how to finance investment property

How to Finance Investment Property.

You might find the perfect investment property, but before you can buy it you need to obtain financing. Many people will go to a bank and ask for a conventional loan with a repayment period of 25-30 years. Before doing so, however, you should analyze your credit history to check that you are a good credit risk. You have more options than simply relying on a conventional loan. For example, you could cash out the equity in your home or seek owner financing of the investment property.

Method 1 Obtaining a Conventional Loan.

1. Pull together a down payment. You can’t rely on mortgage insurance to cover your investment property. Accordingly, you will need a sizeable down payment, around 20-25%.

2. Consider a neighborhood bank. Smaller banks might be more flexible about lending to you if you don’t have a large down payment or if your credit score isn’t perfect. Local banks also may have a stronger interest in lending for local investment, so they are a good option.

You might not know anything about smaller lenders, so you should do as much research as possible. Ask people that you know whether they have ever done business with the bank.

You can also check online. Look for reviews.

3. Gather necessary paperwork. Before approaching a lender, you should pull together required paperwork. Doing so ahead of time will speed up the process. Get the following.

two months of bank statements, prior two months’ statements for investment accounts and retirement accounts, last two pay stubs.

information about self-employed income, such as last two year’s tax returns or business financial statements, driver’s license.

Social Security card, papers related to bankruptcy, divorce, or separation (if applicable).

4. Work with a mortgage broker. A mortgage broker will apply for loans on your behalf with many different lenders and will compare the rates. The broker can also try to negotiate better terms for you. Using a mortgage broker is a good idea if you are too busy to comparison shop by going to many different lenders.

Mortgage brokers don’t work for free. You typically will pay about 1% of the loan amount. For example, if you borrow $250,000, then you can expect to pay around $2,500 to the mortgage broker.

You can ask other investors or a real estate agent for a referral to a broker. Before hiring, make sure that you interview the person and ask how much experience they have and what services they offer.

5. Compare loans. If you don’t want to work with a mortgage broker, then you will need to educate yourself about the basics of home financing. You might be an experienced pro who has borrowed before. However, if you haven’t, then remember to consider the following when comparing loans.

Interest rates. An interest rate is a percent of the loan amount that you pay as a privilege for borrowing the money. Interest rates can be fixed for the entire length of the loan or fixed for only a portion of the loan term.

Discount points. For some loans, you can pay points, which will lower your interest rate.

Loan term. This is the length of the loan. A shorter loan will cost more each month, but you will pay it off sooner and with less interest.

Origination charge. This amount of money covers document preparation, fees, and the costs of underwriting the loan.

6. Seek pre-approval. You should try to get pre-approved for a loan before searching for properties. Make sure to request the pre-approval in writing because sellers might want to see that you are pre-approved.

7. Don’t forget other team members. Purchasing investment property requires the expertise of many different professionals. You should begin assembling your team early—even before you get financing. You will probably need the help of the following people.

An accountant who can help you understand investment tax strategies.

A realtor who can help you sign an appropriate real estate contract.

An attorney who can help you protect your assets, for example by forming a limited liability company to hold the property.

An insurance agent.

Method 2 Using Other Finance Options.

1. Use the equity in your home. You might be able to use the equity in your current home to purchase an investment property. Generally, you can borrow around 80% of your home’s value. There are different ways you can tap the equity in your home, such as the following.

You could get a Home Equity Line of Credit (HELOC). A lender will approve you for a specific amount of credit, and you use your current home as collateral for the loan. The credit is available for a certain amount of time. At the end of this draw period, you must have paid back the loan.

You might also get a cash-out refinance. The lender will pay you the difference between the mortgage and the home’s value, but is usually limited to 80-90% of the home’s value. For example, if you have $20,000 remaining on your mortgage, but your home is valued at $220,000, then $200,000 could be available. You could get 80-90% of $200,000 ($160,000-180,000). This option usually has a lower interest rate than a HELOC.

Both a HELOC and a cash-out refinance put your home at risk if you can’t make repayments. For this reason, you should think carefully before tapping the equity in your home to finance investments.

2. Obtain a fix-and-flip loan. You might be able to get this type of loan if you want to purchase a property in order to renovate and then quickly sell. The loan will be short-term and is secured by the property. Fix-and-flip loans have high interest rates, so you need to renovate and sell quickly.

You might find it easier to qualify for a fix-and-flip loan compared to a conventional loan. However, lenders will still look at your credit history and income.

The lender will also want to know the estimated value after repair, which can impact whether they extend you a loan and the terms.

3. Research peer-to-peer lending sites. Peer-to-peer lending connects investors with lenders who are willing to lend. Two of the more well-known peer-to-peer lending sites are Prosper and LendingClub.

Peer-to-peer lenders will require that you complete an application. They look at your credit score and credit history. They may also have minimum credit scores in order to qualify.

You might not be able to get a large personal loan through peer-to-peer lending. However, small businesses can typically borrow more, so if you create an LLC then you might be able to borrow up to $100,000.

4. Find a business partner. You might not be able to secure a loan on your own, in which case you will need to consider other options. One option is to find a business partner who you can invest with.

You will want to screen any potential business partner, just as a bank would screen you. If you are counting on the partner to help pay for the loan, then you will need to check their credit history and employment.

You also need to consider how you will hold the investment property. For example, it might be best to create an LLC and to both be owners of the LLC. The LLC will then hold title to the investment property.

5. Consider owner financing. With owner financing, the owner lends you the money that you use to buy the property. Sometimes the owner will lend only a portion of the price, which you then supplement with a conventional loan. You should analyze the pros and cons of owner financing.

A benefit of owner financing is that an owner might be willing to lend if you don’t have perfect credit or a huge down payment available. You and the owner can work out loan terms that are acceptable to both of you.

Typically, the seller’s loan will be for a short period of time (such as five years). At the end of the term, you are obligated to pay off the loan with a “balloon payment.” This usually means you need to get a conventional loan to make this balloon payment. You should analyze your credit to see if you can qualify for a conventional loan in the near future.

See Owner Finance a Home for more information.

Method 3 Analyzing Your Credit Score.

1. Obtain a free copy of your credit report. Your credit score will have the largest impact on your ability to get a loan, so you should obtain a copy of your credit report.[18] You are entitled to one free credit report each year from the three national Credit Reporting Agencies (CRAs). You shouldn’t contact the CRAs individually. Instead, you can get your free copy from all three using one of the following methods.

Complete the Annual Credit Report Request Form, which is available here: https://www.consumer.ftc.gov/articles/pdf-0093-annual-report-request-form.pdf. Once completed, submit the form to Annual Credit Report Request Service, PO Box 105281, Atlanta, GA 30348-5281.

2. Find errors on your credit report. You should closely look at you credit reports to find any errors that might lower your credit score. If your score is below 740, then you will probably have to pay more to borrow. For this reason, you should do whatever you can to increase the score. Look for the following errors.

credit information from an ex-spouse, credit information from someone with a similar name, address, Social Security Number, etc.

incorrect payment status (e.g., stating you are late when you aren’t), a delinquent account reported more than once.

old information that should have fallen off your credit report, an account inaccurately identified as closed by the lender.

failure to note when delinquencies have been remedied.

3. Consider whether you should fix certain problems. There may be negative information on your credit report that you want to fix. For example, you might want to pay an old collections account. However, you should think carefully before fixing certain problems.

