Bankruptcies in India Inc: Vulture capitalists, clearance sale seekers can solve the problem
Stories of failed businesses are all around us, a sad by-product of an era of unbridled growth in the lending markets, where optimism about the future was highest.
The jewels were on offer at throwaway prices—diamond earrings, bangles and necklaces. Friends called one another to discuss, to decide, to compare prices. Finally, no one bought a thing. They felt the jewellery could be unlucky. The seller was near bankrupt, in distress due to a business failure.
Humungous debt that can take away everything one has can be scary to deal with. Not just material possessions and wealth, it can take away the business activity that generates income, the social status that comes with it, and relationships. It leaves one bereft and bewildered about the next course of action.
Stories of failed businesses are all around us, a sad by-product of an era of unbridled growth in the lending markets, where optimism about the future was highest. Business plans were made with assumptions about market and consumption growth, and funded with high cost loans that seemed to be easily available and quickly processed. The personal guarantees and the mortgaging of residential property did not seem like staking too much, when the going was good.
We can list the obvious personal financial management errors that many of these business families made. First, the assets and wealth were concentrated in the business. Diversification is the first and the simplest route to managing risk. Many fail to create assets and interests outside the core activity that can act as the fall back option.
Second, even where assets were created, they were mostly physical assets such as land and property, gold and precious jewellery.
These assets were seen as “safe and solid” and easy to acquire. However, they are the toughest to sell and suffer the steepest erosion in value during distress. We need assets whose value will be driven by a larger market and not the personal situation of the owner.
Third, the dividing line between business and personal assets is eroded when homes are mortgaged or when personal guarantees are provided. The family and its future are staked when these assets are encroached upon for business. We need assets earmarked and isolated for the use of the family, and derisked from the needs of the business.
Fourth, there is a lifestyle creep that erodes the notions about value of money. During the good times money is spent lavishly on possessions and expensive habits, which then become a social norm. Going bankrupt becomes unbearable when the social and psychological price is too high to pay.
If we took away the optimism about the future and the willingness to risk everything to chase the opportunity that one visualises, we would kill entrepreneurship. There is no persuading someone who sees high risk as well worth a pursuit, to take a conservative view. Not many small businesses can invest in a treasury management function that manages money efficiently and ring fences the business from risks. Even in larger firms with formal treasuries, there are instances of business owners and ambitious managers overruling advice against risky practices.
What we need is a formal market for distressed assets. We have to move away from the traditional taboo associated with incomplete projects, unutilised assets and failed businesses. There may be good businesses grounded by poor management; or bad business decisions made by otherwise good managers. If we are able to see these events as part and parcel of an entrepreneurial environment, we will seek solutions that appeal to a risk-taking community.
We need a junk bond market to correct the excesses of the lending market that faces an overnight change in credit rating from AAA to default. Instead of moralistic questions about how such a change in fortune could happen or what can be done to prevent such events from happening, the problem of a bad loan is better solved by allowing someone else to acquire and start over.
For that to happen, there is the need to see every cycle as one of opportunity. We now bemoan the fall in consumption, question the GDP forecasts, worry about large businesses not making new project decisions, and about job creation. In the aftermath of a failed borrowing cycle, optimism will be in short supply. The failed borrowers of today were the big dreamers of yesterday.
What the market needs is a set of vulture capitalists, junk bond buyers, clearance sale seekers, turnaround specialists and buyers of distressed assets. Lending institutions do not have the capability to hold on to failed assets and nurse them till recovery. It is expensive for a finance business to hold on to a NPA for a long time. Nor can they manage, sell or otherwise turnaround the NPAs.
To think that the government can solve this problem by creating institutions that will buy and hold distressed assets is to assume a turn in a business cycle can be achieved by funding, by structure, and by processes. That is a staid approach.
It is important to see that there are pockets of the economy that continue to do well. For a set of failed large and small businesses, there are several other innovative businesses that have solved problems intelligently and are seeing growth in profits and revenues. The distressed sellers of assets are still able to seek buyers who sense the opportunity. That is the market at play, and needs to expand.
The market only cares about the right price, at which a buyer of an asset would emerge and be willing to make a deal. If we recognize that allowing a new set of businessmen who will pick up a deal for its attractive price, turnaround a business for the challenge it offers, and can thrive on pessimism as an opportunity, we would have sown the seeds for this cycle of bad debts and bankruptcies to end.
The family that is selling its jewels has gone into hiding. If a legal environment enabled them to declare bankruptcy and find a formal way out of their debt, they would find a new life.
(The writer is Chairperson, Centre for Investment Education and Learning.)