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Never start funding discussion on “how much is the rate of interest”

Almost 6/7 out of 10 entrepreneurs we meet for funding discussion, start the discussion on interest rate ? Yes, it is part of the deal. But never should be the heart of the deal. 

As discussed in the earlier blog (https://bit.ly/33sIj4t ), to de-clutter and simplify your funding effort you need to start simple on the 5 bullet points. You would notice, interest rates actually do not appear there. It gets covered under the  funding terms. 

We met a real estate developer from Pune. He has been looking for Rs. 10 cr funding for his Phase 2 of the residential real estate project. They wanted funding for both certain fees to be paid to the Local Authority as well as for construction. They seem to have a sanction from a Private Bank but the interest rate was not much attractive. So in search of a better interest rate they happen to meet us. While we tried reasoning to them that for real estate and in such a difficult market, getting money is more important and finishing the project on time, than to look for 1-2% savings in the interest rate. The opportunity lost in these interim period, may be that was a good time, when few customers would have booked the flats, may be we are approaching a bad phase of material / labour shortage and finishing work on time should be our priority, or may be a some other macro changes would make funding difficult for a long time. (In fact in this particular case when we meet the Developer January 2020, all these scenarios happened simultaneously). 

So an entrepreneur should focus on the Opportunity Cost (of his time and effort) and not ONLY on the interest cost. The Real Estate project referred to above, needed Rs. 10 Crore loan. In its life cycle of 2 years, 1% p.a. Interest rate extra means Rs. 10 Lakh extra. 2% means Rs. 20 Lakh extra. This project would have a total cost of Rs. 30 Crore and Sale value of Rs. 40 Crore. Assuming 15 Crore is collected already, by delaying the loan decision and not finishing the project at a faster pace, we are delaying the sale of these unsold flats of Rs. 20 Crore. So on a revenue of Rs. 20 Crore Rs. 10-20 Lakh means 0.5 – 1% of extra interest cost.

So, a loan with seemingly higher interest by (2% more) actually appears to be 0.8% when we look at the opportunity being lost – incremental revenue (Rs. 25 Crores) 

Now what is the Opportunity Cost ? The decision of waiting and finding a better interest rate might have resulted in 1-2 months of delay. But what is the opportunity lost in these 2 months? What is the cost of such lost opportunity ? Did we lose some customers by not having management focus on the project progress, marketing and selling the flats ? Did we lose construction progress by not being available for project monitoring ? 

Beauty is, Interest Cost is it is visible, but the Opportunity Cost is not visible/measurable. (We really don’t know how many customers we lost in the interim period.) So, by human nature, we tend to address what is visible, and ignore what is not visible. 

But the business acumen lies in knowing the implications of such invisible costs and its impact on the business. I think to grab a loan, albeit at a seeming higher rate and finishing the project should be the focus. 

Bird in hand is better than two in the bush – the saying goes.