Negative information must fall off your credit report after a certain amount of time. For example, an account in collections should fall off after seven years. If the account is six years old, you might want to wait and let it fall off rather than pay it off.

If you need help considering what to do, then you should consult with an attorney who can advise you.

4. Fix errors. You can correct errors by contacting each CRA online or by writing a letter. To protect yourself, you should probably do both. Mail your letter certified mail, return receipt requested.

The Federal Trade Commission has a sample letter you can use: https://www.consumer.ftc.gov/articles/0384-sample-letter-disputing-errors-your-credit-report.

See Dispute Credit Report Errors for more information on how to fix errors.

December 15, 2019

How to Finance Investment Property

How to Finance Investment Property.

You might find the perfect investment property, but before you can buy it you need to obtain financing. Many people will go to a bank and ask for a conventional loan with a repayment period of 25-30 years. Before doing so, however, you should analyze your credit history to check that you are a good credit risk. You have more options than simply relying on a conventional loan. For example, you could cash out the equity in your home or seek owner financing of the investment property.

Method 1 Obtaining a Conventional Loan.

1. Pull together a down payment. You can’t rely on mortgage insurance to cover your investment property. Accordingly, you will need a sizeable down payment, around 20-25%.

2. Consider a neighborhood bank. Smaller banks might be more flexible about lending to you if you don’t have a large down payment or if your credit score isn’t perfect. Local banks also may have a stronger interest in lending for local investment, so they are a good option.

You might not know anything about smaller lenders, so you should do as much research as possible. Ask people that you know whether they have ever done business with the bank.

You can also check online. Look for reviews.

3. Gather necessary paperwork. Before approaching a lender, you should pull together required paperwork. Doing so ahead of time will speed up the process. Get the following.

two months of bank statements, prior two months’ statements for investment accounts and retirement accounts, last two pay stubs.

information about self-employed income, such as last two year’s tax returns or business financial statements, driver’s license.

Social Security card, papers related to bankruptcy, divorce, or separation (if applicable).

4. Work with a mortgage broker. A mortgage broker will apply for loans on your behalf with many different lenders and will compare the rates. The broker can also try to negotiate better terms for you. Using a mortgage broker is a good idea if you are too busy to comparison shop by going to many different lenders.

Mortgage brokers don’t work for free. You typically will pay about 1% of the loan amount. For example, if you borrow $250,000, then you can expect to pay around $2,500 to the mortgage broker.

You can ask other investors or a real estate agent for a referral to a broker. Before hiring, make sure that you interview the person and ask how much experience they have and what services they offer.

5. Compare loans. If you don’t want to work with a mortgage broker, then you will need to educate yourself about the basics of home financing. You might be an experienced pro who has borrowed before. However, if you haven’t, then remember to consider the following when comparing loans.

Interest rates. An interest rate is a percent of the loan amount that you pay as a privilege for borrowing the money. Interest rates can be fixed for the entire length of the loan or fixed for only a portion of the loan term.

Discount points. For some loans, you can pay points, which will lower your interest rate.

Loan term. This is the length of the loan. A shorter loan will cost more each month, but you will pay it off sooner and with less interest.

Origination charge. This amount of money covers document preparation, fees, and the costs of underwriting the loan.

6. Seek pre-approval. You should try to get pre-approved for a loan before searching for properties. Make sure to request the pre-approval in writing because sellers might want to see that you are pre-approved.

7. Don’t forget other team members. Purchasing investment property requires the expertise of many different professionals. You should begin assembling your team early—even before you get financing. You will probably need the help of the following people.

An accountant who can help you understand investment tax strategies.

A realtor who can help you sign an appropriate real estate contract.

An attorney who can help you protect your assets, for example by forming a limited liability company to hold the property.

An insurance agent.

Method 2 Using Other Finance Options.

1. Use the equity in your home. You might be able to use the equity in your current home to purchase an investment property. Generally, you can borrow around 80% of your home’s value. There are different ways you can tap the equity in your home, such as the following.

You could get a Home Equity Line of Credit (HELOC). A lender will approve you for a specific amount of credit, and you use your current home as collateral for the loan. The credit is available for a certain amount of time. At the end of this draw period, you must have paid back the loan.

You might also get a cash-out refinance. The lender will pay you the difference between the mortgage and the home’s value, but is usually limited to 80-90% of the home’s value. For example, if you have $20,000 remaining on your mortgage, but your home is valued at $220,000, then $200,000 could be available. You could get 80-90% of $200,000 ($160,000-180,000). This option usually has a lower interest rate than a HELOC.

Both a HELOC and a cash-out refinance put your home at risk if you can’t make repayments. For this reason, you should think carefully before tapping the equity in your home to finance investments.

2. Obtain a fix-and-flip loan. You might be able to get this type of loan if you want to purchase a property in order to renovate and then quickly sell. The loan will be short-term and is secured by the property. Fix-and-flip loans have high interest rates, so you need to renovate and sell quickly.

You might find it easier to qualify for a fix-and-flip loan compared to a conventional loan. However, lenders will still look at your credit history and income.

The lender will also want to know the estimated value after repair, which can impact whether they extend you a loan and the terms.

3. Research peer-to-peer lending sites. Peer-to-peer lending connects investors with lenders who are willing to lend. Two of the more well-known peer-to-peer lending sites are Prosper and LendingClub.

Peer-to-peer lenders will require that you complete an application. They look at your credit score and credit history. They may also have minimum credit scores in order to qualify.

You might not be able to get a large personal loan through peer-to-peer lending. However, small businesses can typically borrow more, so if you create an LLC then you might be able to borrow up to $100,000.

4. Find a business partner. You might not be able to secure a loan on your own, in which case you will need to consider other options. One option is to find a business partner who you can invest with.

You will want to screen any potential business partner, just as a bank would screen you. If you are counting on the partner to help pay for the loan, then you will need to check their credit history and employment.

You also need to consider how you will hold the investment property. For example, it might be best to create an LLC and to both be owners of the LLC. The LLC will then hold title to the investment property.

5. Consider owner financing. With owner financing, the owner lends you the money that you use to buy the property. Sometimes the owner will lend only a portion of the price, which you then supplement with a conventional loan. You should analyze the pros and cons of owner financing.

A benefit of owner financing is that an owner might be willing to lend if you don’t have perfect credit or a huge down payment available. You and the owner can work out loan terms that are acceptable to both of you.

Typically, the seller’s loan will be for a short period of time (such as five years). At the end of the term, you are obligated to pay off the loan with a “balloon payment.” This usually means you need to get a conventional loan to make this balloon payment. You should analyze your credit to see if you can qualify for a conventional loan in the near future.

See Owner Finance a Home for more information.

Method 3 Analyzing Your Credit Score.

1. Obtain a free copy of your credit report. Your credit score will have the largest impact on your ability to get a loan, so you should obtain a copy of your credit report.[18] You are entitled to one free credit report each year from the three national Credit Reporting Agencies (CRAs). You shouldn’t contact the CRAs individually. Instead, you can get your free copy from all three using one of the following methods.

Complete the Annual Credit Report Request Form, which is available here: https://www.consumer.ftc.gov/articles/pdf-0093-annual-report-request-form.pdf. Once completed, submit the form to Annual Credit Report Request Service, PO Box 105281, Atlanta, GA 30348-5281.

