you have a bad advisor, you’ll really see how bad they are now they have to really work for their money and it will confirm your feeling that it is time to move on. Let me give you an example I have alluded to in the past. My parent’s current investment advisor was appointed by their financial institution after the unfortunate death of their previous advisor. The new advisor simply stinks. He kept trying to get my parents to sell stock when the market panicked earlier this year. I believe he must have skipped class the day they taught “buy low, sell high” but took extra notes on the class about how advisors are compensated. My parents obviously thought he was from Mars and didn’t follow his “advice” (I use the term loosely). Now to find them another advisor…

The point being engage your investment advisor in a meaningful dialogue in difficult times. You’ll know what you have on your hands. The good advisors earn their keep in difficult times while the meek crumble.

There are primarily three sets of options that one can do in order to credit proof themselves, I generally describe them as:

1. Contracts
2. Structuring
3. Insurance

Ideally, all three options should be done. However, given that we all have finite resources, my favorite credit proofing tool is insurance. It is relatively cheap and it immediately shifts risk away from you and your family and to a third party (with a lot more money than you and I). There’s a lot of bad press about insurance but, if you read the fine print carefully, a contextual and well-drafted insurance policy should provide ample protection.

Contracts

The primary function of a contract is to set out the terms and conditions between parties and, if well-drafted, also minimizes risk. For employee with manageable debt and those without manageable debt (see yesterday’s post for how I define this term), there are two primary situations where a contract can minimize the largest risk factor of job loss:

1. You are part of a union and your employment is evidenced by a contract between yourself and your union (in a unionized context, your employer is your union). In most unionized environments, the primary risk factor that any employee faces, job loss or you cannot make money for any other reason, is minimized in some part by generous severance packages (compared to non-union counterparts), a package of insurance entitlements (health and, depending on the union, disability and critical illness insurance). The down-side is that most unions are found in older industries and, after the generous severance is paid, it is not a guarantee that one can find an equivalent position.
2. You have an employment contract in a non-unionized environment. Depending on the jurisdiction you live in, the law may provide very poor severance entitlements (in Ontario, it is generally one week of working notice or payment in lieu of notice for every year of service). If you are in a white collar environment, however, the courts have stated that middle management is entitled to more service than the law allows (generally between 2-4 weeks of working notice or payment in lieu of notice for every year of service depending on a wide variety of factors). Obviously, the best way to ensure you are paid a reasonable amount of severance is to have it stated in an employment contract rather than fight for it in court. The best approach is credit proofing is to review an employment agreement to see how much of a financial cushion one has in the event of termination and, along with some of the options below, devise a strategy to minimize the shock of job loss to the household financially.

The point is that although a contract cannot prevent an employee from being terminated, a contract can set out sufficient monetary protection to ride out the short-term financial impact of job loss until a new job is found.

The use of contracts for entrepreneurs basically deals with minimizing the business risk of any relationship by reducing or eliminating liability from the transaction. This is a completely separate topic so I am not going to address it here.

STRUCTURING

Structure is a catch-all phrase to describe how one can organize their financially affairs to protect assets and minimize risk. There are variety of structuring options one can take:

• Legal structures: Incorporation shields entrepreneurs to the extent that the corporation is a separate legal entity from the owner-manager and liability do not spill over to the owner-manager. However, lenders are increasingly asking for personal guarantees which nullifies some of the benefits of incorporating. Employees traditionally have no idea to incorporate but employees and entrepreneurs alike could consult their advisors about the possibility of establishing trust structures ranging in complexity from informal trusts to full-out family trust incorporating holding companies which owns the corporation which conducts business (which many well-off entrepreneurs set up). Trusts, depending on how they are set up, minimize the risk of paying too much tax and avoid the concentration of wealth in one family members hands. If wealth is concentrate in one person’s hands, the risk is always something may happen to that person and jeopardize the family’s finance affairs. Family trusts are one way around this issue although I readily admit not a contextually appropriate option for most middle management employees.
• Rich spouse, poor spouse: A take on the Rich Dad, Poor Dad brand, this strategy is related to the above and is appropriate for entrepreneurs and employees with unmanageable debt. The primary purpose of this strategy is to place resources into the less risk exposed partner and protect the family resources and expands on my point yesterday that good credit proofing isolates risk not expands it. The strategy is quite simple- put all the resources of the household into the name of the spouse who has smaller risk exposure (i.e. is not the spouse running the business or has bad debt management) and keep the financial affairs of the spouses separate (i.e. no joint accounts, no co-signing anything). Above all, always keep one spouse “safe” by not exposing them to the other spouse’s risk. This includes not co-signing loans, credit cards, personal guarantees etc. To avoid triggering unnecessary tax liability, speak to your accountant before you transfer anything to anyone. What happens if you don’t trust your spouse… well, legally, your lawyer can give you options but you probably have a larger issue which is not part of this blog’s topic….
• Build up your financial parachute. This option is applicable to everyone. Make sure you have a financial parachute/money you can access easily for the worse case scenario whether that be job loss (employees with manageable debt and unmanageable debt), a sudden financial crisis (everyone) or a required infusion of cash into the business (entrepreneurs). Have a source of money you can tap into. I know there is some debate between an emergency fund vs. a line of credit, the point is have one or the other or both before a crisis occurs. If you are an employee with a long employment history, apply for a LOC now.

