investors divided by $100,000). Cash-on-Cash Percentage—Another factor to consider when determining whether debt or equity is better is cash-on-cash return. Let’s assume in the debt example that you had to contrib- ute $20,000 of your own cash as “skin in the game.” Let’s say you grossed the same $40,000 profit and after interest of $16,200 you took home $23,800. Your cash-on-cash return is $23,800 divided by $20,000 or 119 percent. For the equity deal, you may have only needed to contribute $10,000. Your share of the profits, in this example, of $20,000 earns you a 200 percent cash-on-cash return ($20,000 divided by $10,000). Another thing to consider, which is outside the scope of this article, is tax implications of each structure. For debt, the interest is an expense, meaning you only pay taxes on the $23,800 you net. On the equity side, the full $40,000 gets taxed, leaving both you and your inves- tor with less cash in your pockets. KEY TAKEAWAY We leave cost of capital for last because it also considers risk and ease. On a cash-on-cash basis equity looks “cheaper,” as you get a higher return on your capital (200 percent versus 119 percent). However, you put less actual cash in your pocket ($20,000 before taxes for equity versus $23,800 on debt). You also have less risk on the equity deal, as you only have $10,000 exposed. Cash-on-cash is a great way to measure risk-adjusted return as long as you believe there are outsized risks present. If you have a strong belief in the project, we’re in favor of putting more skin in the game, doing debt and pocketing more of the profits. The amount of time you put into structuring equity deals and managing investors should also be considered in your “cost” equation. You’ll need to file tax documents, manage communications and generally keep your investors happy. Securing debt is much more transactional and requires much less time to manage. SUMMARY Picking the right structure really
depends on your goals. Equity can offer less risk and higher cash-on-cash re- turns. It can take up more of your time, and you’ll likely give away more of your profits when projects are successful. For us, we like going the equity route when a certain level or creativity is required and the project is a bit “outside the box.” Debt is clean, simple to repeat and straight-forward in terms of calculating cost of capital. It can be a bit more risky in the sense that your equity is exposed ahead of the lender’s position but also gives you more upside potential. We like to go with debt on our cookie-cutter projects that we’re confident will hit our projections. You can visit our website at www. fundthatflip.com/tools to download a free copy of the spreadsheet we use to analyze cost of capital on our deals. •
Matt Rodak is the CEO of Fund That Flip, an online lender that provides short-term loans to experienced residential real estate redevelop-
ers. His team has completed more than 200 fix-and-flips over the years. Rodak’s experience includes several roles at a leading commercial property insurance and risk management firm. He managed a multimillion-dollar book of business, with responsibility for new business development and profitability. He advanced through the ranks of the company, eventually providing leadership to the corporate marketing department of a $950 million division of the company. Here, he influenced the company’s two largest web application builds and overall global marketing strategy. Rodak holds a busi- ness finance degree from John Carroll University in Cleveland, Ohio—his hometown.
14 | INVESTOR REVIEW
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