Go for angel or VC funding if cashflows are likely to be uncertain. Else, borrow from family and friends
Anil Rego | July 25, 2015 Last Updated at 22:04 IST | Business Standard
Financial planning is crucial for any entrepreneur. That’s because entrepreneurship is a high-risk choice that can impact one’s personal as well as family’s well-being. Once salary income stops, it becomes much more difficult to take care of regular expenses such as equated monthly instalments (EMIs) for repaying home loans. This is especially so if your spouse is not working. After assessing cash flow requirements, the next step is to realign existing assets to provide a monthly income. Look at the worst possible scenario and assess how much time you would give yourself to exit the business if it is not successful. It is advisable to plan for three to five years of monthly income, or till business cashflows stabilise.
By doing this beforehand, you will know the time you have to self-sustain the business, or abandon the venture and get a job.The financial plan should include both the business as well as personal life goals, since both are integrated with one’s financial well-being.
Cashflow is the lifeline of any business. Unlike salaried income, cashflow from business is likely to be irregular. You need to forecast the cashflow requirement not only for the start-up phase but also when the business grows to different stages. In the initial years, you may have to fund the operating expenses of your business as well as your family’s personal expenses.
For example, if your monthly expenses including EMIs are Rs 80,000 and your business requires Rs 1 lakh a month, you need to generate a monthly income of Rs 1.8 lakh. You may need to take a call on whether you are okay with eroding capital for a few years if the capital you have built is insufficient.Apart from regular cashflow required to manage operational costs, there could be major investments required in the form of capital. Further, capital infusion is not limited to the initial phase but every subsequent/new phase (like expansion). Entrepreneurs have to make sure that there is adequate capital available to avoid getting into a debt trap or losing out on potential opportunities. If you plan to fund these cash flow requirements from your own assets, it needs to get connected to your personal financial plan.
Debt forms a part of one’s financial plan especially while starting a new business. Typically, cashflows while starting a new venture are managed by borrowing funds. However, debt always has an impact on one’s monthly cashflow since it needs to be serviced regularly in the form of EMIs. The quantum of debt you take would depend on the cashflow analysis you have done. In the previous example, some expenses maybe required upfront and one may need to use debt instead of funding it from your investments. For example, apart from Rs 1 lakh of operating expenses per month, if you are servicing another Rs 50,000 of business loan EMI, then you need to plan for a monthly income of Rs 2.3 lakh per month. If the returns from your investment are unable to cover Rs 2.3 lakh, set a limit for your self on how much capital you can afford to erode.
Servicing debt can become difficult if cashflows are irregular. Thus if an entrepreneur has taken debt or borrowed funds and is regularly paying EMIs, he needs to create a contingency fund which can be in the form of a separate liquid fund or bank deposit. The corpus in the emergency fund can be equivalent to three to four months of monthly expenses and should be touched only during emergencies. If the loan amount is too high, it is advisable to take a risk cover which is equivalent to the outstanding loan amount in order to cover the liability in case of an unfortunate event.
The first place you can go to for borrowing is family and friends as this is unlikely to come with an interest component. However, if there is an issue with repayment, it could impact one’s personal relationships. Banks and NBFCs are options but may not give you loans in the initial stages of your business. So, it is advisable to take loans while you are still working. Mortgage loans are a good option as the interest rate is lower; so is loan against securities like shares. Personal loans, however, can prove costly and should be avoided. If cashflows are not very certain, it maybe a good idea to get equity funding for your business from angel investors or venture capital funds.
Managing investments is crucial. Let’s assume you had a financial portfolio of Rs 1.8 crore, giving a weighted average return of 12 per cent, or Rs 21.6 lakh a year. The portfolio is spread across bank fixed deposits (40 per cent), equity mutual funds (40 per cent) and equity shares (20 per cent). You will need to generate Rs 2.3 lakh a month (as mentioned earlier). As such, there would be a yearly shortfall of Rs 6 lakh which would result in an erosion of Rs 30 lakh in a five-year period.
This portfolio will need to be rejigged to ensure sufficient liquidity and generate returns high enough to replenish the fixed income portion. For this, part of the amount in fixed deposits can be put into liquid funds with a systematic withdrawal option. Periodically, gains from equity shares/equity MFs can be used to replenish the fixed income.
Illiquid assets like real estate or concentrated equity like Esops should be liquidated.
On starting a new venture you will be losing out on the health cover from the company that you had been working for; so it is advisable to have a family health cover. One could go in for a family floater health insurance policy of Rs 10 lakh or more. Sufficient life cover through a simple term plan is necessary to cover your loans. If your spouse is working and you are able to get cover by virtue of her company coverage, then this requirement would be addressed.
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