INSURANCE

I suspect somewhere there is job loss insurance being made available to someone but for those of us without the resources to find and pay for this here are some insurance policies to consider:

• Disability and critical illness insurance: I have written about these types of insurance before and it is appropriate for all with particular importance of disability to entrepreneurs.
• Life insurance: This is pretty self-explanatory. The only note I would add is that most people think of life insurance as a means to look after their dependents, which is certainly true, when dependents are quite young. However, as one’s net worth increase, life insurance should be seen as a option to minimize tax liability for the estate upon death since the proceeds of insurance would be used primarily to pay off taxes. For entrepreneurs, remember that life insurance is collateral in a loan if structured correctly which may, depending on negotiations, eliminate or minimize personal guarantees.

This is some debate on what to get first: life insurance or disability or critical illness insurance. It really depends on the circumstances. An employee regardless of debt levels may have greater need for disability insurance if they are the sole bread-winner and has a family history of poor health. Alternatively, an employee with unmanageable levels of debt may use disability insurance as a forced savings vehicle if they buy a return of premium rider (an expensive savings vehicle but one nonetheless).

Just a few concluding notes:

• if the “barbarians are at the gate” (i.e. creditors are at the doors), there are laws which prohibit the implementation of some of the options above since they could be deemed to be “fraudulent conveyances”. Thus, please consult a lawyer if you are in this situation
• The point of credit proofing is not to eliminate risk (since risk can never be eliminated) but to set up appropriate options to ensure your loss is minimal and survivable financially
• everything is contextual, take a look at yesterday’s post and figure out which category you fit in and assess your risk accordingly. Then see if any of these options fit the bill and see a qualified advisor to discuss.

Good luck.

First of all- what is due diligence? In its simplest terms, due diligence is doing your research and investigation and determining what someone says about something is true. Is this actually a good stock? Should you lend money to someone?Is this house a great investment?

We all do due diligence every day of our lives. For example, you are thinking of hiring someone at work. They claim on their resume that they went to Harvard, graduated at the top of the class, worked at Acme Consulting Inc. and have references from noted leaders in your industry. They sound like a perfect candidate but you wouldn’t hire this person without checking up on their claims would you? Most employers would ask for university transcripts, call the Harvard alumni registry, check up with Acme Consulting and call the references. We call this “reference checking” but this is due diligence (in the broadest sense of the term) just in the HR context.

In the investing world, due diligence primarily concerns whether the financial numbers can support the claims made or valuations given for stock, real estate or a business. On an non-exhaustive basis, here are some typical types of investigation one should make before buying typical investment products:

STOCKS

• What does the company do? Does it do it well or poorly? Is it an industry leader or just another competitor?
• Where does it do business? Is this a safe jurisdiction or are there a lot of risks doing business in that jurisdiction?
• What is its stock price compared to its peers? If it is higher than industry average? If so, why? Is it because it is the undisputed leader in the field or is the price high because of some one time event (i.e.  is it being bought)?
• I always like looking at the statement of cash flows, especially cash flow from operations (i.e. cash it makes from operating the business rather than from its investments). Is it positive? If so, for how many years? It is harder to fake cash; earnings can be manipulated.
• If you are investing in a dividend yield stock, how much of its profit is being paid out as dividend (aka the dividend payout ratio)? Does the company consistently increase dividends? Is there cash on hand to pay the dividend (see my above question about cash flow from operations)

This all sounds very daunting and, frankly, a lot of hard work but most financial websites will now summarize a lot of this information for you rather than reading through hundreds of pages of the financial reports.

