Problems of small businesses
It is not easy to be a small businessman, wrote one of my readers. Much as he tries to get his personal finances in order, he finds himself failing. We decided to discuss, over several weeks, many aspects of his financial position. A small business is simply an understanding of an opportunity, as it presents itself, he said. There is no written business plan or strategy, but a shrewd understanding that there is a sustained demand that can be met at a profit. As one goes along, one learns the tricks of the trade. Over generations, this knowledge is passed on, even as it is sharpened for the changes in the environment in which the business operates.We discussed whether this skill and knowledge is monetised for the benefit of him and his family. Structures that pay out salaries, bonuses, profits and benefits were in place. But these funds were not invested systematically. There is strong adamance about spending this money or investing it in physical assets. The problem for the businessman is that the rules of the game keep changing. There is competition to contend with. Most of the time, friends and family who see a successful operation want to replicate it and expect one to help them set it up and get established. Some protections go away; new threats come in; some plans fail; some investments are lost and one runs along hoping to find ways to make profits. We agreed that the business must be structured to deal with contingencies. The assets of the business must extend beyond stocks in trade. We identified own offices and property, investments in other businesses for diversified cash flows and business assets that can be liquidated in need as buffers.
The funding of the business is not formal. There are lines of credit available from suppliers who also come from similar community and native backgrounds. Borrowing and leverage is common. Informal funding at high cost is preferred for the low disclosures it seeks. The books and accounts are maintained with a strict eye on cash flows. Costs are controlled very tightly. Anything that saves taxes is always welcome. There is enough paid off under the desk to various entities to feel guilt about evading taxes.
We discussed how to transition to formal finances and clean and transparent books of accounts. There may not be the scope to list on the stock market, but building value that can be transferred to a potential buyer is valuable. We also agreed that formal treasury operations were needed.
There is no diversification. Nor is any surplus invested significantly in anything else but the business. However, the lure of real estate and gold is too much to ignore. Real estate investments offer prestige and status among cohorts. Gold keeps the family happy and content about their prosperity and wealth. Some stocks and bonds are held, but too little to matter. Any amount of persuasion about separating business from the household and building diverse assets did not change his mind.
We moved to the other difficult questions. What happens if the next generation has no interest in continuing the business? Equity that has been built in the business lies invested in creditors that trust them with money and customers that patronise the goods. Both cannot be encashed, transferred or valued for realis-1able cash. Without assets that store the value created by the business over the years, the equity may simply remain uncashed. How is the wealth passed on? Primarily in the form of physical assets, which lead to squabbles and acrimony, when the division among the siblings is not seen as fair. The lack of other assets, and the opaqueness in the books of accounts and in dealings with others makes it tough to take charge of assets after the death of the patriarch running the show. Estate planning was absent and it was common for cases in the courts around assets of the deceased.
How does one deal with risks? When the business fails, or when there is debt that cannot be repaid, there is really no bail out. Typically personal assets are sold or the family chooses to abandon everything to flee elsewhere. There is also the stigma of bad luck to contend with while selling the assets. Most view failure as created by factors beyond one’s control. Superstitions and rituals continue to prevail to ward off the ‘evil eye’. Formal risk management systems are seen as a joke and theoretical. What happens when illness hits? There are hardly adequate insurance covers. Paying a premium is painful. Nor is delegation or succession planning clear. Family members do not completely know or understand how the business is being run. There is no hoard of wealth except for stocks in trade and physical assets to fund the emergencies. Many businesses get taken over by relatives, who may be benevolent or greedy or anything between.
What happens at old age? Most assume they would run their businesses until they pass on. However, fear of lifestyle diseases is high. There is no retirement corpus or plan. Denial rules. The assumption is that it is the business that generates the income and profit and that it will live on and keep working. My reader pointed out how even the oldest living members of the family received substantial payouts from profits and lived in comfort in their own large homes. That model of comfort from the business incomes is too deep to be questioned for its risks. We could see as we discussed that the model in the mind of the small businessman was that of smart management for profit, shrewd leverage for owners’ benefit, steady and generous sharing of income with the family, lavish spending from these surpluses, and ostentatious physical assets to showcase wealth. These don’t fit into personal finance dictums as we know them.
As we discussed how these businesses may be operating in a very personalised, concentrated and high risk environment, it became clear that there were many such household and family businesses that operate at this scale. Wealth is being created. It is also spent lavishly. Assets are built, but poorly used and bequeathed. The problem is that while risks are denied, the remedies are not easily adopted.
By the Author:IS CHAIRPERSON,CENTRE FOR INVESTMENT EDUCATION AND LEARNING
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
This story originally appeared on: Muscle & Fitness - Author:Tax Cognition
