Characteristics of Young Companies and their Value Drivers

Characteristics of young companies

            Young companies are diverse, but they share some common characteristics. In this section, we will consider these shared attributes, with an eye on the valuation problems/issues that they create.

1.     No history: At the risk of stating the obvious, young companies have very limited histories. Many of them have only one or two years of data available on operations and financing and some have financials for only a portion of a year, for instance.

2.     Small or no revenues, operating losses: The limited history that is available for young companies is rendered even less useful by the fact that there is little operating detail in them. Revenues are small or non-existent for idea companies and the expenses often are associated with getting the business established, rather than generating revenues. In combination, they result in significant operating losses.

3.     Dependent on private equity: While there are a few exceptions, young businesses are dependent upon equity from private sources, rather than public markets. At the earlier stages, the equity is provided almost entirely by the founder (and friends and family). As the promise of future success increases, and with it the need for more capital, venture capitalists become a source of equity capital, in return for a share of the ownership in the firm.

4.     Many don't survive: Most young companies don't survive the test of commercial success and fail. There are several studies that back up this statement, though they vary in the failure rates that they find. A study of 5196 start-ups in Australia found that the annual failure rate was in excess of 9% and that 64% of the businesses failed in a 10-year period.  Knaupand Piazza (2005,2008) used data from the Bureau of Labor Statistics Quarterly Census of Employment and Wages (QCEW) to compute survival statistics across firms.  This census contains information on more than 8.9 million U.S. businesses in both the public and private sector. Using a seven-year database from 1998 to 2005, the authors concluded that only 44% of all businesses that were founded in 1998 survived at least 4 years and only 31% made it through all seven years. In addition, they categorized firms into ten sectors and estimated survival rates for each one. Table 9.1 presents their findings on the proportion of firms that made it through each year for each sector and for the entire sample:

Table 9.1: Survival of new establishments founded in 1998

	Proportion of firms that were started in 1998 that survived through
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
Natural resources	82.33%	69.54%	59.41%	49.56%	43.43%	39.96%	36.68%
Construction	80.69%	65.73%	53.56%	42.59%	36.96%	33.36%	29.96%
Manufacturing	84.19%	68.67%	56.98%	47.41%	40.88%	37.03%	33.91%
Transportation	82.58%	66.82%	54.70%	44.68%	38.21%	34.12%	31.02%
Information	80.75%	62.85%	49.49%	37.70%	31.24%	28.29%	24.78%
Financial activities	84.09%	69.57%	58.56%	49.24%	43.93%	40.34%	36.90%
Business services	82.32%	66.82%	55.13%	44.28%	38.11%	34.46%	31.08%
Health services	85.59%	72.83%	63.73%	55.37%	50.09%	46.47%	43.71%
Leisure	81.15%	64.99%	53.61%	43.76%	38.11%	34.54%	31.40%
Other services	80.72%	64.81%	53.32%	43.88%	37.05%	32.33%	28.77%
All firms	81.24%	65.77%	54.29%	44.36%	38.29%	34.44%	31.18%

Note that survival rates vary across sectors, with only 25% of firms in the information sector (which includes technology) surviving 7 years, whereas almost 44% of health service businesses make it through that period.

5.     Multiple claims on equity: The repeated forays made by young companies to raise equity does expose equity investors, who invested earlier in the process, to the possibility that their value can be reduced by deals offered to subsequent equity investors. To protect their interests, equity investors in young companies often demand and get protection against this eventuality in the form of first claims on cash flows from operations and in liquidation and with control or veto rights, allowing them to have a say in the firm's actions. As a result, different equity claims in a young company can vary on many dimensions that can affect their value.

6.     Investments are illiquid: Since equity investments in young firms tend to be privately held and in non-standardized units, they are also much more illiquid than investments in their publicly traded counterparts.

Young growth companies – Value Drivers

Revenue Growth

For a young, growth company to become valuable, small revenues have to become big revenues. To make judgments on revenue growth in the future, we have to assess two variables:

a.     Potential market for the product/service:  The first step in deriving the revenues for the firm is estimating the total potential market for its products and services. There are two challenges we face at this juncture.

                                               i.     Defining the product/service offered by the firm: If the product or service offered by the firm is defined narrowly, the potential market will be circumscribed by that definition and will be smaller. If we use a broader definition, the market will expand to fit that definition. For example, defining Amazon.com as a book retailer, which is what it was in 1998, would have yielded a total market of less than $ 10 billion in that year, representing total book retailing sales in 1998. Categorizing Amazon.com as a general retailer would have yielded a much larger potential market. While that might have been difficult to defend in 1998, it did become more plausible as Amazon expanded its offerings in 1999 and 2000.