MUTUAL FUNDS

• What is the mutual fund’s fundamental objectives? Growth or capital preservation? Does this match your goal?
• What does this mutual fund actually buy? Are they good companies or bad?
• How does this mutual fund perform compared to mutual funds in a similar category?
• What is the mutual funds management fees? Are they higher than lower than other mutual funds in the same category?
• How long has manager of the mutual fund been with the fund (on the assumption that the longer the tenure, the more likely it has performed well)?
• What restrictions are there on selling the fund? Do you have to hold on to it for a period of time?
• What is the investment advisor’s compensation for selling you the fund?

Most of this information is summarized in a mutual fund prospectus which is a disclosure statement required by law to be given to you. Please read this before you buy a mutual fund even if your advisor thinks this is the greatest thing since sliced bread. Most web-sites will also compare mutual funds in the same category.
REAL ESTATE

• Bring your own contractor with you (not your real estate agents) when you see a house, ask them about the house and how much it would cost to fix the deficiencies in your home. Don’t cheap out on this part. Get a true estimate of how much it would cost to bring the house to your desired level of livability.
• Try to meet the vendors of the house- do they look like they kept up the house (for example, if the vendors are in their 90′s, chances are they don’t have the physical capacity to maintain the house in the last few years)?
• Look at the historical pricing for similar sized homes in the neighborhood- is the house listed above or below historical pricing? If it is below, ask why- is there something wrong with the house or has it been priced for a bidding war?
• Is this a safe area? How is the local school rated? Your insurance agent can implicitly tell you if the area is safe or not by the insurance rate they quote you.
• If this is an investment property, conduct a true financial analysis of the costs of upkeep including items such as property tax, utilities (if it is included in the rent), upcoming maintenance issues (which is why you bring a contractor with you), local by-laws (i.e. how many tenants can you put in the house or is the duplex a legal duplex) and compare with rental rates in the area.

Your real estate agent can help you with a lot of this research (make them earn their commission!).

___________________________________

Effective due diligence is equivalent to being a 7 year old kid. Keep asking “why, why, why” until you get the answers. Drill down into someone’s claim until they can substantiate it. It is not that difficult of a process just a lot of hard work. Good luck.

Documents about you

• Social Insurance Number
• Work history (yes, it is asked for; lenders want to see stability and job hoppers scare them); get a letter from HR on how long you have worked, current salary etc; They write these often so they know the format.
• Notice of assessment from the tax authorities for last 3 years (this a one page document which is sent to you showing your taxable income and amount of taxes paid); they can be obtained quite quickly by calling the tax authorities.
• Calculate your net worth
• Run your own credit score (here’s a primer on how to obtain your credit score in the U.S. and obtaining your credit score in Canada)
• For small businesses, a business plan is needed in certain circumstances (i.e. government backed programs) but not in others. The newer the business, the more likely a business plan is required.

All of the above apply to small business loans as well since most small business loans are backed by personal guarantees.
I suggest you run your own credit score since financial institutions have a funny habit of running your credit score as soon as you say you are interested in obtaining a loan. The more your credit score is checked, the lower it gets (an often complained about deficiency in how a credit score is determined). The institutions shouldn’t do this but they do.

If you tax returns show a blip (you income dipped one year; you were laid off, took time off between jobs, back-packed through Asia), immediately put in a cover letter why this occurred. Remember always to deliver the bad news first.

Reference Letters

• Bank reference letter (shows you how long you have been with them, approximately balance, whether they have been any defaults, over-drafts above allowable limit and, generally, whether you are a good customer). Only needed if you are shopping around for a loan because it costs money to obtain these (unless you know the branch manager)
• Employment letter (addressed above)
• For small business loans, get a letter from a supplier indicating you pay on time all the time. This gives comfort to the lender. Also get a letter from customers indicating they are happy to use your service in the future (tells the lender you are getting cash into the business).

