When is a sole proprietorship appropriate in India ?

When you are toying with your first business idea, the initial costs and procedural encumbrances associated with company formation in India may deter you. While a company (private or public limited) structure offers its directors and promoters a certain amount of security should things turn sour with the business, a sole proprietorship format can work just fine under the right conditions.

In India, the majority of businesses are sole proprietorships. Obviously, we are mainly talking about small, one man or family businesses. A sole proprietorship, by definition, has a single owner, who has total control over the business. In the eyes of the law, the proprietor and the proprietorship are one and the same.

What this means is that the proprietor is entitled to all the profits of the proprietorship business. On the flip side, he or she is totally personally liable for any loss, debt or liabilities of any other kind. Should the business go bankrupt, the proprietor’s personal assets can be at risk.

That being said, this business structure offers several advantages, simplicity and ease of operation being the foremost. There are hardly any formalities to starting a sole proprietorship

• There is no need for registration with the Registrar of Companies in India, and therefore, no requirement of filing a Balance Sheet with them each year. Neither is there a need for elaborate accounting and auditing


• It costs next to nothing to set one up. Since the proprietor’s personal finances are the principal source of funding, this is a pretty big plus point


• It can be set up very quickly, as opposed to establishing even a simple private limited company that can take a few weeks


• And best of all, the proprietor is assured of total control over the business and complete confidentiality.

A sole proprietorship makes good sense if the business has some of these characteristics:

• Is small in scale


• Is relatively risk free – for example a mom and pop store, or is an independent professional rendering services


• Is not geographically diversified


• Is heavily dependent on one individual.

Importantly, there are certain precautions that the proprietor can take to protect his or her financial position:

• Make sure your personal financial assets are protected through appropriate legal structures, should your business run into trouble. Your chartered accountant and lawyer should be able to advise you on this matter


• Insure fixed assets, equipment etc. that may have been purchased for the business


• Take adequate life/health/other insurance cover for the proprietor.

So, if you think that you can manage the risks quite comfortably, you can choose to start the business as a proprietorship concern. But sooner or later, you will have to switch to a more complex structure when your capital and human resource/expertise requirements expand. Last but not least, a company structure ensures business continuity, whereas a proprietorship ceases when the proprietor is no more.

India home loan rates heading downwards

In an earlier post, we mentioned that HDFC was looking to lower home loan rates. They have since announced their revised home loan rates:

1. 'Special' rate of interest of 10.5% for customers availing of floating rate home loans. This is 0.75% lower than HDFC's regular rates

2. This offer is available for all loans disbursed on or before 31 Oct 2007

3. However, interest rate for fixed rate loans is 13.25%.

The wide difference between fixed and floating rates is said to be in place to act as a disincentive for consumers going for fixed rate loans.

Interestingly, Mr. Deepak Parekh, Chairman HDFC mentions in a TV interview that the Finance Minister thought HDFC should go deeper with the interest rate cuts !

Therefore, please continue to watch this space.

Indian stock market index Sensex at 17000 - however, you wonder why your portfolio is not following suit !

The T20 world cup has been won, people are ecstatic and roads in Mumbai have been suitably jammed at this afternoon's victory parade. Investment gurus think there is a rising tide of good cheer what with the world cup and Sensex at 17,000. Some of the braver ones talk of 19,000 !

You must be feeling rich if you have stayed with the stock market roller coaster over the last few years. On the other hand, you may be surprised that your portfolio does not necessarily reflect the full impact of this wonderful turn of events.

Some observations, based on market commentators' views:

1. There is a view that foreign institutional investors (FII) are throwing money at emerging markets like India to get away from the sub-prime mortgage mess and lowering interest rates in the US. As we have seen before, this flood can come and go at reasonably short notice ...

2. Rally has been led by large cap stocks this time around. Good for you if you were mirroring the large caps in your portfolio. However, the last rally was mid cap based ! Even better, if you had both sectors covered - if not, you are probably hurting in some areas ...

3. Some suggestion that markets show an overbought position ...

4. Let us get to the 'other hand' of this story. Bulls mention corporate earnings continue to grow robustly, inflation (as measured officially) has been reined in and therefore an ongoing growth in the stock market cannot be ruled out (remember the pundits who talk of 19000) ...

If like many of us, you also cannot time the markets, then a few thoughts for you:

1. Invest on fundamentals of the companies

2. Stay with them for a reasonably long period if you like the firms' business, their management strength and growth story

3. Ride short term price gyrations - provided the firms continue to do well

4. Remain diversified in your portfolio mix.

If you are a novice in stock markets, then consider hiring a professional portfolio manager and / or devour analyst reports regularly so that you can take measured actions.

Good luck !

Interesting opportunity - deposits vs home loans in India

There has been pressure in recent times for Indian banks to lower deposit rates. However, reports suggest that SBI is hesitant to do so as it seeks to continue to grow the deposit business. Therefore, one can still secure around 9% pa interest rates on deposits with SBI. Other banks are seeking to lower deposit interest rates but can't really do so if SBI maintains this position. On the other hand, HDFC is showing signs of lowering home loan rates.

This points to a potential to get best of both worlds by splitting your deposit and home loan relationships, if not done so already. Multi-bank relationships are quite normal and a customer should seek the best product features/deals in all major products - a bank should offer you significant additional value should it want to keep most of your relationship.

Calculating your Net Worth

So you think, you are well on your way to building wealth. Let us do a test to measure your current Net Worth:

1. Start with current market value of your major physical assets: house you are living in (if owned) + investment properties + bullion/jewelry. etc.