                                              ii.     Estimating the market size: Having defined the market, we face the challenge of estimating the size of that market. For a product or service that is entering an established market, the best sources of data tend to be trade publications and professional forecasting services. Almost every business has a trade group that tracks the operating details of that business; there are almost 7600 trade groups just in the United States, tracking everything from aerospace to telecom.  In many businesses, there are firms that specialize in collecting information about the businesses for commercial and consulting purposes. For instance, the Gartner Group collects and provides data on different types of information technology business, including software.

                                            iii.     Evolution in total market over time: Since we have to forecast revenues into the future, it would be useful to get a sense of how the total market is expected to change or grow over time. This information is usually also usually available from the same sources that provide the numbers for the current market size.

b.     Market share: Once we have a sense of the overall market size and how it will changeover time, we have to estimate the share of that market that will be captured by the firm being analyzed, both in the long term and in the time periods leading up to steady state. Clearly, these estimates will depend both on the quality of the product or service that is being offered and how well it measures up against the competition. A useful exercise in estimation is to list the largest players in the targeted market currently and to visualize where the firm being valued will end up, once it has an established market. However, there are two other variables that have to be concurrently considered. One is the capacity of the management of the young company to deliver on its promises; many entrepreneurs have brilliant ideas but do not have the management and business skills to take it to commercial fruition. That is part of the reason that venture capitalists look for entrepreneurs who have had a track record of success in the past. The other is the resources that the young company can draw on to get its product/service to the desired market share.  Optimistic forecasts for market share have to be coupled with large investments in both capacity and marketing; products usually don't produce and sell themselves.

Target Operating Margin

Revenues may be the top line but as investors, but a firm can have value only if it ultimately delivers earnings. Consequently, the next step is estimating the operating expenses associated with the estimated revenues. We are stymied in this process, with young companies, both by the absence of history and the fact that these firms usually have very large operating losses at the time of the estimate. Again, we would separate the estimation process into two parts. In the first part, we would focus on estimating the operating margin in steady state, primarily by looking at more established companies in the business. Once we have the target margin, we can then look at how we expect the margin to evolve over time; this 'pathway to profitability' can be rockier for some firms than others, with fixed costs and competition playing significant roles in the estimation. One final issue that has to be confronted at this stage is the level of detail that we want to build into our forecasts. In other words, should we just estimate the operating margin and profit or should we try to forecast individual operating expense items  such as labor, materials, selling and advertising expenses? As a general rule, the level of detail should decrease as we become more uncertain about a firm's future. While this may seem counter intuitive, detail in forecasts leads to better estimates of value, if an only if we bring some information into that detail that otherwise would be missed. An analyst who has a tough time forecasting revenues in year 1 really is in no position to estimate labor or advertising costs in year 5 and should not even try. In valuing young companies, less (detail) is often more (precision).

Survival

Many young firms succumb to the competitive pressures of the market place and don't make it. The probability of failure can be assessed in one of three ways.

c.      Sector averages: Earlier in the chapter we noted a study by Knaup and Piazza (2007) that used data from the Bureau of Labor Statistics to estimate the probability of survival for firms in different sectors from 1998 to 2005. We could use the sector averages from this study as the probability of survival for individual firms in the sector.

d.     Probits: A more sophisticated way to estimate the probability of failure is to look at firms that have succeeded and failed over a time period (say, the last 10 years) and to then try to build a model that can predict the probability of a firm failing as a function of firm specific characteristics – the cash holdings of the firm, the age and history of its founders, the business it is in and the debt that it owes.

e.     Simulations: In chapter 3, we noted that simulations can be put to good use, when confronted with uncertainty. If we can specify probability distributions (rather than just expected values) for revenues, margins and costs, we may be able to specify the conditions under which the firm will face failure (costs exceed revenues by more than 30% and debt payments coming due, for example) and estimate the probability of failure.

