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There may have been a time in your life when you were considering the purchase of a boat or a vacation cabin in the mountains with some of your friends. It is a fact that, if there is money involved, there is power in numbers.

The pooling of investment dollars is popular among investors, it has contributed to the introduction of mutual funds and Real Estate Investment Trusts and other similar practices. The concept of the participation loan is the same, but the investment at hand is a credit facility.

In general terms; a participation loan can signify entering into three different types of partnerships, that involve loans. A group of owners can get together as borrowers; a lender can partner with the borrower, taking an ownership stake in the project being financed; or a group of lenders can partner up, jointly fulfilling the debt needs of one borrower.

Borrowers usually team up to increase their purchasing power and to reduce the risk that is involved in borrowing. In order to get financing, each individual partner on the team of borrowers becomes an individual borrower or mortgagee on the loan project. The lender, probably, will require each borrower to be individually responsible for the entire amount of the loan, in these types of loan situations.

A borrower and a lender most often participate together in commercial real estate mortgages. A share of the proceeds when the property is sold, is offered to the lender in exchange for more attractive loan terms. If the mortgage is funding the purchase of undeveloped commercial property, which may later be developed and sold for profit, the lender may ask for a participation arrangement.

The common practice in the world of commercial business lending is participation among lenders. There are several reasons why a lender would be motivated to team up with competitors, but most of them can be put down to risk and the need to diversify. Just as carefully as investors try to manage their investments, lenders try to manage their loan portfolios.

A lender may recruit partner lenders to share the risk, because a large credit facility could easily upset a lenders diversification strategy. The other side of the story is that a lender with small capital assets could have difficulty lending out enough to keep its loans diversified. Participation does allow this lender to diversify by taking small shares in various credit facilities.

Under a participation arrangement, the originating lender is called the lead bank and is the customer’s primary point of contact. The lender usually informs the customer of its intention to bring in partner lenders during the proposal and negotiation phase.

Borrowers and lenders are often open to new partnerships that help them reduce risk. You likely would not have considered purchasing that boat or cabin on your own, without your friends, many of the normal financing transactions could not take place without participation arrangements.

More of Alisdair Cosgrove’s articles are available at Glitec Finance which also offers great personal loans and debt consolidation loans.