Last week we highlighted how speculative ventures sink thriving businesses and examined the case of a cybercafé owner who comes across a lucrative opportunity to make some extra cash arising from the expected spike in demand for specialised Valentine’s Day merchandise.
After pulling working capital from the cybercafé, the business suffers greatly and the Valentines Day bet ultimately doesn't pay off.
Investing in speculative ventures isn’t the only way entrepreneurs divert financial resources from their core businesses.
Kenyan entrepreneurs also frequently withdraw funds from their companies to invest in what economists call dead-end investments. These consume large sums of cash upfront but generate no future cash flows.
Examples include buying a dream car or home, or that coveted plot in an upmarket neighbourhood. There's nothing inherently wrong with these assets. The problem arises when they're funded by pulling money out of a business. These withdrawals severely reduce working capital the most vital lifeblood that keeps a business running day-to-day.
One key aspect that many entrepreneurs miss is that dead-end investments do not generate any immediate or future cash for their businesses. In fact, they are “one-way streets” where money goes out but never comes back making these diversions true sunk costs.
Consider the retailer whose flourishing business makes her eligible for a mortgage to build a residential house worth millions. Since banks rarely offer 100 percent mortgages (due to additional costs like stamp duty, architect, and legal fees), she covers the shortfall by withdrawing money from her business.
Once that money is diverted, it’s gone for good. Even if she saves on rent by moving into her home, she still faces severe liquidity constraints. And don’t forget the ongoing mortgage repayments. Instead of restocking inventory, her cash now services debt creating an unsustainable financial situation.
Her retail business, once booming, now struggles. Like the cybercafé owner, she’s locked up critical working capital in an asset that, while desirable, offers no value to the day-to-day running of her business.
In both examples, we observe a common thread: entrepreneurs redirecting funds from growing their core businesses into ventures with poor cash-generation potential. Whether it's speculative red roses or a dream house, the result is the same; businesses are slowly cannibalised by poor financial choices.
The point we’ve been labouring in these two parts is simple but profound: the undisciplined diversion of your business's working capital, however attractive the target, could lead to the premature death of your enterprise. Or worse, you could lose both the business and the assets you bought with its cash.
The writer is Director of Strategy, WYLDE International.