The Little Book of Valuation

Aswath Damodaran

Characteristics of Growth Companies and their Value Drivers

Characteristics of growth companies

            Growth companies are diverse in size, growth prospects and can be spread out over very different businesses but they share some common characteristics that make an impact on how we value them. In this section, we will look at some of these shared features:

1. Dynamic financials: Much of the information that we use to value companies comes from their financial statements (income statements, balance sheets and statements of cash flows). One feature shared by growth companies is that the numbers in these statements are in a state of flux. Not only can the numbers for the latest year be very different from numbers in the prior year, but can change dramatically even over shorter time periods. For many smaller, high growth firms, for instance, the revenues and earnings from the most recent four quarters can be dramatically different from the revenues and earnings in the most recent fiscal year (which may have ended only a few months ago).
2. Private and Public Equity: It is accepted as conventional wisdom that the natural path for a young company that succeeds at the earliest stages is to go public and tap capital markets for new funds. There are three reasons why this transition is neither as orderly nor as predictable in practice. The first is that the private to public transition will vary across different economies, depending upon both institutional considerations and the development of capital markets. Historically, growth companies in the United States have entered public markets earlier in the life cycle than growth companies in Europe, partly because this is the preferred exit path for many venture capitalists in the US. The second is that even within any given market, access to capital markets for new companies can vary across time, as markets ebb and flow. In the United States, for instance, initial public offerings increase in buoyant markets and drop in depressed markets; during the market collapse in the last quarter of 2008, initial public offerings came to a standstill. The third is that the pathway to going public varies across sectors, with companies in some sectors like technology and biotechnology getting access to public markets much earlier in the life cycle than firms in other sectors such as manufacturing or retailing. The net effect is that the growth companies that we cover in chapter will draw on a mix of private equity (venture capital) and public equity for their equity capital. Put another way, some growth companies will be private businesses and some will be publicly traded; many of the latter group will still have venture capitalists and founders as large holders of equity.
3. Size disconnect: The contrast we drew in chapter 1 between accounting and financial balance sheets, with the former focused primarily on existing investments and the latter incorporating growth assets into the mix is stark in growth companies. The market values of these companies, if they are publicly traded, are often much higher than the accounting (or book) values, since the former incorporate the value of growth assets and the latter often do not. In addition, the market values can seem discordant with the operating numbers for the firm – revenues and earnings. Many growth firms that have market values in the hundreds of millions or even in the billions can have small revenues and negative earnings. Again, the reason lies in the fact that the operating numbers reflect the existing investments of the firm and these investments may represent a very small portion of the overall value of the firm.
4. Use of debt: While the usage of debt can vary across sectors, the growth firms in any business will tend to carry less debt, relative to their value (intrinsic or market), than more stable firms in the same business, simply because they do not have the cash flows from existing assets to support more debt. In some sectors, such as technology, even more mature growth firms with large positive earnings and cash flows are reluctant to borrow money. In other sectors, such as telecommunications, where debt is a preferred financing mode, growth companies will generally have lower debt ratios than mature companies.
5. Market history is short and shifting: We are dependent upon market price inputs for several key components of valuation and especially so for estimating risk parameters (such as betas). Even if growth companies are publicly traded, they tend to have short and shifting histories. For example, an analyst looking at Google in early 2009 would have been able to draw on about 4 years of market history (a short period) but even those 4 years of data may not be particularly useful or relevant because the company changed dramatically over that period – from revenues in millions to revenues in billions, operating losses to operating profits and from a small market capitalization to a large one. 

While the degree to which these factors affect growth firms can vary across firms, they are prevalent in almost every growth firm.

Growth companies- Value Drivers

Scalable growth

The question of how quickly revenue growth rates will decline at a given company can generally be addressed by looking at the company's specifics – the size of the overall market for its products and services, the strength of the competition and quality of both its products and management.  Companies in larger markets with less aggressive competition (or protection from competition) and better management can maintain high revenue growth rates for longer periods.

            There are a few tools that we can use to assess whether the assumptions we are making about revenue growth rates in the future, for an individual company, are reasonable:

1.     Absolute revenue changes: One simple test is to compute the absolute change in revenues each period, rather than to trust the percentage growth rate. Even experienced analysts often under estimate the compounding effect of growth and how much revenues can balloon out over time with high growth rates. Computing the absolute change in revenues, given a growth rate in revenues, can be a sobering antidote to irrational exuberance when it comes to growth.

2.     Past history: Looking at past revenue growth rates for the firm in question should give us a sense of how growth rates have changed as the company size changed in the past. To those who are mathematically inclined, there are clues in the relationship that can be used for forecasting future growth.

3.     Sector data: The final tool is to look at revenue growth rates of more mature firms in the business, to get a sense of what a reasonable growth rate will be as the firm becomes larger.

