Long live the “Lalaji” and his advisor!!
Indian businesses are run by promoters and their business style is notoriously called “Lala” style reminiscing the legendary market phenomena of an Indian trader, often called “Lala”, by his employees and his customers, who would typically sit on a cushion, have a fat belly and treat his employees and his customers as means to an end “Daily Profit”! This Lala would not be very prudent with finances (Most Lalas either inherited the business from their fathers and their fathers from their fathers and so on or they started the business from partition or distribution of family heritage and wealth) hence he would have a “Munshi” by his (Can’t make it gender neutral as our business society was majorly patriarchal till very recently) side who would take care of the finances. Typically, this munshi would not be a people’s person and his role was limited to being the magic man of finance. Decades have passed and trading has given way to enterprises but the promoter is still notoriously called “Lala” as his quest for profit has not reduced and his absolute disregard to human development has shrunk only a little. Case in point, recently a famous Indian automobile manufacturer garnered limelight because of its poor handling of the Covid situation at one of its plant. This so called “Lala” has developed quite a lot, in these bygone decades. He/She now wears a suit, can speak English, has employed an HR division and has annual appraisal for his/her (Gender neutrality is slowly finding its way) employees. With this development, another development has happened, Lala now has an advisor instead of a Munshi and he/she is not on the payroll. This can be a CA of Lala or a financial advisor. This advisor helps him/her raise money for his/her business, helps him/her find loopholes in tax regulations to evade a certain amount of tax, helps him/her launder money and he/she is now not a sidekick who is like any other peasant for the Lala, Lala respects him/her and pays him/her well. Partly because the businesses have become fairly complex today. The enterprise of today is way more legitimate than trading of yesteryears hence advisors have become like doctors to the businessmen. They know the illness but treat for the symptoms, not the cause. In this process, the retainer fee or consulting fee keeps pouring in.
It would be foolish to compare these advisors, to the respected lawyers or consultants which businesses need for business continuity. These professionals might also seem like vultures in some scenarios but they most often than not, do not exercise such a tight grip on the promoter that he/she turns blindside to the world. They are much more secure in their profession as they have multiple clients. The insecurity comes when you have 1 or 2 clients and if you lose one of them, your next month’s EMI payment might look daunting. This role is typically reserved for unorganised, fragmented investment bankers and CAs. This understanding, in Indian context, can better be paraphrased as a “Circus of quid pro quo” as the patient doesn’t want to reveal to the world/authorities that he/she has a contagious sickness and the doctor helps him/her to keep it under wraps while giving him/her an illusion of curing the sickness. Earlier the promoter trusted no one, not even his/her munshi, because the world was a much simpler place but now, in this world of a global pandemic which has made everyone forget profit and think about survival, the promoter can’t manage everything on his/her own and he/she needs someone outside the system so that he/she can’t dethrone him/her from the business. The promoter doesn’t mind paying 4–5% of his/her revenues annually as advisory fee to this advisor but the promoter seriously worried if he/she has to shell out 7–8% of his/her revenues for just one year on a long term, one time solution. Hence the advisor is such a nice and humane person who charges him/her “less”. Did you understand why the second model is more suitable for the promoter? Don’t worry, neither does he/she! Now this relationship will go on till the next wave of development strikes India which has started happening. In the last paragraph, I would like to share a couple of examples to underline why this continued reliance on advisor can be detrimental for the promoter.
If we look at India and look at the most successful businesses, names like Reliance Industries, HDFC Bank, Asian Paints, Tata Consultancy Services etc. come to mind. What is the common thread between all of these? They haven’t borrowed a lot of money to run these businesses. All of these are either net debt(Total borrowed money – cash available with the Company) free or their debt is roughly the same as their operating profit for one year. This means, they can return their debt at the end of any year by utilising their profits. Now keeping that mind, I will now introduce the concept of an advisor to the promoter who helps him/her raise loans from the market. Let’s take Reliance for example. It’s net debt is approximately INR 1.8 Lac Cr. This debt it has accumulated over the years for setting up Reliance Jio, buying tower assets, for its oil assets etc. Using this debt, it has been able to build a telecom and petroleum business which is valued at INR 12 Lac Cr. It has helped Mr. Ambani to capture market share from other telecom players to become No. 1 in Telecom Industry and as a result he has been able to create something called “Shareholder Value” which has resulted in him being able to sell around 24% of Reliance Jio shares for INR 1.2 Lac Cr which has made entire Reliance Industries net debt free (it raised some INR 60k Cr more through other initiatives like rights issue etc.). Because he utilised his debt to build his business (I am going by public reports), he became a top player in the industry and more and more people want to be a part of this company for which they have given him INR 1.8 Lac Cr and increased the value of his Company from some INR 2.5 Lac Cr, 5 years back, to INR 12 Lac Cr today. Mr Ambani holds 50% shares in Reliance as of today. If he has to cash out his shares, he would get around INR 6 Lac Cr against INR 1.25 Lac Cr, 5 years back. Now let’s step back. Imagine if Mr Ambani would have had an advisor who would have asked him to take more debt. As a general banking principal, Companies usually don’t get funding more than 7–8 times their EBITDA (Earnings before Interest, Tax, Depreciation and Amortisation) in worst of the worst cases. Reliance’s EBITDA in 2015 was ~INR 40k Cr. On this, his max debt could have been around INR 3 Lac Cr. Let’s us assume that of this INR 3 Lac Cr, INR 1.2 Lac Cr was utilised for personal usage as it was surplus and not required for business. Now the financial burden of this additional INR 1.2 Lac Cr would have to be taken by the business which would result in lower profits (as business will have to service a higher interest now) and the probability of default will also increase. Case in points are examples of Mr. Rana Kapoor of Yes Bank, Mr. Naresh Goyal of Jet Airways and others. All have been accused of taking on extra debt and diverting funds for personal gains and I have also had a similar experience in the lender market. More money makes advisor and promoter both happy at the start but the burden of the same falls on the business and ultimately on the promoter. In today’s scenario, this situation would have been like that of his telecom rival, Airtel who has debt of about 3 times its EBITDA. Look at its equity value. It’s INR 3 Lac Cr. Assuming a like to like comparison, it’s safe to assume that Reliance’s equity value would have been around INR 3 Lac Cr instead of INR 12 Lac Cr. This would leave Mr. Ambani with a total wealth of INR 1.2 Lac Cr from bank loans and INR 1.5 Lac Cr from shares of Reliance which he might not have been able to cash out easily as he would have given personal guarantees on loans and those would have been utilised to recover the bad loans. In an ideal scenario also, his estimated networth would have been less than 50% of what his networth is today! Not desirable, isn’t it? In business, for every INR 1 taken out from the business by the promoter for personal gains, it can result in INR 0.2 lost in profits (a simple math that for every INR 1 of new assets purchased by business, additional 20 paise in profits would be added as typical payback cycle of any plant and machinery asset is 5 years in manufacturing industry). So if today your business gives you a profit of INR 0.4 on INR 1 of revenue, and you reinvest that INR 0.4 back in business, it will result in profit increasing to INR 0.48 next year and then reinvest and so on and within 5 years, the profit will increase to ~INR 0.9 and your shareholder value would have grown multi fold (Typically share value of any company is 10–12 times its operating profit so with profits going from INR 0.4 to INR 0.9, the increase in value for Promoter would be INR 5-INR 6 as against him/her taking out INR 2 in 5 years)! But your shareholder value is not of concern to your advisor because if you are financially prudent then he/she won’t make their commissions or advisory fee. So Long Live the Advisor, Long Live the Promoter and we will sit back and enjoy new business scandals every year till we hit “Next Wave of Development”