2. Find errors on your credit report. You should closely look at you credit reports to find any errors that might lower your credit score. If your score is below 740, then you will probably have to pay more to borrow. For this reason, you should do whatever you can to increase the score. Look for the following errors.

credit information from an ex-spouse, credit information from someone with a similar name, address, Social Security Number, etc.

incorrect payment status (e.g., stating you are late when you aren’t), a delinquent account reported more than once.

old information that should have fallen off your credit report, an account inaccurately identified as closed by the lender.

failure to note when delinquencies have been remedied.

3. Consider whether you should fix certain problems. There may be negative information on your credit report that you want to fix. For example, you might want to pay an old collections account. However, you should think carefully before fixing certain problems.

Negative information must fall off your credit report after a certain amount of time. For example, an account in collections should fall off after seven years. If the account is six years old, you might want to wait and let it fall off rather than pay it off.

If you need help considering what to do, then you should consult with an attorney who can advise you.

4. Fix errors. You can correct errors by contacting each CRA online or by writing a letter. To protect yourself, you should probably do both. Mail your letter certified mail, return receipt requested.

The Federal Trade Commission has a sample letter you can use: https://www.consumer.ftc.gov/articles/0384-sample-letter-disputing-errors-your-credit-report.

See Dispute Credit Report Errors for more information on how to fix errors.

December 15, 2019

How to Finance a Business

How to Finance a Business.

When it's time to finance a business, there can be substantial work involved to facilitate this step. Every small business is different, and businesses in different industries and sectors have different ways of going about getting credit. There are various costs which widely range over the span of particular sectors. However, for the core process of securing the financial assistance that a business owner needs for a start up, some basic guidelines and principles will help create effective programs and a solvent business model. Estimate the costs of doing business, find out what you need to borrow money, and then research your financing options.





Estimating Costs of Your Business.



Determine the one-time costs of your business. These are costs that will only occur at the very beginning of opening your business. These include mileage (getting to a location), market research, advertising, and training. You will also need to look up any fees which will occur, such as a lawyer or consultant fee.



Calculate the recurring costs of your business. These are costs that you will have to pay over and over again, usually on a weekly, bi-weekly, or monthly basis. These include costs of utilities, insurance, wages, etc. Recurring costs are generally larger than one-time costs, and span a length of 10-30 years depending on your financing options. Calculate not only the total cost over the lifespan of your business, but also that on a yearly, and bi-yearly basis.



Ascertain whether costs are fixed, or variable. Fixed costs are those which will not change. The cost of your utilities, or your administrative costs are all fixed. Variable costs are those which will change over time. This includes wages, insurance, and shipping/packaging costs. The best way to keep all this information organized is to create a spreadsheet (use Excel). That way you can graph out this information, and view it multiple ways(bar graph, line chart, etc.).



Create a balance sheet. If you are just starting a small business, it is important that you write out balance sheets, which include: assets, liabilities, and equity. Each of these three categories will help you keep track of the finances of your business, and make it easier to pay your bills.

Assets = current assets(cash, accounts receivable, notes receivable, inventory) + fixed assets(land, building, machinery, furniture, improvements) + intangibles(research, patents, charity, organizational expense)

Liabilities = current liabilities(accounts payable, accrued expenses, notes payable, current long-term debt) + non-current liabilities(non-current long-term debt, notes payable to shareholders and owners, contingent liabilities)

Equity = Assets - Liabilities



Develop a cash flow analysis. This measures money which goes in and out of your business. This is then broken down into operational activities, investment activities, and financing activities. This analysis will help you determine when you break even, and can start reinvesting/expanding your business. Once more, the best way to do this is to create a spread sheet. Find all of your financial statements and gather them together before you start to analyze.

Operational = net income, loses of business, sales, and business expenditures.

Investment = purchases and sales of property, assets, securities, and equipment.

Financing = cash flows of all your loan borrowing and repayment.







Borrowing Money for Your Business.



Use equity financing to start your business. Equity financing usually comes from a primary investor, or other business. They will provide you a sum of money, in exchange for part-ownership of your company. This is a good option because investors look further down the road than a loan company, and you will have more money on hand. However, the investors will naturally want to interfere, and change aspects of your business model.

There are networks online which can set you up with a primary investor.

You can also check out private equity firms, which contain a vast array of specialized and experienced investors.

Remember, that small business owners generally use very little equity financing. It all depends on your business model, and the potential for growth.



Start your business using debt financing. Debt financing is when you take out a loan, usually from a bank or lending institution. This is a great option because the bank will have no say in how you run your business. The loan is tax deductible, and you can get short-term or long-term loans. However, you must have the loan repaid in a certain amount of time, and if you don't, you could have a hard time getting capital investment.

Talk to your local bank, or lending institution about the qualifications for specific loans. You will probably have to fill out some paperwork to determine whether or not you are qualified.

When using a local bank, you may be able to set up a personal relationship. This way, you can postpone a few payments if you fall on hard times.



Find out about credit scores and ratings. The higher your score is, the less risky you are to investors. In many cases, the initial business loan will be based on the borrower's own personal credit score. However, in some cases where a business is already operational, a business plan and other documents can provide for a different kind of credit specifically for the continued operations of that enterprise.

Use the online company TransUnion or EquiFax to determine your credit score. It is important to get an independent analysis, otherwise your own calculated score could be biased.

The main focus of the score is how long you have maintained a credit line, and how many monthly payments you have made on time.

If you have no prior experience taking out credit, it may be hard to get a loan. It is best to start using a credit card on small things like gas, or grocery store trips. Then gradually build up. Show the creditors you are a responsible client.[12]



Maintain an adequate debt to equity ratio. You want to make sure that the total debt and liabilities of your business is no more than four times the equity in the business. Equity simply means any retained earnings and cash injections by investors. In order to start out with equity, the owner of the business usually has to put in anywhere from 20-40%. This will maintain an adequate debt to equity ratio, and allow you to get a loan.



Put up collateral to start your business. Before you get a loan, the lending institution or bank will ask for collateral. This means you risk some of the items you own. In the case you cannot repay the loan, the bank can seize your property. Collateral usually includes homes, cars, furniture, equipment, stocks, bonds, etc. this is a scary proposition, so you need to be sure that your business will be financially successful beforehand.



Shop around for different lenders. There are a variety of lenders who may or may not be willing to issue new business loans, and all of these potential lenders have their own terms and conditions. Talk to various lenders and ask them about what kinds of loans are available. Evaluate loans by timeline. Lenders will offer various short-term, long-term or revolving-credit loans to business owners. Look at which ones suit the needs of a startup the best.

Look at secured and unsecured business loans. Secured loans actually use existing assets as collateral. For example, the person trying to start a business can use his or her home, or other property, as collateral and get lower interest rates for the loan. However, this leaves the assets vulnerable to seizure in cases of nonpayment. Unsecured loans rest solely on the borrower's credit score. See which of these types of loans best matches desired risk.

Select the best deals. You want a loan that has the lowest interest rates and most favorable terms for repayment.









Financing Your Business.



Get a bank loan. Small, local banks have received more strict standards after the financial crash of 2008. However, large investment banks such as JP Morgan Chase and Bank of America have received a set of moneys from the Federal Reserve to lend out to small businesses. This is your best option to go with, although it takes the long to pay off. Local banks will set you up with a contract, and a monthly payment. The other benefit is that you can get this loan postponed if you are having trouble paying it off.