In summary, expected revenue growth rates will tend to drop over time for all growth companies but the pace of the drop off will vary across companies.

Sustainable margins

To get from revenues to operating income, we need operating margins over time. The easiest and most convenient scenario is the one where the current margins of the firm being valued are sustainable and can be used as the expected margins over time. In fact, if this is the case, we can dispense with forecasting revenue growth and instead focus on operating income growth, since the two will be the equivalent. In most growth firms, though, it is more likely that the current margin is likely to change over time.

            Let us start with the most likely case first, which is that the current margin is either negative or too low, relative to the sustainable long-term margin. There are three reasons why this can happen. One is that the firm has up-front fixed costs that have to be incurred in the initial phases of growth, with the payoff in terms of revenue and growth in later periods. This is often the case with infrastructure companies such as energy, telecommunications and cable firms. The second is the mingling of expenses incurred to generate growth with operating expenses; we noted earlier that selling expenses at growth firms are often directed towards future growth rather than current sales but are included with other operating expenses. As the firm matures, this problem will get smaller, leading to higher margins and profits. The third is that there might be a lag between expenses being incurred and revenues being generated; if the expenses incurred this year are directed towards much higher revenues in 3 years, earnings and margins will be low today.

            The other possibility, where the current margin is too high and will decrease over time, is less likely but can occur, especially with growth companies that have a niche product in a small market. In fact, the market may be too small to attract the attention of larger, better-capitalized competitors, thus allowing the firms to operate under the radar for the moment, charging high prices to a captive market. As the firm grows, this will change and margins will decrease. In other cases, the high margins may come from owning a patent or other legal protection against competitors, and as this protection lapses, margins will decrease. 

            In both of the latter two scenarios – low margins converging to a higher value or high margins dropping back to more sustainable levels – we have to make judgment calls on what the target margin should be and how the current margin will change over time towards this target. The answer to the first question can be usually be found by looking at both the average operating margin for the industry in which the firm operates and the margins commanded by larger, more stable firms in that industry. The answer to the second will depend upon the reason for the divergence between the current and the target margin. With infrastructure companies, for instance, it will reflect how long it will take for the investment to be operational and capacity to be fully utilized.

Quality Growth

A constant theme in valuation is the insistence that growth is not free and that firms will have to reinvest to grow. To estimate reinvestment for a growth firm, we will follow one of three paths, depending largely upon the characteristics of the firm in question:

1.     For growth firms earlier in the life cycle, we will adopt the same roadmap we used for young growth companies, where we estimated reinvestment based upon the change in revenues and the sales to capital ratio.

Reinvestment_t = Change in revenues_t/ (Sales/Capital)

The sales to capital ratio can be estimated using the company's data (and it will be more stable than the net capital expenditure or working capital numbers) and the sector averages. Thus, assuming a sales to capital ratio of 2.5, in conjunction with a revenue increase of $ 250 million will result in reinvestment of $ 100 million.  We can build in lags between the reinvestment and revenue change into the computation, by using revenues in a future period to estimate reinvestment in the current one.

2.     With a growth firm that has a more established track record of earnings and reinvestment, we can use the relationship between fundamentals and growth rates that we laid out in chapter 2:

Expected growth rate in operating income = Return on Capital * Reinvestment Rate + Efficiency growth (as a result of changing return on capital)

In the unusual case where margins and returns and capital have settled into sustainable levels, the second term will drop out of the equation.

3.     Growth firms that have already invested in capacity for future years are in the unusual position of being able to grow with little or no reinvestment for the near term. For these firms, we can forecast capacity usage to determine how long the investment holiday will last and when the firm will have to reinvest again. During the investment holiday, reinvestment can be minimal or even zero, accompanied by healthy growth in revenues and operating income.

With all three classes of firms, though, the leeway that we have in estimating reinvestment needs during the high growth phase should disappear, once the firm has reached its mature phase. The reinvestment in the mature phase should hew strictly to fundamentals:

Reinvestment rate in mature phase = 

In fact, even in cases where reinvestment is estimated independently of the operating income during the growth period, and without recourse to the return on capital, we should keep track of the imputed return on capital (based on our forecasts of operating income and capital invested) to ensure that it stays within reasonable bounds.

The Little Book of Valuation

Aswath Damodaran

EPF: Lump-sum or partial withdrawals at 55?

