What is the Fair Market Value of the Note? No Valuation Formula or Rule of Thumb Exists Each note investment must be individually analyzed.
The puzzle exists because there is no "one-size-fits-all rule of thumb"; a quick and easy answer does not exist.
Attorneys, CPAs, Financial Planners, and Investors all need to know the value of an asset.
Unfortunately, they all tend to get their information from the guy down the hall, at the water cooler, or from the "expert" they play golf with.
They are often willing to rely on rumors and guess-work that has been passed down for years.
Why would anyone do a big, important transactions based on guesswork and hunches? There are eight key factors affecting the Fair Market Value of a note.
Each factor requires individual analysis; then the eight factors have to be combined into one intelligent valuation conclusion.
There is no "one-size-fits-all valuation rule of thumb".
The eight key factors are: 1.
Interest rate competitiveness The interest rate on the investment is in competition with rates available on similar investments.
A prudent investor maximizes the yields on each investment.
If the yield provided by the asset is below current market rates its principal balance must be discounted to provide a competitive rate.
2.
Borrower/Debtor financial strength The financial strength of the borrower is critical to the success of the investment.
The borrower's ability to keep his promise is vital.
If the investment is only secured by the borrower's promise (an unsecured note), the borrowers financial strength is providing total support.
A financially weak borrower increases the risk of loss.
That risk factor must be compensated for by adjusting the principal balance paid for the asset.
3.
Collateral Security quality and quantity To increase the value of a note and to decrease its risk, additional collateral security is added to the borrower's signature.
The additional collateral security can be real estate (deed of trust or mortgage), a co-signer, business assets, or other valuable assets.
The quality and quantity of the additional collateral security determines the ultimate Fair Market Value of the investment.
4.
Payment amount and frequency Over the term of the loan the amount of each payment received and the frequency of receipt provides the "cash-flow" to the investor.
Most investors seek high, frequent cash flows.
As an example, an asset having no payments for five years and one final "balloon payment will command a lower value than a similar note with monthly payments that amortize it over five years.
Cash-flow is king in the investment world.
5.
Liquidity & Marketability Most investors value the ability to sell an investment within a reasonable time at a reasonable price.
This ability is called "marketability and liquidity".
Lacking this capability causes an investment to be reduced in value.
If no active market exists, and if there are few potential buyers for an investment, the investment is discounted in value to compensate for the risks of loss.
Bank financing to a potential buyer or holder of this asset is limited or unavailable.
6.
Document terms and conditions Weak, unconventional, unjust, and unbalanced terms and conditions cause misunderstandings, arguments and collection problems.
Terms too favorable to the borrower, or to the lender, result in unpredictable enforceability in a court of law.
The asset is discounted to compensate for these unknown risks.
7.
Document language clarity Poor, ambiguous, unusual, or contradictory language devalues the asset.
Clarity of terminology and language are vital to a successful investment.
8.
Negotiable Instrument factors There is a law of negotiable instruments that greatly affects the collectability, marketability, and value of a note.
The term "Holder in Due Course" applies.
Obtaining experienced legal services when originating or buying a promissory note is very important to the success of the investment.
Summary To determine the Fair Market Value of a note eight factors must be considered individually and then collectively.
The puzzle exists because there is no "one-size-fits-all rule of thumb"; a quick and easy answer does not exist.
Attorneys, CPAs, Financial Planners, and Investors all need to know the value of an asset.
Unfortunately, they all tend to get their information from the guy down the hall, at the water cooler, or from the "expert" they play golf with.
They are often willing to rely on rumors and guess-work that has been passed down for years.
Why would anyone do a big, important transactions based on guesswork and hunches? There are eight key factors affecting the Fair Market Value of a note.
Each factor requires individual analysis; then the eight factors have to be combined into one intelligent valuation conclusion.
There is no "one-size-fits-all valuation rule of thumb".
The eight key factors are: 1.
Interest rate competitiveness The interest rate on the investment is in competition with rates available on similar investments.
A prudent investor maximizes the yields on each investment.
If the yield provided by the asset is below current market rates its principal balance must be discounted to provide a competitive rate.
2.
Borrower/Debtor financial strength The financial strength of the borrower is critical to the success of the investment.
The borrower's ability to keep his promise is vital.
If the investment is only secured by the borrower's promise (an unsecured note), the borrowers financial strength is providing total support.
A financially weak borrower increases the risk of loss.
That risk factor must be compensated for by adjusting the principal balance paid for the asset.
3.
Collateral Security quality and quantity To increase the value of a note and to decrease its risk, additional collateral security is added to the borrower's signature.
The additional collateral security can be real estate (deed of trust or mortgage), a co-signer, business assets, or other valuable assets.
The quality and quantity of the additional collateral security determines the ultimate Fair Market Value of the investment.
4.
Payment amount and frequency Over the term of the loan the amount of each payment received and the frequency of receipt provides the "cash-flow" to the investor.
Most investors seek high, frequent cash flows.
As an example, an asset having no payments for five years and one final "balloon payment will command a lower value than a similar note with monthly payments that amortize it over five years.
Cash-flow is king in the investment world.
5.
Liquidity & Marketability Most investors value the ability to sell an investment within a reasonable time at a reasonable price.
This ability is called "marketability and liquidity".
Lacking this capability causes an investment to be reduced in value.
If no active market exists, and if there are few potential buyers for an investment, the investment is discounted in value to compensate for the risks of loss.
Bank financing to a potential buyer or holder of this asset is limited or unavailable.
6.
Document terms and conditions Weak, unconventional, unjust, and unbalanced terms and conditions cause misunderstandings, arguments and collection problems.
Terms too favorable to the borrower, or to the lender, result in unpredictable enforceability in a court of law.
The asset is discounted to compensate for these unknown risks.
7.
Document language clarity Poor, ambiguous, unusual, or contradictory language devalues the asset.
Clarity of terminology and language are vital to a successful investment.
8.
Negotiable Instrument factors There is a law of negotiable instruments that greatly affects the collectability, marketability, and value of a note.
The term "Holder in Due Course" applies.
Obtaining experienced legal services when originating or buying a promissory note is very important to the success of the investment.
Summary To determine the Fair Market Value of a note eight factors must be considered individually and then collectively.
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