MONEY TALKS

Credit Series- 9/ Related party Value chain

It’s interesting to see how businesses have evolved over the period and share some common trends. Today while evaluating majority of borrowers including an SME; you will see that promoter will have at least two business entities doing similar or different activities .

Single product, single entity and single promoter is rare to see now .

So why do the businesses form different entities:

  • To diversify if getting into new business line via a new entity . ( Thin line between diversify and divert, so understand the reasoning).
  • To take benefit of incentives or arbitrage which may be available on certain constitutions and locations.
  • To prepare for succession planning.

Having multiple entities in itself not a sign of anything. Understanding the value chain between those – in terms of dependence on sales and purchases and true nature of transactions is what is critical; along with obviously how important is the business you are proposing to lend to is in the overall structure.

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Image by Jerzy Górecki from Pixabay

Some core steps which helps understand it better :

  • Evaluate the notes to accounts/ other disclosures on related party transactions as a starting point and the overall quantum & trend therein in terms of size of company.
  • One limitation in above is how the related party is being treated and which ones are being treated. So for that understand the different businesses run by the same promoter group. You can look for common directorships or you can look at sources of income in case not a limited company.
  • Understand dynamics behind group company sales and purchases in case they are significant.
  • Understand who are the major customers and suppliers and relate that to the banking transactions.
  • Always take help of google on customers/ suppliers with whom major business is being done if other than known entity.

If you find a missing link in any of the above with what you understand about your borrower; then that’s the area you need to decide whether in the overall pros and cons of the credit proposal you can accept that.

So how do you evaluate the related businesses ?

Link to Credit Series : https://preetymundhra.com/2019/02/21/credit-series-introduction/