The Soft Stuff

• Introduce yourself to your branch manager and/or assistant branch manager before you are going to apply; tell them you are going to apply for a loan and ask them what they need (in other words, tell them implicitly that you will make their job easier). Ask them if they are interested in loan money to you.
• If the branch has a loan officer, make sure you are introduced to them and repeat the above.
• Remember to dress professionally- treat this like a job interview (you are applying for money after all)
• If you are shopping around for a loan, don’t just walk into any old branch. Ask someone if they have obtained a loan from the same institution and ask for an introduction to the person who reviewed or administered the loan. In other words, network until you find a loan officer you can work with.
• Always get two quotes. There is no such thing as “home field advantage” in lending; you have to push your own bank to match the competitor.
  

This is the most overlooked part of the loan process. Lenders are human too; connect with them on a human level. I have seen situations where borrowers are perfectly acceptable on paper but, upon meeting them, the lender begins to form doubts based on things like being unprofessional (these were business loans so this was particularly important), being arrogant during the process and saying the wrong things during the process (“…the first thing I am going to do after getting this loan is to take a three week vacation…” This makes the lender think you are spending their money on the wrong thing).

What most lenders do not tell you is that they have the discretion to charge lower rates, go above their loan book (how much they can lend out in certain categories of loans) and extend loan terms. These items being discretionary, it pays to be nice to the lender since it could save you thousands of dollars.

Did I miss anything?

Having represented lenders in a past-life, sat on loan review committee and lent money in business, here are a few tips to increase your chances of obtaining a loan:

COME PREPARED

Run your own credit score first and clean up anything that can be cleaned up. Obtain letters of reference from other people you have borrowed money from, employers, banking reference (you usually have to pay for this letter) etc. Find your tax returns from the last three years. Compile all the data to complete a net worth statement.

In other words, have your documents ready. Even p2p lending groups like Prosper, which require minimal paperwork, still requires you to dig up some documentation about yourself (like your social insurance number).

Never, EVER, say you need money NOW

To a lender, the phrase “I need money now” sends warning flags up. Why are you in such a rush to get money? Is another creditor after you? Are you behind on other types of payments? Are you desperate? Desperate people do desperate things including lie on their loan application. The practical consideration is that lenders need to conduct due diligence before they make a loan. This takes time (the amount of due diligence a lender has to conduct is the same for a $10,000 loan as it is for a $200,000 loan- this is why lenders tend to shy away from smaller loans).

Plan ahead. If you need money 30-45 days from now, start applying for loans now. Most lenders, even the non-traditional ones, need at least 2-4 weeks to look at your application, interview you, arrange to transfer money to you etc. (I am not talking about payday loans).

WHAT’S IN IT FOR THE LENDER?

What is the difference between investing in equity (stocks) and debt (lending people money)? In equity, you are foregoing certainty on a return on investment for upside potential (save for dividend payments). In debt, the lender seeks certainty of payment in exchange for foregoing upside potential (I am not including convertible debt instruments). Most borrowers fail to appreciate this difference and this difference sometimes costs them a loan.

A lender is not particularly concerned that you could take a $5,000 small business loan and make $200,000 with it. The lender’s primary concern is that they get the $5,000 back at maturity and the interest payments are paid on time. When applying for a loan tell the lender how it will be paid back. Most borrowers spend all their time telling the lender how it is going to spend the loan proceeds. (this raises the question of what’s in it for the lender for borrowers on Prosper who need money to go on vacation- um…). The story you tell cannot be all about you- address what’s in it for the lender.

I will give you an example. I once heard of a private individual who lent money to people to buy cars no matter how bad their credit score was. All the borrower had to do was show the lender that they needed the car to work- either as a traveling salesmen or the job was not accessible by public transit and prove that this job paid enough to pay back the loan after all other expenses (i.e. show a pay-stub, get a letter from the employer etc). The theory behind this loan criteria was that the lender (who I never met) believed someone would bounce a rent cheque before their car loan since the car was absolutely essential as a means of producing income. The lender made the borrower show what’s in it for the lender since they had to prove that the loan was being used to generate income which would increase the chances he got paid.

DELIVER THE BAD NEWS TO THE LENDERS FIRST

There is an old saying in politics- be the first to deliver the bad news. The same rule applies to applying for a loan. If you have a skeleton in the closet (bad credit score, taxes outstanding, behind on support payments), reveal it during the application and provide a plausible and reasonable story on why this is not an issue (I was young and didn’t used my credit card improperly but that was 5 years ago, I have a payment plan set up with the tax authorities etc. etc.). If the lenders have to find this out during their due diligence period, it slows down the application process and a borrower has a better chance of crafting a story around the bad news and mitigating its impact then the lender finding out this surprise and jumping to its own conclusions.

