financial planning: Want to start a business by liquidating assets? Consider these factors

Arunima is 36 and is a well established architect with her own practice. She lives with her parents and has been working out of her parents’ home for almost a decade. She now wants to take up her own business space. She has identified a good location and worked out the capital requirements to set up the office. Arunima estimates that she will be able to cover the initial cost in 15-18 months. Her portfolio consists of investments in mutual funds, PPF and deposits. She needs to make a big decision—should she liquidate her personal holdings for her capital requirements or take a loan?

Arunima should identify the purpose or the long-term goals of her investment portfolio first. Has she saved it for her wedding? Or is it set aside for retirement? Liquidating investments will put her long-term goals at risk, since it will be difficult to create that asset again. Arunima can look at taking an unsecured loan from a bank but the interest rate will be high.

Another option is to use her portfolio to raise funds. Taking a loan against her securities is a better way to generate liquidity, without selling the long-term investment portfolio, especially since this is a short-term requirement. Interest rates on loans against securities are lower than that of unsecured loans with no collateral. In loan against securities, the amount sanctioned is lower than the value of the investment offered as collateral. The difference is called margin and is determined by the lender. If the loan is against the face value of a debt instrument and is not risky, the rate and the margin are likely to be lower. In products such as open-ended mutual funds or equity shares, where the value of the collateral can change due to change in market value, the margin and the rate will be higher. Loans against shares are typically available for short periods. Lenders will seek a lien to be registered on the security, and invoke it if the loan is not repaid. Products such as equity shares, mutual funds and life insurance policies have standard lien-marking processes making it easy to take loans against them.

Arunima should look at leveraging her current portfolio to generate liquidity for the short term. This will protect her long-term goals and generate the necessary liquidity. However, she must note that it may not make financial sense to hold an asset that is generating 8% and take a loan at 12%. She must consider her long-term goals and overall market environment before deciding between sell-off, unsecured loan or loan against securities.

(Content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)

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