There are a few well known and universally recognized principles in Economics and Finance when it comes to sick companies. These are
- Do not throw good money to chase bad money
- Concept of sunk cost
- Cut your losses
I was working as adviser to the scion of a traditionally managed Indian conglomerate. My client had inherited a few companies when family assets were partitioned amongst different branches of the large joint family.
One such mid-sized company, which came to my client, was an almost 50-year-old company on the verge of sickness. It suffered from the usual maladies of companies of this vintage – old and inefficient technology (some of the controls still used old electronic vacuum tube valves) and precarious health of badly maintained machinery. Clearly, it needed a major revamp and a consequent infusion of fresh funds.
But unfortunately, the owner did not have sufficient liquidity of his own to pump into this unit; and no bank or financier was willing to lend money to this losing concern. We were in a Catch 22 situation. My suggestion was to bring a strategic partner on board who could bring capital in lieu of a share in the equity. But my client was not keen on selling a stake in the family company. He somehow was optimistic that in the next 3 months, he would be able to revive the company by better working of the plant and generating internal resources. I was clearly very skeptical of this happening.
After 3 months when we reviewed, the situation had deteriorated further, despite the owner pumping in some of his own money. Once again, I told him that these small doses of money were like putting a few drops of water on a hot girdle – the water just evaporates. Unless a critical mass of capital is injected, the unit could not be revived. Once again, he gave himself 3 months time. I do not know what gave him the optimism that in 3 months, he would get sufficient funds. This was a clear case where sentimental attachment to a company (started by his grandfather) was clouding his business decision.
At this moment, I decided to tell him the following parable.
This is the story of two donkeys who were identical twins. Once, their parents took them to “Kumbh Mela” where they got separated and lost due to the surging crowd. (A favorite story of many Hindi Films).
After a couple of years, accidentally, they met in a market place and somehow recognized each other. It was an emotional moment for both.
They then started exchanging notes about their life since the time they got separated. For ease, let us call them Ram and Shyam. Ram looked very happy and healthy. He said he was picked up by a kindhearted washerman (dhobi in Hindi). In the morning, the washerman loaded all the clothes on Ram and went to the river. There, while he was washing the clothes, he would set Ram free to graze around. The riverbank was full of the best quality green grass and Ram feasted on that. In the afternoon, Ram was again loaded with the washed laundry, which the washerman delivered to the customers. In short, Ram was having an incredibly good life.
Now came the turn of Shyam – who looked very weak, malnourished, and had festering wounds on his skin. He said that he was picked up by a village potter (kumhar in Hindi), who was not only poor but was also very ill-tempered. He would not allow Shyam enough rest, would not give him enough to eat and would beat him with his stick very often.
Ram was very sad to hear this story of his twin, Shyam. He knew that his owner “the washerman” was going for an expansion and was looking to recruit one more donkey. So, Ram suggested that Shyam should abandon the potter and come with him to join the washerman instead. He was sure that his kindhearted owner would give a better life to Shyam.
Contrary to his expectations, Ram found that Shyam was not enthused by this idea. In a sad tone, he said, “I am grateful to you, my brother, for thinking about my future. However, I do not want to change my job”. When a shocked Ram asked for the reason for this seemingly foolish decision, Shyam explained, “My owner has a pretty young daughter, and I am in love with her. Every time, she handles the pots, her ill-tempered father shouts – be extra careful with the pots; if you break even one of them, I will get you married to this donkey. So, my brother, you will appreciate that my present is wretched, but my future is very bright”
While this is a hilarious story, we can find many Shyams around us. A large number of closed businesses are a testimony to the unfounded and unrealistic optimism of owners for a “Bright Future” which did not allow them to take hard corrective actions in time.