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I have a business situation where one party will agree to defer some costs until a future date, perhaps two years, but no fixed time. This principal will increase linearly over the course of 6 months (deferred costs are for hourly work).

After two years, the lender is repaid in a lump sum. Alternatively, the debtor would have become insolvent and the lender doesn't get paid back.

Because the principal is built over time, it seems to me to be rather like a line-of-credit. But instead of interest payments, there is proposed an equity stake in dollars at the debtor's current valuation.

How can we model a reasonable dollar value of waiving the interest on this line of credit? Including the fact that periodic payments will not be made.

What is the (range of) fixed interest rate that our U.S./global market currently supports?

Starting out, there's no collateral, and high risk to the lender (perhaps) but the principal is small. As the principal grows, the risk falls as certainty increases. The lender would be contractually obligated to work the full project, but is also directly involved and has major influence on the outcome (solvency).

Is there a standard formula for this situation?

Thanks!

  • Is this homework? Is this personal finance? If this is personal, are you contracting work and deferring getting paid until the project is complete? This could be on topic, but your language is pretty vague; also tag with your country because that might make a difference. – MrChrister Nov 15 '13 at 16:57
  • This is not homework. This is in the US. I don't want to disclose which side of the deal I represent because I want an fair/impartial analysis. Is that enough? – Jason Kleban Nov 15 '13 at 17:08
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    I think the community is voting to close because the way it is written, this isn't personal finance, but a business negotiation. You can't get advice that isn't biased towards personal finances on this site? Small, sole proprietorships can be on topic though. – MrChrister Nov 15 '13 at 17:52
  • I can't see the close votes. It is a small, sole proprietorship situation. Seems to me that the answers would equally well apply to strictly personal situations too. Pretend it's person who needs money to pay their mortgage or something and the lender wants part ownership of their house or something in lieu of interest. – Jason Kleban Nov 15 '13 at 18:01
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    I think from that perspective, it is a valid question (since OnStartUps is closing) and our community might be able to answer it. – MrChrister Nov 15 '13 at 18:13
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There's no standard formula. You can compare the going rates on the market for unsecured LOCs and take that as the starting anchor. Unsecured lines of credit run in the US at about 8-18%.

Your risk should be reflected in the rate, and I see no reason why the rate would change throughout the loan.

As to the amount of principal changing? Just chose one of the standard compounding options - daily (most precise, but most tedious to calculate), monthly average balance, etc.

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    Principle should never change..... +1 by the way. – JTP - Apologise to Monica Nov 15 '13 at 22:24
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    Forgive my bad attempt at spelling humor. "Principle" should never change. The "principal" will change as you described. – JTP - Apologise to Monica Nov 15 '13 at 22:58

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