In an earlier article, we explained how a revenue sharing loan works. This time, we’re focusing on term loans.
Term loans are something most of us have experience with – car payments, home mortgages and student loans are all term loans. The way term notes work on NextSeed is similar. If you invest in a note issued by a business, the business agrees to pay you the same amount every month until it’s paid off.
Let’s walk through an example of how this works:
The growing business
Say there’s a gym in town that everyone is raving about – Lickety Split. It’s got the best equipment, and it’s staffed with coaches who know how to motivate. The owners, Morgan and Alex, see that their customers are increasingly interested in yoga and Pilates workouts.
Morgan and Alex decided to scoop up the unit next door and turn it into a dedicated area for yoga and Pilates classes. They’re hiring a great team of instructors and renovating the space.
Why a business would choose a term note
Along with their own money, Morgan and Alex have decided to apply for a $100,000 loan on NextSeed to help complete their buildout. They’ve got a loyal following and want to invite everyone to share a piece of the pie. They also want to attract new customers to fill up the new spots that will open up after the expansion.
Offering a term note makes sense because Morgan and Alex have an established business that’s already generating consistent cash flow. What they want is certainty each month. With a term note, they will know exactly how much they need to pay investors every month. They may also choose to pay off the loan early if the expansion goes well.
Putting the offering together
NextSeed uses standardized metrics to evaluate the new business and proposes appropriate investment terms for Morgan and Alex to choose from. These are the terms that Morgan and Alex would offer to potential investors on NextSeed. They choose term notes with the following terms:
Interest rate: 18%
Maturity: 42 months
This means Lickety Split agrees to pay investors their principal investment plus an 18% annual interest rate for 42 months. Payments will start after the first full month following a successful closing.
NextSeed does its due diligence and background checks on the company and its owners. Morgan and Alex provide their financials, business plan and renderings of their new space. NextSeed helps them put together their offering page, and they’re ready to launch an offering for the expansion of Lickety Split.
Your investment and getting paid
Imagine that you invested $1,000 into Lickety Split, and it successfully raises the $100,000 from investors. Construction has been ongoing and the newly renovated space is open for business soon after closing.
In a month or so, you get an email saying “Hooray! You received a payment today” and it notifies you that you’ve been paid $32.26!
Here’s how your payment was determined:
You invested $1,000 into Lickety Split, which agreed to pay you an 18% annual interest rate for 42 months. The loan payments are amortized (like a mortgage), where each monthly payment is the same and contains a payment of interest and a payment of your principal. So in this example, your payment of $32.26 is about the same amount that you will receive every month until the entire principal is paid down.
Since the annual interest rate is 18%, the monthly interest rate is 1.5% (18%/12 months = 1.5%).
In month 1, your $1,000 investment is your starting principal. The interest on your investment is calculated by multiplying the monthly rate (1.5%) with the outstanding principal during that month. So in month 1, your interest is $15 (1.5% x $1,000 = $15). From the total payment of $32.26, $15 is your interest payment. The remaining $17.26 ($32.26 – $15 = $17.26) pays down your principal. After this payment, your outstanding principal investment decreases to $982.74 ($1,000 – $17.26 = $982.74).
In month 2, the same calculation takes place – this time with your new starting principal. The monthly payment of $32.26 remains the same, but as time goes on, your interest payments decrease while payment on your principal increases, just like mortgage payments. Thus, 1.5% x $982.74 = $14.74 is your month 2 interest payment. Again, the total monthly payment is $32.26. The rest, $17.52 ($32.26 – $14.74 = $17.52), goes to pay down your principal. Your new principal is now $965.22 ($982.74 – $17.52 = $965.22).
Here’s a chart that shows how it works month after month:
|Month||Your principal investment||Total monthly payment||Interest Payment||Principal Payment||Ending balance of your principal investment|
These payments are expected to continue until the business pays you in full after 42 months. Congrats on helping a popular imaginary gym expand!
Disclaimer: This example is for illustrative purposes only and does not reflect an actual deal or performance. The terms of each deal differ. Payments are not guaranteed or insured and investors may lose some or all of the principal invested if the business cannot make its payments.