EPF: Lump-sum or partial withdrawals at 55?
Written by Celine Tan of theedgemalaysia.com
Wednesday, 31 August 2011 00:12
KUALA LUMPUR: Upon reaching 55, most people prefer to withdraw all their savings in the Employees Provident Fund (EPF) but more and more people are opting for flexible withdrawals (partial or monthly payments).

According to the EPF, last year, 235,931 employees made withdrawals at age 55 and 70% of the withdrawals were full withdrawals. The number of flexible withdrawals increased by 41.67% to 82,690, compared with 2009.

Choosing between withdrawing a lump sum and making a partial withdrawal depends on many factors. Financial planners say you can ask five questions when crunching the numbers for your retirement plan, not at 55.

1) What is your behaviour towards money?


Your EPF savings can be the single largest disbursement of money you will see in your lifetime. “It is something that most individuals look forward to throughout their working life. It gives them a sense of fulfilment when they receive it since they believe that it is then possible to achieve their life goals,” says K Gunasegaran, founder and licensed financial planner of Wealth Street Sdn Bhd.


If you are quick to spend money without a plan, think twice before withdrawing the whole. “Those who are not used to having large sums of money tend to get emotionally charged. It can lead to splurges on big-ticket items such as luxury cars. While the money is rightfully yours and it is not entirely wrong to benefit from your retirement savings, be aware of the consequences. If you know that you are an emotional spender, it is best to drop the idea of a lump-sum withdrawal because you have to make smart choices with the money,” says Gunasegaran.


2) Can you generate higher returns at a higher risk?
The primary concern of retirees is whether their retirement savings can sustain them throughout their golden years and generate sufficient returns to outpace inflation.

Headline inflation, as measured by the Consumer Price Index (CPI), increased to 3.3% on an annual basis in May, according to Bank Negara Malaysia (BNM). From 2005 to 2010, the average inflation rate in the country was 2.77%, reaching a historical high of 8.5% in July 2008 and a record low of –2.4% in July 2009.

For the past 59 years, from 1952 to 2010, the EPF has declared annual dividend rates of between 2.5% and 8.5%. In the past 10 years, the highest dividend payout from the EPF was 6% in 2000 and the lowest dividend payout was 4.25% in 2002. “If you are conservative and expect the EPF to continue providing decent annual dividends, opt for flexible withdrawals,” says Wong Keng Leong, practice manager and licensed financial adviser representative at Standard Financial Planner Sdn Bhd.

Headline inflation, however, is not necessarily a reflection of the rise in a household’s real cost of living. This means that the returns on your retirement savings should far exceed the reported CPI figures.


“Also, the EPF promises a minimum dividend of 2.5% per annum. If you think that you or your financial adviser or fund manager can surpass the average returns made by the EPF, consider a lump-sump withdrawal to boost your retirement nest egg,” says Gunasegaran.

When doing so, observe the associated costs such as sales charges or management fees levied by the financial professionals and financial institutions. If you decide to retain your retirement savings with the EPF, there will be a small charge that differs from year to year.


3) Would you still be paying debts at age 55?


If you will still be servicing high-interest debts at age 55, consider using your EPF savings to pare down or settle the loans. This is especially so if the interest levied is higher than the returns generated by your savings.

“High-interest debt includes credit cards [interest rate ranges from 13.5% to 17.5% a year] and personal loans [interest rate ranges from 8% to 12%]. Holding any of these debts negates any investment gains unless you are able to get superior returns on your investment over the years. Withdrawing your retirement savings, be it in a lump sum or partially, to settle your high-interest debt is a smart option but ensure that there is still some money left for your retirement, says Wong.

There is no fixed rule on how much debt you should settle. “How much you should pay off depends on the quantum of your savings. Also, it is good to check whether your debt can be restructured to reduce the interest you have to pay. If so, evaluate the financial benefit of settling this debt with a lump sum withdrawal of your EPF savings,” says Gunasegaran.


4) Do you want to control your retirement funds?

Contributors have little control over how their savings are managed and invested by the EPF, which has sole discretion on how to invest the money that they receive and the dividend (over the minimum amount guaranteed) to declare.


“If you want to take full charge of your retirement savings [either on your own or with professional help], you can do so at 55. When you take a lump-sum payment, you are able to invest in investments that may not be available to you if you were to retain your savings in the EPF [withdrawals can be made to EPF-approved local equity funds],” says Wong, who observes that most of his retired clients withdrew all their EPF monies at 55 as they were comfortable with managing their own money.