Place your home up as collateral. Banks will generally allow you to borrow up to 75-80% of your home's worth, as long as you have at least 10-15% already down on your home. This is great because the loan will have a much lower interest rate than a credit card. Talk with your financier, or local mortgage company for more detailed information.



Use your credit card. This is a very dangerous game to be played. You need to stay on top of your monthly payments. If you fall behind, you get trapped in a death spiral. However, when carefully managed, credit cards can be great to get out of an emergency. Only use a credit card occasionally, when you are experiencing a hole you know that you can get out of.



Tap into your 401(k) plan. You will need a financial expert who can start up a C Corporation which you can then roll your retirement assets into. This is also a risky business, because you are tapping into your nest egg. This should only be done if you have more money put away in a savings account, or if you are independently wealthy.



Try loaning money from your friends and family. Ask who would be willing to make a contribution, or purchase a percentage of the company. Go about asking members of your church for donations. Let local businesses to partner with you. You might make some acquaintances, and make some deals (you make cheese, they make wine, a chance to exchange).



Pledge your future earnings. Some companies, or peoples, are willing to gamble and put money upfront, if you are willing to commit a certain percentage of future profits. This is a gamble because they, and you, are betting that you will be able to earn enough in the future. There is usually a contract involved, guaranteeing that they will at least get some money back, so keep that in mind.



Kickstart your business. Crowd funding, in the age of the internet, has become a very popular way to finance businesses. Write a description of your business idea online, at sites like Kickstarter, and convince people to donate to your business. You will want to be really descriptive, and excited in your word choice. The downside of this is that it could take months or years before you raise enough money.



Secure an SBA loan. SBA (Small Business Administration) is a branch of the Federal Government that supplies loans to businesses struggling to get off the ground. However, there are a number of qualifications. You had to have been denied a loan from another bank before. You have to meet the government's definition of a small business. You will also have to meet other restrictions, depending on the type of SBA loan. Go to the SBA's website, and fill out a form if you think you might meet these qualifications.



Attract an angel investor. These are wealthy individuals who like to bet on the financial success of start-up businesses. Angel investors are usually found at private-equity, and venture capital firms. You will want to bring someone older, who looks like he has had experience in business before. Be passionate about your idea when you present, and know all of the financial details before you walk in the room. Keep in contact with the investor days and weeks after your initial meeting.





Tips.

Talk to numerous lending institutions before you pick a loan. Some will have better interest rates, while others will have better repayments.

Consult with family members first. Getting a small loan from them can avoid dealing with greedy credit lenders.

Get some experience in the business before you start your own. If you want to start a restaurant, make sure you have worked in a restaurant before. If not, you will wind up purchasing outside help which will cost you astronomical amounts of money.



Warnings.

Talk to a lawyer and a financial advisor to avoid colossal mistakes. The biggest regret of many first-time small business owners is not consulting with a professional before they begin the process.

If you are a person living paycheck-to-paycheck, it is best to wait to start a small business. If the business goes down hill quickly, you could lose your assets, and your life savings.

Take a year to save up money and make a detailed plan. You do not want to go into small business owning head first.

November 13, 2019

how to finance a business well

How to Finance a Business.

When it's time to finance a business, there can be substantial work involved to facilitate this step. Every small business is different, and businesses in different industries and sectors have different ways of going about getting credit. There are various costs which widely range over the span of particular sectors. However, for the core process of securing the financial assistance that a business owner needs for a start up, some basic guidelines and principles will help create effective programs and a solvent business model. Estimate the costs of doing business, find out what you need to borrow money, and then research your financing options.





Estimating Costs of Your Business.



Determine the one-time costs of your business. These are costs that will only occur at the very beginning of opening your business. These include mileage (getting to a location), market research, advertising, and training. You will also need to look up any fees which will occur, such as a lawyer or consultant fee.



Calculate the recurring costs of your business. These are costs that you will have to pay over and over again, usually on a weekly, bi-weekly, or monthly basis. These include costs of utilities, insurance, wages, etc. Recurring costs are generally larger than one-time costs, and span a length of 10-30 years depending on your financing options. Calculate not only the total cost over the lifespan of your business, but also that on a yearly, and bi-yearly basis.



Ascertain whether costs are fixed, or variable. Fixed costs are those which will not change. The cost of your utilities, or your administrative costs are all fixed. Variable costs are those which will change over time. This includes wages, insurance, and shipping/packaging costs. The best way to keep all this information organized is to create a spreadsheet (use Excel). That way you can graph out this information, and view it multiple ways(bar graph, line chart, etc.).



Create a balance sheet. If you are just starting a small business, it is important that you write out balance sheets, which include: assets, liabilities, and equity. Each of these three categories will help you keep track of the finances of your business, and make it easier to pay your bills.

Assets = current assets(cash, accounts receivable, notes receivable, inventory) + fixed assets(land, building, machinery, furniture, improvements) + intangibles(research, patents, charity, organizational expense)

Liabilities = current liabilities(accounts payable, accrued expenses, notes payable, current long-term debt) + non-current liabilities(non-current long-term debt, notes payable to shareholders and owners, contingent liabilities)

Equity = Assets - Liabilities



Develop a cash flow analysis. This measures money which goes in and out of your business. This is then broken down into operational activities, investment activities, and financing activities. This analysis will help you determine when you break even, and can start reinvesting/expanding your business. Once more, the best way to do this is to create a spread sheet. Find all of your financial statements and gather them together before you start to analyze.

Operational = net income, loses of business, sales, and business expenditures.

Investment = purchases and sales of property, assets, securities, and equipment.

Financing = cash flows of all your loan borrowing and repayment.







Borrowing Money for Your Business.



Use equity financing to start your business. Equity financing usually comes from a primary investor, or other business. They will provide you a sum of money, in exchange for part-ownership of your company. This is a good option because investors look further down the road than a loan company, and you will have more money on hand. However, the investors will naturally want to interfere, and change aspects of your business model.

There are networks online which can set you up with a primary investor.

You can also check out private equity firms, which contain a vast array of specialized and experienced investors.

Remember, that small business owners generally use very little equity financing. It all depends on your business model, and the potential for growth.



Start your business using debt financing. Debt financing is when you take out a loan, usually from a bank or lending institution. This is a great option because the bank will have no say in how you run your business. The loan is tax deductible, and you can get short-term or long-term loans. However, you must have the loan repaid in a certain amount of time, and if you don't, you could have a hard time getting capital investment.

Talk to your local bank, or lending institution about the qualifications for specific loans. You will probably have to fill out some paperwork to determine whether or not you are qualified.

When using a local bank, you may be able to set up a personal relationship. This way, you can postpone a few payments if you fall on hard times.



Find out about credit scores and ratings. The higher your score is, the less risky you are to investors. In many cases, the initial business loan will be based on the borrower's own personal credit score. However, in some cases where a business is already operational, a business plan and other documents can provide for a different kind of credit specifically for the continued operations of that enterprise.

Use the online company TransUnion or EquiFax to determine your credit score. It is important to get an independent analysis, otherwise your own calculated score could be biased.

The main focus of the score is how long you have maintained a credit line, and how many monthly payments you have made on time.