2. Add current market value of liquid and movable assets: mutual funds, stocks, bonds, bank accounts, derivatives, deposits, retirement accounts (PF), automobile(s), consumer durables (s) etc. Please note that automobiles and consumer durables would have depreciated in value and therefore use a reasonably accurate value of their market value

3. Add payout value (including target bonus) of endowment/investment type insurance policies. Ideally, you should use present value of the proposed payouts - however, if you cannot do this, use the payout value as an approximation. This approximation could overstate the current value of such instruments.

The total is your assets.

Now deduct the following liabilities:

4. Value of outstanding loans taken to buy properties + automobile(s) + consumer durables

5. Value of balance on credit cards + student loans + marriage loans + other loans/commitments

The net result is your current Net Worth. Does the picture still look pretty ?

Typically, one is financially stretched during the family building stage (30 - 50 years) after which a rapid rise in Net Worth is required for comfortable retirement. Please remember that people are retiring earlier and living longer !

'Personal Finance in India' moves here

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Reverse Mortgages in India: Loan against your home

We were asked to clarify issues surrounding reverse mortgages. Please note that each country will have specific features for the product that need to be understood based on where the property is situated. Our comments are specific to the product in India.

The National Housing Bank (subsidiary of Reserve Bank of India) has described the principles of the product in a presentation dated Feb 2007. The presentation is available at http://www.nhb.org.in/. To summarize, product features are:

1. Senior citizens in India are eligible. Main criteria are that one of the spouses needs to be a senior citizen and house where they live in India needs to have been fully paid up. Income criteria is not to be used for this loan

2. Loan is for a max term of 15 years and will be against the house they currently live in. Typically, the husband and wife will be co-borrowers

3. In this type of loan, a bank or housing finance company (HFC) in India is to grant the loan to the borrowers in either a lump sum or in various instalment modes (e.g. monthly, quarterly, etc)

4. Loan amount will depend on age of main borrower and value of the property

5. Loan can be used for living expenses, renovation of home or other purposes

6. Borrowers do not have to service the loan for the term - i.e. no interest payment or principal repayment is expected for the 15 year term

7. Borrowers are expected to pay back loan principal + accumulated interest at the end of 15 years. Each financial service institution retains the right to set interest rates

8. Should the main borrower die before the 15 year term, his/her spouse can continue to live in the property till either he/she also dies or term is up. Should both spouses die before the end of the 15 year term, the bank or HFC will give the first right to settle the loan to the borrowers' heirs. Should this not be possible, the bank/HFC will sell the property, clear the loan outstanding (principal + interest) and return the balance to the borrower's estate

9. Other events that can trigger a full payment of loan outstanding is the sale of the property by the borrowers or them moving out to live elsewhere

10. The loan can be paid off at any time without any prepayment penalties.

While this product is expected to be valuable to senior citizens who have cash flow problems, main issue is the risk of them outliving the 15 year term. Should this happen, they will have to pay back the loan outstanding. As they took the loan in the first place to bolster cash flow, it is not clear where they will get the money to settle the loan ! Therefore, one needs to exercise care in using this product like any other debt product - unless repayment sources are clear, debt can be a difficult thing !

Can retirement hurt less ?

Retirement is a financial challenge for most. What one saves through working life can seem less than adequate for the 'peaceful' years of retirement. Increasing life spans make it critical for people to plan for 25 + years of retirement, inflation continues to erode savings and interest rates continue to moderate as the Indian economy matures. What should you do if you are intent on having a pleasant retirement ?

1. Set your target: It is important to know what amount of money, in today's terms, you would need at your retirement. For example, if you are 35 years of age and think that Rs 25,000 per month (in today's terms) is a good sum for retirement, plan to retire at 65 and hope to live till 80, then you can expect to require close to Rs 1,10,000 every month in the 66th year. This is simply because inflation continues to lower the purchasing power of your money. To get to this number, you should plan to have savings of approximately Rs 2 crores by the time you retire. If you want to maintain your lifestyle, this pool needs to be closer to Rs 4 crores in your 80th year !

2. Start young: Only way to do this is to start young ! A typical rule of thumb is to save up to 30% of your gross salary through your working life. Compound interest helps the savings pool grow in a healthy way even as your earning and savings power increase over the course of your career.

3. Create a portfolio: Build a balanced portfolio throughout your life. It should have a good mix of real estate, stocks, mutual funds, bonds, deposits and possibly gold. The riskier assets like stocks and and equity based mutual funds could form larger portion of your portfolio when you are younger (say 70%) and move to a more stable portfolio as you arrive into your 50s (deposits, real estate and bonds forming most of your portfolio). Many people forget to create a portfolio and put all their eggs in one basket - typically real estate !

4. Leverage early: Another way to create wealth over the longer term is to take loans wisely. Home loans are an important instrument that one could use from fairly early in life. It has been observed in most developed countries that people build property assets by taking loans and upgrading throughout their life. Home loans also offer tax advantage. While home loans can be useful, excessive debt on credit cards, personal loans or margin lending (against stocks) can be dangerous - use such debt only with care !

5. Manage your portfolio: It is normally wise to take profits along the course of your investment period and reinvest into the lows. While very few can time markets, it is important for investors to remain flexible in terms of liquidating assets, booking profits and waiting to pick new assets at the lower end of price cycles. Being brave is key, especially in turbulent economic times !

6. Plan tax wisely: It is important to plan taxes well. There are approved tax breaks like the ones on home loans and 80c that should be considered carefully.In closing, it must be highlighted that the above ideas are just pointers. It is important that you seek advice on your finances and taxes from professionals early on. Should you find good ones, there may be a chance of getting to the number !!