A key benefit of withdrawing your retirement savings in a lump sum is that it allows you to expose your loved ones to managing money with a long-term perspective. “At the point of death, most of us will not want to leave a large sum of money to loved ones who cannot manage it. In all likelihood, the money will be spent sooner than planned. Withdrawing your retirement savings in a lump sum at the point of retirement allows you to slowly educate your young-adult children on how to manage a big sum of money. Let them know where you keep your savings and what you are doing with it. This is an alternative to receiving a lump sum from the EPF when you are no longer around,” says Gunasegaran.


5) Do you have a plan to access your money?


If you are 55, under the EPF’s monthly payment withdrawal scheme, the board will transfer the total amount into a special account and put monthly payments into your bank account.

If you opt for a lump-sum withdrawal, how will you draw down your money to fund your lifestyle? There are two options to evaluate. Wong suggests that you should plan a draw-down strategy that includes either a quarterly or half-yearly redemption. “Note that some instruments allow you to make periodical withdrawals but may impose charges.”

On the other hand, Gunasegaran thinks that it is more advisable for retirees to put their retirement savings into annuity-like insurance plans, under which they will receive annual payments after a certain number of years.

http://www.theedgemalaysia.com/personal-finance/192209-epf-lump-sum-or-partial-withdrawals-at-55-.html

Taking a loan in your golden years

Taking a loan in your golden years
Written by Celine Tan of theedgemalaysia.com
Monday, 31 October 2011 07:48


Banks might be reluctant to lend to retirees but there are ways to increase your chances of getting a loan


For retirees, the best practice is to live on cash. Says Ng Chee Yong, a licensed financial planner at the financial care centre of wealth solutions provider CWA, “Whenever possible, pay with cash. A loan is taken to finance items that you cannot afford, a situation that retirees without a steady income should avoid.”

Nevertheless, unforeseen events or emergencies may compel you to borrow. For instance, an offspring may face financial difficulties and most parents would find it difficult to deny assistance. Or you might want to start a business or invest in properties. “After retiring at 55, many retirees start small businesses.

It is not surprising to find them applying for business or personal loans,” says Thoo Mee Ling, head of secured lending at OCBC Bank (M) Bhd. “Apart from that, those who are active in the property market will continue to buy and sell. They need to turn to banks for home loans.”

Louis Loh, business development manager at VKA Wealth Planners Sdn Bhd, says most of his retired clients take loans to buy new cars or refinance their homes.

“Some retirees may prefer to get a loan when purchasing big-ticket items although they can afford them. They think that they will be audited by the Inland Revenue Board if the items are paid in cash.”


Generally, financial institutions deny loans to those who are not earning an income. However, you can obtain a loan in certain situations, especially if you have planned for it. Here are six tips to maximise your chances of getting a loan in your golden years.

1 Take the loan before you turn 60


Each financial institution implements and adheres to a set of lending guidelines. “The guidelines are essential for the bank to manage its risk and returns. These guidelines include risk criteria set out by regulatory bodies such as Bank Negara Malaysia. Age [of borrowers] is a variable that a bank controls through its lending guidelines,” says Thoo. “If you think that you might want to get a loan during retirement, it is best to take the loan before you turn 60. The most ideal time is between 50 and 55,” says Loh.

2 Cut margin of finance and/or loan tenure


“Nowadays, some financial institutions prefer to give out lower margins of finance because they want to decrease their non-performing loans. Generally, banks will give loans to retirees who ask for a 50% margin of finance,” says Loh.

“If you are 56 and want to get a 15-year loan, the financial institutions may be concerned. But, if you want to get an eight- or 10-year loan, they are more comfortable with it. In addition, this lowers your borrowing cost,” says Ng.


Loh observes that it is far easier for retirees to obtain car loans, which have short tenures of two to five years, rather than home loans. “Note that most financial institutions are reluctant to give out loans to retirees over 60 even if they have repayment capacity or are willing to cut the loan tenure.”

3 Document your sources of income


One of the most important aspects of getting your loan approved is your repayment capacity. “Your income [finances] must be able to prove that you can,” says Loh.

“Make your income ‘official’. For instance, if you sell cakes or babysit, legalise your business by setting up a sole proprietorship. This will need few months of planning,” suggests Ng.

If you are going to use rental income to support your loan application, provide proper documentation. “Get your tenancy agreement stamped and keep all records of payments. Get the tenant to bank the rent into your account,” says Ng. Besides receiving a continuous stream of income from these assets, Loh adds that your chances of obtaining a loan will improve if your existing properties are fully paid up.