If you have no prior experience taking out credit, it may be hard to get a loan. It is best to start using a credit card on small things like gas, or grocery store trips. Then gradually build up. Show the creditors you are a responsible client.[12]



Maintain an adequate debt to equity ratio. You want to make sure that the total debt and liabilities of your business is no more than four times the equity in the business. Equity simply means any retained earnings and cash injections by investors. In order to start out with equity, the owner of the business usually has to put in anywhere from 20-40%. This will maintain an adequate debt to equity ratio, and allow you to get a loan.



Put up collateral to start your business. Before you get a loan, the lending institution or bank will ask for collateral. This means you risk some of the items you own. In the case you cannot repay the loan, the bank can seize your property. Collateral usually includes homes, cars, furniture, equipment, stocks, bonds, etc. this is a scary proposition, so you need to be sure that your business will be financially successful beforehand.



Shop around for different lenders. There are a variety of lenders who may or may not be willing to issue new business loans, and all of these potential lenders have their own terms and conditions. Talk to various lenders and ask them about what kinds of loans are available. Evaluate loans by timeline. Lenders will offer various short-term, long-term or revolving-credit loans to business owners. Look at which ones suit the needs of a startup the best.

Look at secured and unsecured business loans. Secured loans actually use existing assets as collateral. For example, the person trying to start a business can use his or her home, or other property, as collateral and get lower interest rates for the loan. However, this leaves the assets vulnerable to seizure in cases of nonpayment. Unsecured loans rest solely on the borrower's credit score. See which of these types of loans best matches desired risk.

Select the best deals. You want a loan that has the lowest interest rates and most favorable terms for repayment.









Financing Your Business.



Get a bank loan. Small, local banks have received more strict standards after the financial crash of 2008. However, large investment banks such as JP Morgan Chase and Bank of America have received a set of moneys from the Federal Reserve to lend out to small businesses. This is your best option to go with, although it takes the long to pay off. Local banks will set you up with a contract, and a monthly payment. The other benefit is that you can get this loan postponed if you are having trouble paying it off.



Place your home up as collateral. Banks will generally allow you to borrow up to 75-80% of your home's worth, as long as you have at least 10-15% already down on your home. This is great because the loan will have a much lower interest rate than a credit card. Talk with your financier, or local mortgage company for more detailed information.



Use your credit card. This is a very dangerous game to be played. You need to stay on top of your monthly payments. If you fall behind, you get trapped in a death spiral. However, when carefully managed, credit cards can be great to get out of an emergency. Only use a credit card occasionally, when you are experiencing a hole you know that you can get out of.



Tap into your 401(k) plan. You will need a financial expert who can start up a C Corporation which you can then roll your retirement assets into. This is also a risky business, because you are tapping into your nest egg. This should only be done if you have more money put away in a savings account, or if you are independently wealthy.



Try loaning money from your friends and family. Ask who would be willing to make a contribution, or purchase a percentage of the company. Go about asking members of your church for donations. Let local businesses to partner with you. You might make some acquaintances, and make some deals (you make cheese, they make wine, a chance to exchange).



Pledge your future earnings. Some companies, or peoples, are willing to gamble and put money upfront, if you are willing to commit a certain percentage of future profits. This is a gamble because they, and you, are betting that you will be able to earn enough in the future. There is usually a contract involved, guaranteeing that they will at least get some money back, so keep that in mind.



Kickstart your business. Crowd funding, in the age of the internet, has become a very popular way to finance businesses. Write a description of your business idea online, at sites like Kickstarter, and convince people to donate to your business. You will want to be really descriptive, and excited in your word choice. The downside of this is that it could take months or years before you raise enough money.



Secure an SBA loan. SBA (Small Business Administration) is a branch of the Federal Government that supplies loans to businesses struggling to get off the ground. However, there are a number of qualifications. You had to have been denied a loan from another bank before. You have to meet the government's definition of a small business. You will also have to meet other restrictions, depending on the type of SBA loan. Go to the SBA's website, and fill out a form if you think you might meet these qualifications.



Attract an angel investor. These are wealthy individuals who like to bet on the financial success of start-up businesses. Angel investors are usually found at private-equity, and venture capital firms. You will want to bring someone older, who looks like he has had experience in business before. Be passionate about your idea when you present, and know all of the financial details before you walk in the room. Keep in contact with the investor days and weeks after your initial meeting.





Tips.

Talk to numerous lending institutions before you pick a loan. Some will have better interest rates, while others will have better repayments.

Consult with family members first. Getting a small loan from them can avoid dealing with greedy credit lenders.

Get some experience in the business before you start your own. If you want to start a restaurant, make sure you have worked in a restaurant before. If not, you will wind up purchasing outside help which will cost you astronomical amounts of money.



Warnings.

Talk to a lawyer and a financial advisor to avoid colossal mistakes. The biggest regret of many first-time small business owners is not consulting with a professional before they begin the process.

If you are a person living paycheck-to-paycheck, it is best to wait to start a small business. If the business goes down hill quickly, you could lose your assets, and your life savings.

Take a year to save up money and make a detailed plan. You do not want to go into small business owning head first.

November 12, 2019

How Bitcoin Disrupts the Finance Industry

How Bitcoin Disrupts the Finance Industry .

Cryptocurrencies and their underlying blockchain technology are being touted as the next-big-thing after the creation of the internet. One area where these technologies are likely to have a major impact is the financial sector. The blockchain, as a form of distributed ledger technology (DLT), has the potential to transform well-established financial institutions and bring lower costs, faster execution of transactions, improved transparency, auditability of operations, and other benefits. Cryptocurrencies hold the promise of a new native digital asset class without a central authority.

So what do these technological developments mean for the various players in the sector and end users? “Blockchains have the potential to displace any business activity built on transactions occurring on traditional corporate databases, which is what underlies nearly every financial service function. Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications. DLT is therefore both a great opportunity and also a disruptive threat,” according to Bruce Weber, dean of Lerner College and business administration professor, and Andrew Novocin, professor of electrical and computer engineering, both at the University of Delaware.

Earlier this year, Weber, Novocin, and graduate student Jonathan Wood conducted a literature review on cryptocurrencies and DLT for the SWIFT Institute. Based on this review, the SWIFT institute recently issued a grant to conduct new research on DLT and cryptocurrencies in the financial sector. Weber and Novocin noted that just as disruptors like Amazon, Google, Facebook and Uber built software platforms and thriving businesses thanks to the connectivity provided by internet standards, next-generation startups will build new services and businesses with blockchains. “Many pundits expect blockchain, as a distributed technology, to become the foundation for new services and applications that have completely different rules from those running on hierarchical and controlled databases. Cryptocurrencies are an early example but many others will follow,” they added.

Kartik Hosanagar, a Wharton professor of marketing and operations, information and decisions, pointed out that the financial services sector is full of intermediaries such as banks that help create trust among transacting parties like lenders and borrowers. Blockchain, he said, is a mechanism to create trust without centralized control. “The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”

Regarding cryptocurrencies, Hosanagar pointed out that most of the value today is tied to speculative buying rather than actual use cases. But having a currency without a central authority offers “certain unique kinds of protections especially in countries with troubled central banks.” For example, Venezuela’s currency is rapidly losing value. For people who stored their savings in crypto, there was greater protection against such rapid currency devaluations. “Of course, cryptocurrencies have their own instabilities, but they aren’t tied to actions by central banks and that’s particularly relevant in countries and economies where citizens don’t trust their governments and central banks,” he said.

“Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications.”–Bruce Weber and Andrew Novocin

Hosanagar expects the first wave of applications to be rolled out in “private” blockchains where a central authority such as a financial institution and its partners are the only ones with the permission to participate (as opposed to public, permissionless blockchains where participants are anonymous and there is no central authority). Applications in the private blockchains, he said, will be more secure and will offer some of the benefits of decentralized ledgers but will not be radically different from the way things work at present. However, over time, he expects smart contracts (self-executing contracts when requirements are met) to be offered on public blockchain networks like Ethereum. “When securities are traded, intermediaries provide trust, and they charge commissions. Blockchains can help provide such trust in a low-cost manner. But trade of securities is governed by securities laws. Smart contracts offer a way to ensure compliance with the laws. They have great potential because of their ability to reduce costs while being compliant,” says Hosanagar.

According to Weber and Novocin, one area ripe for transformation is reaching consensus on important benchmark rates and prices. At present, they point out, different proprietary indexes are used to determine interest rates and the price of many mainstream assets. Blockchain can transform this. “Think of the London Interbank Offered Rate (LIBOR) and the recent scandals involving manipulation of benchmark values when they are controlled by a single entity that may not be capable of detecting false or fraudulent data. Blockchain could provide greater transparency around the process of creating agreed upon reference prices, and allow more people to participate in the consensus process.”

Weber and Novocin expect that in some areas intermediaries will find their roles reduced as blockchain allows for automation through greater transparency and traceability. In other areas, intermediaries will find themselves well-placed to take advantage of changing needs of their clients, as firms will need help to manage the shift to new standards as well as the greater complexity of open and traceable blockchain infrastructure. Intermediaries in areas that could potentially be disrupted, they said, “should get involved with projects seeking to set the standards, so that they can stay informed and position themselves to profit from becoming the leaders in the operations of the new markets that will emerge.”

Kevin Werbach, Wharton professor of legal studies and business ethics, and author of a forthcoming book The Blockchain and the New Architecture of Trust,  said that it’s usually not helpful to focus on what aspects of a major existing market will be “transformed” or “disrupted” by new technologies. Important technologies, he said, are far more likely to be integrated into the system than replace it. According to Werbach, while some firms will fail to make the transition and some new ones will take hold, “over the long-run, virtually every historic innovation that eliminated some forms of intermediation also created new forms.”

Blockchain will reduce the massive duplication of information that creates delays, conflicts and confusion in many aspects of financial services, Werbach added. For example, when a syndicate of lenders participates in a loan, having one shared ledger means they don’t all need to keep track of it independently. International payments and corporate stock records are other examples where there are huge inefficiencies due to duplicate record-keeping and intermediaries. “End users won’t see the changes in the deep plumbing of financial services, but it will allow new service providers to emerge and new products to be offered,” said Werbach.

Bumps Along the Way

Angela Walch, professor of law at St. Mary’s University School of Law and a research fellow at the Centre for Blockchain Technologies at University College London, offered another perspective. She said there is a lot of excitement about blockchain as a distributed ledger technology for the financial sector because many believe that it offers a better, more efficient and more resilient form of recordkeeping. However, making use of the blockchain is not as simple as just buying new software and running it. “Blockchain technology is, at core, group recordkeeping. To reap its full benefits, one needs all the relevant members of the group to join the system. This requires collaboration with and across businesses, which is a potentially big hurdle, and may be the hurdle that most limits adoption.”

Governance is the biggest challenge in decentralized organizations, said Weber and Novocin. Members participating in a blockchain-supported financial function may have misaligned incentives, and can end up in gridlock, or with a chaotic outcome. They cite the example of the ‘DAO Hack,’ which was the first prominent smart contract project on the Ethereum network to suffer a large loss of funds. The Ethereum community voted to conduct a hard fork (a radical change to the protocol that makes previously invalid blocks/transactions valid or vice-versa) — reversing the transactions after the hack and essentially refunding the DAO investors. This was in effect a breach of Ethereum’s immutability and it left a sizeable minority of the community bitterly dissatisfied. This group viewed the Ethereum community as forsaking its commitment to immutable, permanent records. They refused to acknowledge the hard fork, and maintained the original Ethereum blockchain, now known as Ethereum Classic (whereas the forked version supported by the Ethereum Foundation is simply Ethereum).

“The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”–Kartik Hosanagar

“Distributed organizations serving an open community need to take care to design their governance systems, incentive structures and decision-making processes to create consensus without unduly slowing down the decision-making,” said Weber and Novocin. “Scenario planning or war gaming are worth exploring at the beginning of blockchain projects. Forward planning enables organizations to swiftly respond in a predictable way that is supportive of stakeholders. Publicizing these plans in advance can also build trust and user confidence.”

Cryptocurrency Risks.

Werbach listed a variety of risks and vulnerabilities related to cryptocurrencies: Bitcoin has shown that the fundamental security of its proof-of-work system is sound, but it has major limitations such as limited scalability, massive energy usage and concentration of mining pools. There has been massive theft of cryptocurrencies from the centralized intermediaries that most people use to hold it, and massive fraud by promoters of initial coin offerings and other schemes. Manipulation is widespread on lightly-regulated cryptocurrency exchanges.

For example, roughly half of Bitcoin transactions are with Tether, a “stablecoin” that claims to be backed by U.S. dollars but has never been audited and is involved in highly suspicious behavior. Money laundering and other criminal activity is a serious problem if transactions do not require some check of real-world identities. “There are major efforts to address all of these risks and vulnerabilities. Some are technical, some are business opportunities, and some are regulatory questions. There must be recognition among cryptocurrency proponents that maturation of the industry will require cooperation in many cases with incumbents and regulators,” added Werbach.

Hosanagar cautions that while decentralization offers significant value — and a significant number of miners/validators must verify the transaction for it to be validated — it is still susceptible to collusion. If one or a few companies running lots of miners/validators in a small network collude, they can affect the sanctity of the network. The big risk with cryptocurrencies, he added, is that most activity as of today is ultimately tied to speculation. It’s important for cryptocurrencies to discover a “killer app soon so there is some underlying value created beyond speculation of its future value,” Hosanagar concludes.

The Way Ahead?

Given all these challenges, what is the current mindset in the financial sector towards adopting these new technologies? And, importantly, should one push for wide acceptance and deployment, or is there need for them to stabilize first?

According to Werbach, “It’s not an either-or” choice. Cryptocurrencies and blockchain technology in general, he noted, are immature currently. However, there are some areas where they are already able to be deployed effectively. The best way to work through today’s problems, is “to build working systems and see where difficulties arise,” Werbach said. Looking ahead, integration with law, regulation and governance will be critical. Blockchain and cryptocurrencies represent a new form of trust, he added. They will only succeed if they become sufficiently trustworthy, beyond the basic security of the distributed ledgers. “Law, regulation and governance are three major mechanisms to produce trustworthy systems that scale up to society-wide adoption. We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables. I’m optimistic about that process over time.”

“We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables.”–Kevin Werbach

Walch noted that while there are claims that some consortia are putting ‘blockchain’ systems into production, in many cases it appears that what they are calling a blockchain bears little to no resemblance to the original blockchain technology behind Bitcoin. In many instances, she said, existing shared databases are being called ‘blockchain’ for marketing purposes. “If people do use something they call DLT or blockchain technology in important financial systems, my hope is that they make the decision based on actual capabilities of the tech rather than its widely hyped and generally overstated capabilities,” Walch said. “Permissioned blockchains, which are the variation most likely to be used for financial systems recordkeeping, are very different from public blockchains like Bitcoin or Ethereum. I hope that a more modest and accurate understanding of the actual characteristics of permissioned blockchains sinks in before they are widely adopted.”

