Trail book demand may be thriving, but buyers can’t afford to ignore these four tips to avoid a rotten deal.
Trail books may be the flavour of the month, but buyers must be cautious before making a purchase, says Jon Denovan of Gadens Lawyers.
As part of Denovan’s interview with MPA TV, he offers four key tips on what brokers should and shouldn’t do.
Do's
Do your due diligence
As somebody who has been involved in his fair share of trail book purchases, Denovan says broker must do their due diligence on the seller’s book.
However, despite brokers doing all their homework, there is still no gaurantee of a positive outcome, he says.
“One thing I have learnt is that it doesn’t matter how much due diligence you do, the lousy deal can always be stuck in the bottom draw and can come out and wipe out the whole trail income because of one deal.”
Furthermore, Denovan says there is no way to protect against this sort of deal, labelling this as the major risk in buying books.
“It’s not because the seller’s a crook,” he adds. “The seller doesn’t know that the dud deal is there either.”
“Because we know that there are borrowers who have sometimes stretched the truth just a little bit – but the broker gets blamed.”
Do take into account taxation aspects
There are all sorts of numbers thrown around the market about how much money to fork out for the book, but a lot of brokers forget about the tax aspect, says Denovan.
“When you buy the book, it’s capital expense. So if I spend $100,000 to buy the book, I effectively have to get $200,000 worth of income to break even because as I get that $200,000 worth of income I pay 50 cents on the dollar, let’s say for ease of calculation, so I have now ended up with $100,000.”
Don’ts
Don’t assume you’re covered by a PI policy
A lot of brokers think the book they’ve just bought is covered by PI policy, but that’s not necessarily the case, says Denovan.
This is because the vendor’s run-off policy only protects the vendor against losses the vendor has incurred. Consequently, if the vendor has sold the book, they incur no loss.
Moreover, the purchase’s insurance policy usually only covers defaults that the purchaser did.
“So it’s covered by neither PI policy,” he says. “So if you’re buying a book you have to get an extension to your PI policy so that the buyer’s PI policy will extend to breaches that were made by the seller.”
Don’t buy from a party you don’t trust
One concern that unites both vendors and purchasers is clawbacks, says Denovan.
“The vendor worries that the purchaser may churn all the book and therefore claw-backs are triggered. And the purchaser is worried that the vendor might churn the book,” he says.
“And so the trail income they got sort of disappeared one night while they were at a party and their book got repaid.”
The way to protect against that sort of churning is to know and trust the broker you’re dealing with, adds Denovan.
“If the person has any doubts, just don’t do it.”
For more essential insights on trail books, click here to view the interview in full.
Related:
How to sell your brokerage at a higher multiple
Trail book buyers: MPA interview
Trail book buying: Your 10 point check-list
What else should brokers watch out for when purchasing a trail book? Share your thoughts below.
As part of Denovan’s interview with MPA TV, he offers four key tips on what brokers should and shouldn’t do.
Do's
Do your due diligence
As somebody who has been involved in his fair share of trail book purchases, Denovan says broker must do their due diligence on the seller’s book.
However, despite brokers doing all their homework, there is still no gaurantee of a positive outcome, he says.
“One thing I have learnt is that it doesn’t matter how much due diligence you do, the lousy deal can always be stuck in the bottom draw and can come out and wipe out the whole trail income because of one deal.”
Furthermore, Denovan says there is no way to protect against this sort of deal, labelling this as the major risk in buying books.
“It’s not because the seller’s a crook,” he adds. “The seller doesn’t know that the dud deal is there either.”
“Because we know that there are borrowers who have sometimes stretched the truth just a little bit – but the broker gets blamed.”
Do take into account taxation aspects
There are all sorts of numbers thrown around the market about how much money to fork out for the book, but a lot of brokers forget about the tax aspect, says Denovan.
“When you buy the book, it’s capital expense. So if I spend $100,000 to buy the book, I effectively have to get $200,000 worth of income to break even because as I get that $200,000 worth of income I pay 50 cents on the dollar, let’s say for ease of calculation, so I have now ended up with $100,000.”
Don’ts
Don’t assume you’re covered by a PI policy
A lot of brokers think the book they’ve just bought is covered by PI policy, but that’s not necessarily the case, says Denovan.
This is because the vendor’s run-off policy only protects the vendor against losses the vendor has incurred. Consequently, if the vendor has sold the book, they incur no loss.
Moreover, the purchase’s insurance policy usually only covers defaults that the purchaser did.
“So it’s covered by neither PI policy,” he says. “So if you’re buying a book you have to get an extension to your PI policy so that the buyer’s PI policy will extend to breaches that were made by the seller.”
Don’t buy from a party you don’t trust
One concern that unites both vendors and purchasers is clawbacks, says Denovan.
“The vendor worries that the purchaser may churn all the book and therefore claw-backs are triggered. And the purchaser is worried that the vendor might churn the book,” he says.
“And so the trail income they got sort of disappeared one night while they were at a party and their book got repaid.”
The way to protect against that sort of churning is to know and trust the broker you’re dealing with, adds Denovan.
“If the person has any doubts, just don’t do it.”
For more essential insights on trail books, click here to view the interview in full.
Related:
How to sell your brokerage at a higher multiple
Trail book buyers: MPA interview
Trail book buying: Your 10 point check-list
What else should brokers watch out for when purchasing a trail book? Share your thoughts below.
