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How to avoid Financial & Social Bankruptcy?

How to avoid Financial & Social Bankruptcy?

A few years ago, one of our clients approached us to help them in raising finance for their packaging unit. Two entrepreneurs, well one entrepreneur and one technocrat. The entrepreneur was riding on the passion of the technocrat. (Technocrat’s blind passion is many a time reasons for business failure).

They had identified machine from Germany to manufacture packaging items for the food industry. Technocrat was extremely passionate about the capacity and quality of output of the machine. They were confident about sweeping the packaging market with the first of its kind machine imported in India.

With equal enthusiasm, an Information Memorandum was presented it to the bank. When any company approaches the lending institutions their financial projections will match the lending institutions’ requirements. As it is done by professionals, knowing the lenders’ requirements. It is the lender’s duty to assess the possibility of achieving the same. (However, it is in the interest of entrepreneurs to make the realistic projections to know the feasibility of the project. The entrepreneur can not fool lenders before fooling the self).

The bank primarily agreed with the project, however being a technical project and machines were imported for the first time in India, they involved their technical team for viability study.

This one man technical team visited the site where land and building were ready, in addition he took some information. They analysed some data and submitted their TEV study to the branch. Thereafter, with due process of processing at appropriate level, the loan was sanctioned for this green field project.

The promoter had a property – i.e. land and building worth US $ 1 mn free from any encumbrances which were offered to the bank as collateral security. The term loan was disbursed as per the bank’s norms. Machine import order was placed. Advance payment was also made. All preparation to commence the production was on a fast track.

Finally, the machine arrived and was to be released from custom by paying duty. There was some technical issue and further disbursement by the bank was delayed by two weeks. There were heavy demurrage charges which were imposed by the customs authority.

Then when the machine was released and arrived at the factory it was the 3rd week of December and there was a closure due to Christmas in Europe. Therefore, Installation was postponed till 2nd week of Jan as technicians from Germany had to travel to India to install the machine and train the people. Further unscheduled delay of almost a month.

Now on the other side promoters could not raise the promoter’s contribution on time and they borrowed from the market their part of the contribution. This additional interest was not factored in the project cost as promoters contribution is expected as capital from promoters.

While processing the proposal, net worth statement of promoters were submitted and immovable property was considered as a part of net worth and bank assumed promoters would liquidate the same to bring promoters finance. This was not possible as the immovable property was their residence.

In between all these, we for our other professional assignment met one of the machine manufacturers in Nasik and incidentally, they were manufacturing the similar machine which the borrower above imported from Germany. We just asked the cost of the machine. To our surprise and shock. the cost was mere 15% of the imported machine from Germany.

The immediate thought occurred – how the project with imported German machine would succeed when the difference in capital expenditure is so much. I wondered whether promoters were not aware about the high cost of Capex they are indulging in? How will they match competitors’ price?

I informed the technocrat partner about the same. He told me their quality will be unmatched. I just inquired packaging is an outer part of the product, whether the market will pay a higher price for things which ultimately will be thrown by the users? But they were confident or rather over-confident oblivious of the market condition.

After a few months when I met them, they were in search of a loan to buy 2nd hand machines at a cheaper cost to bring their cost of production down as their cost of production from German machine was quite higher than the market can absorb. I advised against raising further debt and focussing on marketing to multinational companies where they were getting some success but that too without covering fixed costs.

After a year or so when I met them, I was told they had to sell their land and building to repay to the bank as the account become NPA and property was on sale. They mortgaged their residence to raise a loan to buy that 2nd hand machinery. After selling the factory, they had taken a small unit near Mumbai to manufacture on a smaller scale.

They looked confident that with this small set up they will come out of the financial trouble. I had my own doubt.

Many lessons:

1) The entrepreneur was not literate about the financial implication of their actions.
2) The entrepreneur was fully and blindly relying on the technocrat partner who also happens to be his relative.
3) The technocrat was over confident or rather did not do any homework before indulging such a huge debt and mortgage of property made out of lifetime saving worth US $ 1 mn by his partner.
4) His blind passion about the quality of output and capacity of the German machine was the only drive to set up the project.
5) The bank had done TEV study just for the purpose of record. No in-depth industry / competition analysis was done before committing the debt.
6) Most banks just go by financial projections submitted without trying to test every data.
7) Orders on hand submitted during the time of sanction are not reliable as they come with many conditions and which hardly materialise in reality.
8) Capacity of promoters to invest liquid funds as the margin was neither ascertained by the bank nor planned by the promoters.
9) The bank followed only security and disbursement procedures without going into either technical or market details.

Today they are not reachable. Their cell numbers were changed plenty of time during the last eight years. Of course to avoid calls from creditors. I am sure they must be in serious financial trouble. Once a zero debt entrepreneurs with an asset base of US $ 1 mn in the city of Mumbai now may be either under heavy debt and facing a legal suit from lenders and living somewhere in a distant suburb. They were residing in two of the prominent suburbs of Mumbai.

Debt can be dire. Financial illiteracy and over-confidence of entrepreneurs can be fatal – if not physically then socially. In Indian society failure and bankruptcy are very big crimes.  More than legal consequeces, the social cnsequences are unbearable.

Here I would like to invoke Guy Kawsaki. Someone must play devil’s advocate when any new idea is to be implemented. All pros and cons should be thought through and taken care of. Every action and its implication should be thought through – dispassionately. Rather than doing post-mortem when the damage is done, this kind of pre-mortem is necessary.

In his book Enchantment Guy Kawasaki writes;

Pre-mortems, according to Gary Klein, author of Sources of Power ; How people make decisions; are a better idea because they can help prevent death rather than explain it. … The team leader asks everyone to assume the project failed and come up with the reasons why failure occurred. … The team then figures out ways to prevent these reasons from happening… the goal of pre-mortems is to prevent the potential problems in order to increase the likely hood of success.

Shouldn’t borrowers and lenders both do this Pre-mortems to limit incidences of – bankruptcy and NPAs respectively ?

Sunil Gandhi
Sunil Gandhi

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