Regarding cryptocurrencies or cryptoassets, Walch said that the financial sector’s interest is “less about recordkeeping and more about a new financial asset that it can make money off of.” She pointed out that at present there is no clarity on how power and accountability work in these systems. The ongoing operation of crypto systems and the value they embed and support is reliant on the competence of, and ethical behavior by, unaccountable software developers and validators. “The financial sector believes it understands and can manage the risks of cryptoassets, but I am less certain and worry that hubris and greed are driving the push to create cryptoassets as a real asset class. This has been a bad mixture in the past,” says Walch. “I think it would be more responsible to let cryptosystems exist on their own for a while longer to let more of the kinks get worked out — if they can be; I’m not sure the governance ones can — rather than to rapidly integrate them into the financial system as we seem to be doing.”

“I … worry that hubris and greed are driving the push to create cryptoassets as a real asset class.”–Angela Walch

Conversely, Weber and Novocin feel that the financial industry is cautious about the new DLT technology. According to them, to build confidence in new blockchain systems there needs to be transparency around how the processes work and what the benefits are, and in order to secure adoption, they need to be straightforward to use. “Pundits have drawn parallels to the open source Linux operating system. Although only a few individuals use Linux directly, it quietly runs the vast majority of servers and cloud processors across the world. Similarly, early adoption of blockchain will likely happen in the background of business processes. Companies should get involved now, even if it is just to experiment with the concepts. By gaining familiarity with these new tools, they will be ready as the space continues to develop.”

Weber and Novocin expect that in the next few years, many more businesses will implement private blockchains to improve the transparency and traceability of their financial operations, supply chains, inventory management systems and other internal business systems. Clearer standards will be adopted and a few high-profile projects will emerge. Meanwhile, they said, R&D will continue among the many decentralized blockchain projects to invent more scalable public ledgers whether it be blockchain, Tangle, Hashgraph or something new. “Work is needed on better and more efficient consensus models, whether it be a new form of proof-of-stake or proof-of-work, or something else. There are many established groups, startups, companies and research teams that organizations can join, partner with, or support in order to contribute to research and expand their capabilities.”




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July 16, 2020

How the Blockchain Will Impact the Financial Sector

How the Blockchain Will Impact the Financial Sector.

Cryptocurrencies and their underlying blockchain technology are being touted as the next-big-thing after the creation of the internet. One area where these technologies are likely to have a major impact is the financial sector. The blockchain, as a form of distributed ledger technology (DLT), has the potential to transform well-established financial institutions and bring lower costs, faster execution of transactions, improved transparency, auditability of operations, and other benefits. Cryptocurrencies hold the promise of a new native digital asset class without a central authority.

So what do these technological developments mean for the various players in the sector and end users? “Blockchains have the potential to displace any business activity built on transactions occurring on traditional corporate databases, which is what underlies nearly every financial service function. Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications. DLT is therefore both a great opportunity and also a disruptive threat,” according to Bruce Weber, dean of Lerner College and business administration professor, and Andrew Novocin, professor of electrical and computer engineering, both at the University of Delaware.

Earlier this year, Weber, Novocin, and graduate student Jonathan Wood conducted a literature review on cryptocurrencies and DLT for the SWIFT Institute. Based on this review, the SWIFT institute recently issued a grant to conduct new research on DLT and cryptocurrencies in the financial sector. Weber and Novocin noted that just as disruptors like Amazon, Google, Facebook and Uber built software platforms and thriving businesses thanks to the connectivity provided by internet standards, next-generation startups will build new services and businesses with blockchains. “Many pundits expect blockchain, as a distributed technology, to become the foundation for new services and applications that have completely different rules from those running on hierarchical and controlled databases. Cryptocurrencies are an early example but many others will follow,” they added.

Kartik Hosanagar, a Wharton professor of marketing and operations, information and decisions, pointed out that the financial services sector is full of intermediaries such as banks that help create trust among transacting parties like lenders and borrowers. Blockchain, he said, is a mechanism to create trust without centralized control. “The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”

Regarding cryptocurrencies, Hosanagar pointed out that most of the value today is tied to speculative buying rather than actual use cases. But having a currency without a central authority offers “certain unique kinds of protections especially in countries with troubled central banks.” For example, Venezuela’s currency is rapidly losing value. For people who stored their savings in crypto, there was greater protection against such rapid currency devaluations. “Of course, cryptocurrencies have their own instabilities, but they aren’t tied to actions by central banks and that’s particularly relevant in countries and economies where citizens don’t trust their governments and central banks,” he said.

“Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications.”–Bruce Weber and Andrew Novocin

Hosanagar expects the first wave of applications to be rolled out in “private” blockchains where a central authority such as a financial institution and its partners are the only ones with the permission to participate (as opposed to public, permissionless blockchains where participants are anonymous and there is no central authority). Applications in the private blockchains, he said, will be more secure and will offer some of the benefits of decentralized ledgers but will not be radically different from the way things work at present. However, over time, he expects smart contracts (self-executing contracts when requirements are met) to be offered on public blockchain networks like Ethereum. “When securities are traded, intermediaries provide trust, and they charge commissions. Blockchains can help provide such trust in a low-cost manner. But trade of securities is governed by securities laws. Smart contracts offer a way to ensure compliance with the laws. They have great potential because of their ability to reduce costs while being compliant,” says Hosanagar.

According to Weber and Novocin, one area ripe for transformation is reaching consensus on important benchmark rates and prices. At present, they point out, different proprietary indexes are used to determine interest rates and the price of many mainstream assets. Blockchain can transform this. “Think of the London Interbank Offered Rate (LIBOR) and the recent scandals involving manipulation of benchmark values when they are controlled by a single entity that may not be capable of detecting false or fraudulent data. Blockchain could provide greater transparency around the process of creating agreed upon reference prices, and allow more people to participate in the consensus process.”

Weber and Novocin expect that in some areas intermediaries will find their roles reduced as blockchain allows for automation through greater transparency and traceability. In other areas, intermediaries will find themselves well-placed to take advantage of changing needs of their clients, as firms will need help to manage the shift to new standards as well as the greater complexity of open and traceable blockchain infrastructure. Intermediaries in areas that could potentially be disrupted, they said, “should get involved with projects seeking to set the standards, so that they can stay informed and position themselves to profit from becoming the leaders in the operations of the new markets that will emerge.”

Kevin Werbach, Wharton professor of legal studies and business ethics, and author of a forthcoming book The Blockchain and the New Architecture of Trust,  said that it’s usually not helpful to focus on what aspects of a major existing market will be “transformed” or “disrupted” by new technologies. Important technologies, he said, are far more likely to be integrated into the system than replace it. According to Werbach, while some firms will fail to make the transition and some new ones will take hold, “over the long-run, virtually every historic innovation that eliminated some forms of intermediation also created new forms.”


