Week 9 Family Business

Family business are very unique with major involvement of members of particular family. It is clear that family businesses comprise a very significant proportion of business throughout the world. It is agreed that family business cannot be confined to demographic criteria i.e. number of family members working or the percentage of shareholding of family members in the business. Other factors such as intention, involvement and influence are also becoming increasingly important when defining whether a business is family business or not.(Lumphin et al, 2008)

There are various financial intermediaries which helps the family business in managing their finances. Some are better suited for long term fund requirements and others are better suited for short term requirements.(Allen F. & Santomero A, 1998) The different financial intermediaries that are worth noting are banks, venture capital and informal credit market.

 

The major financing source is Banks, which however are required to limit their exposure to any one borrower to no more than 15 per cent of their equity, and many choose a much smaller threshold. This limit on borrower concentration has the effect of restricting business lending by small banks primarily to small business loans. Moreover, small banks are better for small and medium size firms and family firms as they provide them with personalized services that larger banks generally are unable to provide to these firms. Non-banking financial intermediaries (Insurance companies, pension funds, mutual funds, etc) are normally more operational in rich countries rather than underdeveloped nations. 

 

Informal credit also plays a key role in the financing field which are not regulated by any banking authorities. However, they are very important in the financial system and even more important in developing countries such as India and China because they act as a catalyst between fast growing firms and regulated financial sector. There are three important categories of informal credit lenders. The most important are indigenous bankers who function as commercial banks. They take deposits and give loans but they are not under any formal regulatory authorities. The secondly there are commercial financiers who lend their own funds and finally there are brokers who helps in connecting the lender and the borrowers. (Strahan, P. & Weston, J., 1996)

 

Capital markets are good source of funds as equity capital is not serviced by any interest factor and the shareholders are paid dividend only when company is doing well. But it is also not free from imperfections. (Morris et al, 1997) There is a problem of asymmetric information between provider and user of fund lead to a gap between the cost of external and internal financing which makes raising fund from market expensive on one hand and on the other the investor may be reluctant to invest in a new firm. The capital markets are also an important source of funds for family owned businesses but they are not a viable option for small and medium scale firms as there is a general belief that they would not get correct valuation. Again family firms generally try and keep their financials  undisclosed but when a firm goes for an IPO they have to disclose information that the firm may not be willing to disclose.

 

The work of venture capitalists is not restricted to financing these firms but they also help in overall development of these firms by helping them to overcome their shortcomings. Both types of support imply a positive impact on growth rate of the venture backed firms. Engel (2008) found that venture capital funding has a positive impact on fast growing firms with innovative products.

 

 

                                                                                               Written on 24 March

                                                                                                Revised on 10 May

 

 

 

 

Week 5 Transfer pricing

Transfer pricing is importance to international corporations because their operations extend to countries with diverse taxation regimes and regulatory capacities. The pursuit of profits, cash flows, marketing goals, economies of scale and competitive advantage through joint ventures, subsidiaries and affiliates necessitates estimations of costs to measure performance and taxable profits. In such an environment corporations need to develop processes for allocating  costs and overheads and design strategies for estimating transfer prices for goods and services. Since costs and overhead allocation mechanisms are highly subjective corporations enjoy considerable discretion in allocating them to paricular products and geographical jurisdictions. Such discretion can enable them to minimize taxes and swell profits by ensuring that, wherever possible, most profits are located in  low-tax or low risk jurisdictions. Transfer pricing can enable companies to avoid double taxation.

The offshore companies are typically remunerated using traditional transfer pricing approaches. In case of outsourced services predominantly the cost plus method is applied. However, in view of the substantial cost savings generated through offshoring of activities to low-cost economies and the increasing degree  of complexity of the off shored functions, the tax administrations, in particular of emerging markets such as China and India, have started adopting more aggressive positions with regards to the traditional cost plus mark-ups applied, hence requesting much higher profit margins for the offshore companies. The main concept behind the tax management use of a Tax-Haven by a company is to restructure the company's transactions so that the majority of the taxable profit arises in a very low tax regime. It should be note that the actual operations of the company normally still operate in the original country. A number of companies have inventively restructured them or outsourced their operations to make use of Tax loopholes. The most popular tax heavens are Dublin, Luxembourg, America British Virgin Isles, Cayman Islands, Hong Kong.

Take Jersey as an example, Jersey are tax advantage for customers in that order up to £18 in value are VAT free under the personal import rules. This means that by outsourcing the sale to Indigo Lighthouse, Amazon can enjoy a competitive advantage of 15% (UK VAT) on UK based high street retailers for the same product like HMV or Zavvi. Indigo Lighthouse also deals directly with the contact lens suppliers, including Busch & Lomb, Johnstone & Johnstone, Cooper Vision and Ciba Vision as well as a number of other businesses.