WHAT HAPPENS IF YOU DON’T GET THIS LOAN?

This is a typical question that a lender will ask a borrower. The wrong answer is “its this loan or bust!” In a small business context, the lender is trying to ascertain whether you will put your own money into the business and share in the risk. In the personal finance context, the lender is looking for the same thing- will you come up with more of your own money to buy the house/car/boat etc.; the more money you have in (or the more lenders you find), the less the risk for the lender (and, hence, the entire problem with subprime- the borrowers had no risk having put no money down…).

HAVE YOU SHARED THIS RISK WITH THE LENDER?

To dovetail on my last point, the worse type of borrower is the one who is proposing that the lender put up all the money (and financial risk) and the borrower puts in nothing. Let me put it this way: you go to Vegas and the house gives you $10,000 free as opposed to you putting in $5,000 and the house giving you $5,000. You have one hour to gamble and, at that point, you have to return the free money whether it is the $10,000 or $5,000. Will your betting pattern be the same with $10,000 free or half of your money at stake?

The reasoning behind the borrower “putting skin in the game” is simple: if you have money in, you have shared in the risk. For entrepreneurs, sweat equity is often discounted as skin in the game so keep that in mind. The more risk you have/the more money you are putting in yourself the greater you will want to pay off the loan and the more likely the lender will look upon you favorable and give you a favorable loan term.

For larger loans or loans obtained to acquire assets, collateral will be required. Collateral is a guarantee (usually an asset) to secure the payment of the loan in the event of default (i.e. I take your car if you default on a payment). This is called a secured loan and is probably a much larger topic onto itself. However, the point is you have to show you have a personal stake if things don’t go well. If there is no personal stake then, well, you get subprime and its assorted messes.

Just one final note: lenders may reject your loan for reasons that have nothing to do with you. They may have reached their loan quota, be low on money (remember that lenders have lenders), have too many of one type of loan etc. Don’t take a rejection personally- perfectly good loan candidates can be passed up. Don’t burn your bridges. A lender may remember your professional conduct the first time you applied and give you the benefit of the doubt the next time you approach them for a loan. Good luck.

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On March 13, 2008, I wrote “….I waiting for the other shoe to drop and have some mid-tier financial institution go under; every bubble seems to have some semi high-profile causality which usually marks the bottom.” On March 14, Bear Stearns required emergency funding and, last night, JP Morgan Chase acquired the firm for $2/share (financed by government money). Wow, that was fast. Unfortunately, we are no where near the bottom. Best not to watch bank stocks on the short term.

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I am on business travel this week so there will be two guest posts this week and no posts on Thursday or Good Friday. I have guest posted at Million Dollar Journey on the Smith Manoeuvre (SM), the Lipson case and audit risks of the SM. Thanks for the opportunity FT. I understand it is running this Wednesday. Hope you enjoy it.

This post was supposed to address how much a blog is worth but I thought I would step back and discuss the process of selling a business/blog in general since it is usually a once in a life-time event for most people (perhaps twice if you are a serial entrepreneur).

THE SHARE SALE

If one’s end goal is to build a blog to sell it then one should ideally incorporate and, when the time is right, sell the shares of the corporation (ownership in a corporation is evidenced by shares). The primary reason is tax driven. In Canada, an individual who sells shares of a qualified corporation is eligible for a life-time capital gains exemption of $750,000. In other words, the first three-quarters of a million in profits is tax free (see here for more details on the lifetime capital gains exemption). Even if you live in a jurisdiction where there is not a capital gains exemption, capital gains tax is generally lower than tax levied on income/interest and, depending on the jurisdiction equal to or lower, than dividend income (speak to a professional about your local tax laws). In other words, a share sale puts the most amount of money in your pocket.

What exactly are you selling when you sell all the shares of the corporation? Everything. Since shares evidence ownership in the corporation the process of selling all your shares means you have sold the corporation and all the assets and liabilities it owns. In the blogging word, this means the domain name, ad revenue, the copyright on the posts- everything.