Blockchain will reduce the massive duplication of information that creates delays, conflicts and confusion in many aspects of financial services, Werbach added. For example, when a syndicate of lenders participates in a loan, having one shared ledger means they don’t all need to keep track of it independently. International payments and corporate stock records are other examples where there are huge inefficiencies due to duplicate record-keeping and intermediaries. “End users won’t see the changes in the deep plumbing of financial services, but it will allow new service providers to emerge and new products to be offered,” said Werbach.

Bumps Along the Way

Angela Walch, professor of law at St. Mary’s University School of Law and a research fellow at the Centre for Blockchain Technologies at University College London, offered another perspective. She said there is a lot of excitement about blockchain as a distributed ledger technology for the financial sector because many believe that it offers a better, more efficient and more resilient form of recordkeeping. However, making use of the blockchain is not as simple as just buying new software and running it. “Blockchain technology is, at core, group recordkeeping. To reap its full benefits, one needs all the relevant members of the group to join the system. This requires collaboration with and across businesses, which is a potentially big hurdle, and may be the hurdle that most limits adoption.”

Governance is the biggest challenge in decentralized organizations, said Weber and Novocin. Members participating in a blockchain-supported financial function may have misaligned incentives, and can end up in gridlock, or with a chaotic outcome. They cite the example of the ‘DAO Hack,’ which was the first prominent smart contract project on the Ethereum network to suffer a large loss of funds. The Ethereum community voted to conduct a hard fork (a radical change to the protocol that makes previously invalid blocks/transactions valid or vice-versa) — reversing the transactions after the hack and essentially refunding the DAO investors. This was in effect a breach of Ethereum’s immutability and it left a sizeable minority of the community bitterly dissatisfied. This group viewed the Ethereum community as forsaking its commitment to immutable, permanent records. They refused to acknowledge the hard fork, and maintained the original Ethereum blockchain, now known as Ethereum Classic (whereas the forked version supported by the Ethereum Foundation is simply Ethereum).

“The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”–Kartik Hosanagar

“Distributed organizations serving an open community need to take care to design their governance systems, incentive structures and decision-making processes to create consensus without unduly slowing down the decision-making,” said Weber and Novocin. “Scenario planning or war gaming are worth exploring at the beginning of blockchain projects. Forward planning enables organizations to swiftly respond in a predictable way that is supportive of stakeholders. Publicizing these plans in advance can also build trust and user confidence.”

Cryptocurrency Risks.

Werbach listed a variety of risks and vulnerabilities related to cryptocurrencies: Bitcoin has shown that the fundamental security of its proof-of-work system is sound, but it has major limitations such as limited scalability, massive energy usage and concentration of mining pools. There has been massive theft of cryptocurrencies from the centralized intermediaries that most people use to hold it, and massive fraud by promoters of initial coin offerings and other schemes. Manipulation is widespread on lightly-regulated cryptocurrency exchanges.

For example, roughly half of Bitcoin transactions are with Tether, a “stablecoin” that claims to be backed by U.S. dollars but has never been audited and is involved in highly suspicious behavior. Money laundering and other criminal activity is a serious problem if transactions do not require some check of real-world identities. “There are major efforts to address all of these risks and vulnerabilities. Some are technical, some are business opportunities, and some are regulatory questions. There must be recognition among cryptocurrency proponents that maturation of the industry will require cooperation in many cases with incumbents and regulators,” added Werbach.

Hosanagar cautions that while decentralization offers significant value — and a significant number of miners/validators must verify the transaction for it to be validated — it is still susceptible to collusion. If one or a few companies running lots of miners/validators in a small network collude, they can affect the sanctity of the network. The big risk with cryptocurrencies, he added, is that most activity as of today is ultimately tied to speculation. It’s important for cryptocurrencies to discover a “killer app soon so there is some underlying value created beyond speculation of its future value,” Hosanagar concludes.

The Way Ahead?

Given all these challenges, what is the current mindset in the financial sector towards adopting these new technologies? And, importantly, should one push for wide acceptance and deployment, or is there need for them to stabilize first?

According to Werbach, “It’s not an either-or” choice. Cryptocurrencies and blockchain technology in general, he noted, are immature currently. However, there are some areas where they are already able to be deployed effectively. The best way to work through today’s problems, is “to build working systems and see where difficulties arise,” Werbach said. Looking ahead, integration with law, regulation and governance will be critical. Blockchain and cryptocurrencies represent a new form of trust, he added. They will only succeed if they become sufficiently trustworthy, beyond the basic security of the distributed ledgers. “Law, regulation and governance are three major mechanisms to produce trustworthy systems that scale up to society-wide adoption. We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables. I’m optimistic about that process over time.”

“We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables.”–Kevin Werbach

Walch noted that while there are claims that some consortia are putting ‘blockchain’ systems into production, in many cases it appears that what they are calling a blockchain bears little to no resemblance to the original blockchain technology behind Bitcoin. In many instances, she said, existing shared databases are being called ‘blockchain’ for marketing purposes. “If people do use something they call DLT or blockchain technology in important financial systems, my hope is that they make the decision based on actual capabilities of the tech rather than its widely hyped and generally overstated capabilities,” Walch said. “Permissioned blockchains, which are the variation most likely to be used for financial systems recordkeeping, are very different from public blockchains like Bitcoin or Ethereum. I hope that a more modest and accurate understanding of the actual characteristics of permissioned blockchains sinks in before they are widely adopted.”

Regarding cryptocurrencies or cryptoassets, Walch said that the financial sector’s interest is “less about recordkeeping and more about a new financial asset that it can make money off of.” She pointed out that at present there is no clarity on how power and accountability work in these systems. The ongoing operation of crypto systems and the value they embed and support is reliant on the competence of, and ethical behavior by, unaccountable software developers and validators. “The financial sector believes it understands and can manage the risks of cryptoassets, but I am less certain and worry that hubris and greed are driving the push to create cryptoassets as a real asset class. This has been a bad mixture in the past,” says Walch. “I think it would be more responsible to let cryptosystems exist on their own for a while longer to let more of the kinks get worked out — if they can be; I’m not sure the governance ones can — rather than to rapidly integrate them into the financial system as we seem to be doing.”

“I … worry that hubris and greed are driving the push to create cryptoassets as a real asset class.”–Angela Walch

Conversely, Weber and Novocin feel that the financial industry is cautious about the new DLT technology. According to them, to build confidence in new blockchain systems there needs to be transparency around how the processes work and what the benefits are, and in order to secure adoption, they need to be straightforward to use. “Pundits have drawn parallels to the open source Linux operating system. Although only a few individuals use Linux directly, it quietly runs the vast majority of servers and cloud processors across the world. Similarly, early adoption of blockchain will likely happen in the background of business processes. Companies should get involved now, even if it is just to experiment with the concepts. By gaining familiarity with these new tools, they will be ready as the space continues to develop.”

Weber and Novocin expect that in the next few years, many more businesses will implement private blockchains to improve the transparency and traceability of their financial operations, supply chains, inventory management systems and other internal business systems. Clearer standards will be adopted and a few high-profile projects will emerge. Meanwhile, they said, R&D will continue among the many decentralized blockchain projects to invent more scalable public ledgers whether it be blockchain, Tangle, Hashgraph or something new. “Work is needed on better and more efficient consensus models, whether it be a new form of proof-of-stake or proof-of-work, or something else. There are many established groups, startups, companies and research teams that organizations can join, partner with, or support in order to contribute to research and expand their capabilities.”




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July 16, 2020