The Risks of Mini Perm Loans

Mini perm loans are a type of short term financing to get your construction business or project on its feet. The term “perm,” in this case means permanent. These types of loans typically mature in three to five years and are thus labeled mini-perm loans. Once the loan term is over, more permanent financing is arranged based on the merits of the project. While mini perm loans offer a great way to get a business or project started, there are a number of risks to opting for this type of financing.

Project is Not Immediately Profitable

Mini perm loans are used based on the assumption a business or project will be profitable by the time the financing matures. For example, you may elect a mini perm loan in order to build a hotel. Within five years, it is assumed the hotel will be built and profits will begin coming in the door. These profits are used to pay off the loan, and they are also used to strengthen the balance sheet to arrange permanent financing. If the profits do not come in immediately, your business will be in a bad financial position because the loan proceeds will still be due.

This problem occurs commonly either when a project goes overtime, or over budget. Also, the loan is commonly found when there are significant economy changes around the project. When a project is not complete within the specified loan term, the profits are immediately halted. Further, if more financing is required just to complete the project, then you may again find yourself unprepared to pay off the loan. With small businesses especially, the scenario of a changing economy is always a risk. Even if you have controlled all of the factors of your business's success on your end, a changed economy can sink it before it starts.

Assume too Much Risk Early

Mini perm loans are usually secured against an asset. This means they are riskier for the borrower than for the lender. Taking on this risk of losing an asset, including the risk of paying off the high loan amount, means mini perm loans start a company off in the negative. It will be a fight for any company to simply overcome this initial loan expense in order to reach long-term profitability.

A better option may be to seek investor funding. Investor funding is typically unsecured against an asset. Investors assume a high amount of risk on your behalf when they finance your new venture. Since you are already taking the risk of starting a new business, using investor funds can reduce the risk you are assuming in covering the expense of failure.

Fail to Arrange Permanent Financing

The goal of any mini perm loan or bridge financing is to fill a gap before permanent funds come through. The business model will always rely on these long-term arrangements to continue sustaining corporate growth. If the long-term loans do not get fulfilled, the business may quickly fall apart. 

Small businesses in particular run the risk of short-term success and long-term failure. Reaching moderate profits and paying off an initial loan is not the challenge. Becoming financially viable as a business entity is a bigger challenge for small businesses; without long-term financing, the businesses will not be able to overcome swings in the economy or other small hurdles.