Tax is boring, as much as it is painful. Forget an entrepreneur who is running a million things at a time; even the common man finds it frustrating. Then again, it is only less than 10 percent of the country’s population that pays taxes. For an entrepreneur there is no option but to learn the intricacies of the tax system, says Alok Patnia, founder and CEO of Taxmantra.
Speaking at the Rajasthan Startup Fest in Jaipur, he said, “Most techies think that they can't learn finance. That is a misconception. As an entrepreneur, you need to know everything. You need to understand the regulatory provisions and taxes before starting up."
Giving tips on financial management for businesses, Alok said that allowance of many expenses depend upon their proper accounting and return filing in a startup. He recommends that entrepreneurs outsource business tax and accounting functions instead of hiring in-house accountants. “This will save costs to a great extent. Better, invest in business accounting software. Look for free trials before you buy to make informed decisions,” he said.
According to Alok, the benefits of a good financial management process are:
1.Profit and wealth maximisation
2.Forecasting of growth
3.Maintenance of liquid assets
4.Plan for diversification, new product lines, reaching new markets
5.Prepare for financing (loans)/equity
6.Ensure fair returns to shareholders
Start up without funding
Most entrepreneurs think about funding even before doing a proof of concept. Alok cautions against this tendency. He says, “Funds are just one of the raw materials you need to start up. It is not essential till you have a business and have clients.Understand what kind of business you want to start. Or you will have funding but no business model.”
According to Alok, an entrepreneur should decide if he can sustain by bootstrapping or needs external funding for survival. "Analyse both long-term and short-term situations by looking at payment cycles, recovery cycle, and debtor positions. For instance, before opting for debt financing, you need to consider the repayment terms, interest and fee structures, floating and fixed charges, the burden of debt on business assets and incomes, and debt-equity ratio," he added.
On the other hand, in debt funding, the company is not required to send periodic mailings to large numbers of investors, hold periodic meetings of shareholders, and seek the vote of shareholders before taking certain actions. Debt does not dilute the ownership of the founders.
Also, you need control over cash flow, especially for a bootstrapped company. "After raising funds most startups' quality of decisions go down and end up being unable to pay salaries in three months," warned Alok.
When raising funding
Any seasoned entrepreneur will tell you to avoid highly inflated valuations while fundraising. Alok added to this point, "While making the business plan, make sure you incorporate the big market risks and the means of overcoming them. You have to consider unit economics too. Not to mention, finding the right investor and understand every aspect of the deal."
According to him, the following are the different stages of funding:
- Term sheet negotiation which involves business valuation & business plan
- Due diligence
- Agreement signing and infusion of funds
- Issuance of funding instrument - share-based/debt based funding
- Corporate law and RBI compliances (some compliances start at the initial stage)
Alok recommended appointing an inspector internally to set everything in place before the due diligence check from the investor. "Litigation issues, if any, should be properly recorded and if possible sorted as early as possible," he added.
How to spend (and not)
On the basis of common mistakes that entrepreneurs make, Alok has a few lessons :
- Decide when to purchase new equipment or update existing ones or lease them. Purchasing decisions come with bigger debt burden or results in draining of business savings. Doing a cost and benefits analysis is important.
- Don't mix personal and professional expenses. You need separate bank accounts for both. Or it will be difficult to explain to an investor when you raise funds.
- Plan the amount of cash you need for day-to-day business functions, identify short-term creditors and their payment cycle, how much inventory you have in hand and how much of that is realisable.
- Employ effective accounting methodology to account all expenses, revenue and other financial transactions of the business to build trust among investors and other stakeholders.
How to raise funding
Alok recommends debt funding for the following reasons:
- Debt does not dilute the owner's ownership interest in the company.
- A lender is entitled only to repayment of the agreed-upon principal of the loan plus interest and has no direct claim on future profits of the business.
- Except in the case of variable rate loans, principal and interest obligations are known amounts which can be forecasted and planned for.
- Interest on the debt can be deducted on the company's tax return, lowering the actual cost of the loan to the company.
On the other hand, he added, unlike equity, debt must at some point be repaid. "High-interest costs during difficult financial periods can increase the risk of insolvency. Additionally, debt instruments often contain restrictions on the company's activities, preventing management from pursuing alternative financing options. The larger a company's debt-equity ratio, the more risky the company is considered by lenders and investors," he says, adding that the company is usually required to pledge assets of the company to the lender as collateral, and owners of the company are in some cases required to personally guarantee repayment of the loan.