Purchaser do not like buying shares (as the saying goes: “sell shares, buy assets”). Why? In a share sale, you inherit the liabilities of the corporation. If the corporation owns back-taxes, unpaid employee/contractor wages/pay, contains some libelous comments which may be subject to a future lawsuit, the purchaser inherits it all. Good due diligence and sufficient legal measures (such as obtaining an indemnity from the purchaser) should shield a buyer from most of the “skeletons in the closet” but, frankly, the pain in the butt factor is high to respond to the tax authorities and third parties for something you did not do.

THE ASSET SALE

If the blog is not owned by a corporation or the buyer is a savvy negotiator, you have to sell the assets which compromise of the business of the blog such as the domain name, computer, copyright etc. For the purposes of clarity, it is possible for a corporation to be a “shell corporation” and have no assets in it. Thus, it is possible for a corporation to sell all, or substantially all, of its assets and continue to own the shares which evidence ownership in a corporation- the corporation just happens to own nothing.

An asset sale is more complicated than a share sale because you have to assign a certain tax value to each asset which compromises the blog. For example, if the assets compromising of a blog are sold for $20,000, the domain name could be worth $1,000, the copyright/intellectual property could be worth $5,000, and the ad revenue bought on a dollar for dollar basis for $5,000. In this example, you have only assigned $11,000 of the total purchase price and have $9,000 left over. This excess amount is called “goodwill” in accounting terms. It represents the amount of the purchase price which cannot be directly attributed to assets and liabilities. Goodwill is typically a large component of sales involving technology based businesses (including blogs) since the assets are really not worth much (a two year old router really doesn’t have a lot of market value).

There are two issues which arise from the above paragraph. The first, more relevant issue, is goodwill is taxed unfavorably relative to capital gains. In most jurisdictions, it is taxed as income. Thus, if the value goodwill is quite high, you may push yourself into a higher tax bracket if you sell outside a corporation (the way to mitigate against this is to divide the purchase price between different tax years which gives you tax savings but the advantage is off-set by your additional exposure to non-payment of the remainder of the purchase price). Other jurisdictions limit the amount of goodwill the purchaser can write-off.

Thus, the purchaser may want less goodwill assigned to the purchase price (given it cannot write it off that aggressively) by negotiating a higher tax value to the assets which leads to the 2nd issue. (if this all sounds as clear as mud, it is; preparing a business for sale is a fine art form which is not a DIY adventure because of the tax pitfalls involved) A seller may have to assign tax values to assets which are higher than the depreciation value of the assets which leads to recapture. Recapture is a fancy term which is the difference between the (sale value) – (tax value).

For example, prepare you bought a truck for $100,000 for business purposes. You write off $50,000 of that cost for tax purposes. Thus, in the eyes of the tax authorities, the truck is “worth” $50,000 (tax value and real life values are two different concepts). The truck is then sold for $60,000. Recapture is $60,000 – $50,000 = $10,000 and tax is payable on the recapture amount (based on either the individual or corporate tax rate as applicable).

Having said all of that, the possibility of recapture on selling a blog are quite low. No one really wants to buy your 2 year old Dell Computer; most of the purchase price will be in goodwill. However, I highlight this possibility to show how much more difficult an asset sale is than a share sale. The due diligence and professional work involved in an asset sale is typically more involved than a share sale so, beside the possibility of a higher tax burden, you are paying more in transaction fees.

If your head is spinning reading an asset sale, it highlights the difficult tax and legal issues underpinning an asset sale compared to a share sale and why a share sale is more desired from both a tax and legal perspective.

OTHER THINGS TO CONSIDER

This was a pretty technical post so I wanted to end with a few more general notes:

1. Any savvy purchaser will want you to sign a non-competition and non-solicitation agreement. So be prepared to sit on the sidelines for a period of time after sale.
2. A business should ideally be prepared for sale months before-hand. This means having an accountant make appropriate tax adjustments, putting verbal contracts into writing, tying up loose ends etc. etc.
3. Selling a business is stressful. It requires a great deal of patience and, in every deal involving major dollars, it looks like the deal may fall apart on several occasions. You have to brace yourself emotionally and mentally during the process.

As the above shows, selling a business involves quite a bit of technical legal and tax work. Thus, the first step in selling a business is to see your accountant to put the ship in order. In my next post, we’ll get to the good stuff- how much can you get for selling your blog.