But, bear in mind that financial institutions only consider income that is consistent and secured. “Lenders generally do not favour lending to insurance agents, unit trust agents, direct-selling marketers, remisiers or brokers. This is because their incomes are based on renewal of sales and the lenders assume that such income will not last for a long time, unless they have a group of people to continue running their business,” observes Loh.

Therefore, it is essential to build up a sizeable passive income stream prior to your retirement. Passive income can be generated from rental, dividends from shares, bonds and unit trusts, or commissions. “[Passive income] complements our pension fund and supports our repayment capacity,” says Thoo.


4 Get a guarantor or joint borrower

Generally, financial institutions prefer to give loans to retirees who have a guarantor or joint borrower. “By guaranteeing the loan, the guarantor or joint borrower, usually a family member, is legally liable for the repayments as well,” says Thoo.


Loh observes that financial institutions prefer a joint borrower to a guarantor. “This is because a joint borrower is seen as having more commitment than a guarantor. However, where the joint borrower has a high debt-asset ratio, the financial institution may consider him as a guarantor instead.”

If you ask an income-earning family member to support your loan application, document the agreement. “You need to put everything in black and white. Inform those involved and communicate your plans,” says Ng.

If you are taking a mortgage loan, determine if the joint borrower will co-own your property. If not, this arrangement is tricky and can affect your estate. Also, note that the joint borrower or guarantor will have to continue servicing the loan should you pass away. “If the loan is not insured, your child will be burdened if you pass away while servicing the loan. The debt will not stop when you die, but will pass on to your legal beneficiaries,” says Loh.

5 Pledge collaterals



Collateral such as fixed deposits, unit trusts and shares can be pledged when applying for a loan. “As a rule of thumb, fixed deposits are favoured because they are liquid assets. Most banks, if not all, will offer a 100% loan if it is collateralised by a fixed deposit. Unit trusts and shares can be offered as well, although the margin of finance varies, depending on the bank’s risk appetite,” says Thoo.


If you pledge your fixed deposit, you cannot use the funds in the account throughout the tenure of the loan, says Loh. “Usually, banks will ask for a RM20,000 fixed deposit or a sum equivalent to 10% of the property’s value. This is the minimum amount needed to auction off the property if the borrower defaults.”



Financial institutions typically do not ask for property as collateral for a personal loan. “They are not in the business of liquidating such assets,” says Ng. The bank will incur a cost in holding a property auction and the price of the property will usually be lower than the market rate, explains Loh.

6 Stick to the same bank


Where possible, build a relationship with your banker. “If you have a good relationship with your banker, it might be easier for you to get a loan. For instance, if you always get your loans from the same bank, it might be more lenient and go the extra mile for you,” observes Ng.

http://www.theedgemalaysia.com/personal-finance/195379-taking-a-loan-in-your-golden-years.html

Freehold vs leasehold - the diffences

Freehold vs leasehold - the diffences
Written by Celine Tan of theedgemalaysia.com
Friday, 14 October 2011 17:04



Buying a property? Is it freehold or leasehold? Does it matter?


The main difference between the two tenures is ownership of the land. When it is the former, you will own the land while in the latter situation, ownership is accorded by the government for terms of 30, 60 or 99 years.


Whichever the tenure, you are free to develop the land as desired.

“Of course, it will be subject to planning control and public rights. Whatever you build should not pose a danger to your neighbours,” says PL Lee, managing director of First Pacific Valuers Property Consultants Sdn Bhd.

Clement Ong, principal of Megaharta Real Estate Sdn Bhd, says nine out of 16 property developments launched in the Klang Valley in August were freehold.

“Freehold properties mostly come from developers who are also plantations owners, such as Sime Darby, IOI Properties and Kuala Lumpur Kepong. The state governments had alienated freehold land to the developers for plantation purposes. The land was then converted into residential and non-residential property developments. Other developers who have obtained new alienation from the state governments are likely to receive leasehold land,” he explains.


“When alienating land as freehold or leasehold, state governments consider factors such as the [property] demand in the area and the growth rate of the state,” says A Subramaniam, executive director of PA International Property Consultants Sdn Bhd. New leasehold land in Bukit Jalil, Seri Kembangan and Selayang used to be designated as forest reserves, he says.


While some people do not care about the tenure of the property, others find it important, especially when it comes to renewing leasehold titles. Leasehold properties in certain parts of the Klang Valley, such as PJ Old Town (Selangor), Sungai Besi (Kuala Lumpur), Setapak (Kuala Lumpur) and Jalan Chan Sow Lin (Kuala Lumpur), have 50 or fewer years on their leases.

The owners are concerned that the land tenure may affect the future sale of their properties. Last December, Deputy Prime Minister Tan Sri Muhyiddin Yassin announced that all state governments may approve applications for renewal or extension of leasehold land for a period not exceeding 99 years, unless the land is required for public purposes.

Ong adds that not all titles require the state’s consent. “Not all transfers of leasehold properties need the state authority’s consent, such as those in Batu Caves. Conversely, there are freehold properties that need the consent. Thus, it is important for potential buyers to look at the title of the property.”

Examples of freehold properties with restrictions are the semi-detached houses in Kelana Jaya, says Lee. “These were previously leasehold properties but were changed to freehold. However, the restrictions still apply.”

Transacting property with restrictions


For leasehold and freehold properties with restrictions, any transaction requires the consent of the state government. Thus, the transaction period for secondary leasehold properties is generally longer than that of their restriction-free counterparts.

“Generally, the sale of freehold properties will take three plus one (3+1) months to complete, as stated in the usual sale and purchase agreement,” says Lee.

“However, for leasehold properties, the 3+1 months will only start after consent of the state authorities has been obtained. Getting consent can take about six months to a year. This means that buyers should not plan to move into their leasehold properties in four months’ time. The paperwork to transfer ownership can take as long as a year. It may take longer for leasehold properties in Selangor and Kuala Lumpur because the state offices are overloaded [with consent requests]. A leasehold property bought on the primary market [from a developer] usually doesn’t take such a long time.”

Lee adds that the speed in obtaining consent from the state authority is also determined by the information provided by the seller. “Sometimes, sellers will delay providing such information in anticipation of higher property prices, which they will demand from the buyers. This is a risk that buyers face,” he says.



Property consultants note that it takes more time and effort to transfer a leasehold property from a bumiputera owner to a non-bumiputera buyer. This is probably because the authorities try to maintain a balance between races living in a particular location. “If the state authority rejects the application for transfer, the seller can appeal. Common reasons that are given by the seller [for selling] are health issues and old age,” says Lee.


Purpose of the purchase


Generally, freehold properties are preferred as their values are usually more stable and tend to appreciate in the long term.

“The values of freehold and 99-year leasehold properties go up at a similar rate in the first 20 to 30 years. Sometimes, leasehold properties gain more value than freehold properties during the initial years. But, beyond 30 years, the values of leasehold properties face friction (stagnate, only to depreciate) until the expiry of the lease. On the other hand, values of freehold properties are more stable,” explains Lee.

There is also the possibility of redevelopment of old freehold properties. “Apartments and condominiums will eventually deteriorate. Developers prefer to buy such properties [for development] if the land is designated as freehold. In such cases, owners will receive fair compensation,” says Lee, who thinks that Desa Kudalari, an old freehold condominium in the Kuala Lumpur city centre, is a likely target for redevelopment.


He also finds that financial institutions will not finance those who want to acquire leasehold properties with less than 50 years remaining on the lease.

“Think twice if you face a property with a lease that has 60 years to go. The financial institution may give you a loan now but if you decide to sell the property in 10 years, the next buyer could face difficulty in obtaining a loan. It will not be easy for you to sell.”

However, you are not home free if you hold freehold property as the government may revoke your ownership.

“The government can still take back freehold land under the Land Acquisition Act 1960, to be developed for public purposes [such as an MRT project] or economic development. The term ‘economic development’ is a grey area and the government has the discretion to take over any private property [at any time],” says Ong.

If such an acquisition occurs, property owners will be paid the market value of the property.


The National Land Code 1965 also allows for ownership to be made void if you fail to pay annual quit rents or comply with all the express and implied conditions surrounding the land. “If this occurs, the government has the right to seal the property and auction it off. However, this is rarely done,” says Lee.


If you are interested in rental income, the tenure of the property might not be of significance. “These investors are more concerned with location, and the demand and supply of rental units,” says Ong.

Lee adds that the quality and brand of developers is another factor that carries more weight among property investors than the land tenure.

http://www.theedgemalaysia.com/personal-finance/194627-freehold-vs-leasehold-the-diffences-.html