In an effort to grow their businesses and succeed, entrepreneurs such as Simon Ford can get in over their heads. With proper planning, you can avoid bad debt.
When ambition and finances go off-road
When Simon Ford left Dubai a week ago, he was apologetic. Almost excessively so. His company, an online "gift experience" vendor, had run into rough times during the economic downturn, leaving him little choice, he said, but to flee to protect his family and avoid arrest for being unable to make good on financial obligations. "I am not running away from debt," he wrote in an e-mail to friends and colleagues shortly after leaving the country. "I am purely protecting those dearest to me and getting out of a country which, due to the lack of structured bankruptcy laws and a banking system which has zero flexibility on loan repayments, drives people to make horrible decisions."
Is that the entire story? Were Mr Ford's actions justified? Mr Ford's case exemplifies in stark terms the difficulties many expatriate individuals and businessmen have been facing these past few months. As companies announce waves of redundancies, paring their ranks in response to the global crisis, many expatriates who came to Dubai and other parts of the UAE, attracted by high salaries and tax-free living, are thought to be in the midst of a forced exodus.
Meanwhile, many of the entrepreneurs who cast their fortunes with Dubai's during the economic boom that ended last year are finding themselves in a similar pickle, unable to pay banks and suppliers and fearful of the consequences if they don't. "I am not trying to justify that what has happened is morally correct, it most certainly is not, but there is a very stark reality in doing business in UAE which unfortunately results in the most horrible decisions having to be made," Mr Ford said in his letter.
"We have continued to work with financial institutions and suppliers over the course of the last few days to see if the business can continue in some capacity, but this has now become impossible, resulting in the immediate closure of the business." But while Mr Ford's tale may be an unfortunate one, circumstances like his aren't entirely unavoidable. Ask financial advisers, and they'll tell you that they've heard similar stories time and again in the UAE: an expatriate comes to the country, establishes a business, lives a little beyond his means and winds up heavily in debt. Often, the story ends with a one-way ticket home.
Even if you don't own and run a business, the consequences of getting too deep into debt can be enormous. "What happens is a vicious cycle," says Aadil Kadri, a financial planner at Continental Financial Services in Dubai. "A person comes over here and has a huge credit card limit. He spends that, and then he uses another credit card to repay the first one. He now owns two, and then he will max out his two.
"Then to pay these two he gets a third, then to settle the amount of this third one, he takes a personal loan. There is no end to it. Finally he has to run away because there is no option for him. Or maybe he will even think about suicide." In a way, Mr Ford's decisions were similar. He borrowed money based on future earnings that never materialised. Before leaving, Mr Ford said he invested heavily in hiring new staff and moving to new offices. He "got a little arrogant", as he puts it now. He did, in other words, what many forward-thinking entrepreneurs do: he took a risk, betting on the idea that profits would increase enough to cover the investments he was making. Unfortunately for him, things didn't go as planned.
"Coming out in the summer of 2008, trade didn't pick up the way we expected," he said. If you want to avoid that kind of outcome, either for your business or yourself, advisers say the wisest thing to do is to simply stay out of debt, at least insofar as you don't cripple your future by spending in the present. Debt isn't intrinsically bad, they say, but certain kinds of debt, especially debt used to support an unsustainably lavish lifestyle, are a recipe for disaster.
"It makes sense sometimes to get into debt for something you can't afford in one go, like a car or a house, so you're spreading out the cost over time," says Jonathan Brookes, an adviser at Acuma Wealth Management in Dubai. "But when people are using credit cards to fund lifestyles they can't afford or credit cards to pay credit cards or loans to pay credit cards, that's when they get into trouble. The minimum payments of credit cards take up the majority of their income, and the whole thing spirals out of control. They are trying to live a lifestyle they just can't afford."
Advisers simplify the issue by putting debt into two easy-to-grasp categories: good debt and bad debt. "Good debt" is debt you take on for purchases you simply can't afford to save up for (well, unless you're a phenomenal saver): things like the houses and cars Mr Brookes mentions. Here, taking on debt doesn't sting as much because it is backed by a real asset that could theoretically be sold to pay off the loan - and perhaps net you a handy profit in the process. "Good debt" also tends to come with lower interest rates than other forms of debt that aren't backed by assets.
"Bad debt", though, is to be avoided like the plague. It includes - you guessed it - credit cards. Credit cards in the UAE typically come with interest rates of 30 or 40 per cent per year, an exorbitant rate by any measure. And consumers typically use them to fund lifestyles rather than assets. Bad debt doesn't apply only to credit cards, though. It includes any form of debt you can't afford, used to pay for something you don't need. Bad debt comes with high interest rates, loads of fees and penalties for early repayment. Usually, it is also debt that you don't take on with a specific purpose in mind
"There are lots of people who take out personal loans for no reason, just because they want to see their bank balance go up," Mr Kadri says. "You can go for a personal loan provided you have a specific objective for it, but not just for the sake of increasing your bank balance. You should understand the dire consequences of these loans." But while financial advisers caution against taking out personal loans and racking up credit card debt, even these bastions of bad debt aren't always bad.
It would be difficult, after all, for anyone to survive these days without a credit card. Try signing up for a television subscription or buy a plane ticket online without one. No dice. The key, experts say, is to view credit cards as tools, not temptations to spend. As long as you pay off your balance entirely at the end of each month and don't carry a balance, you won't be charged any interest. With most credit cards, you can set up standing instructions at your bank to pay off your balance in full automatically, a move that gives you financial discipline without any extra effort.
"It's hard to do regular payments without a credit card," Mr Brookes says. "But I would avoid only paying the minimum balance and try to pay off the balance at all times." If you do have a lot of bad debt on your books, Mr Brookes says you should carefully reassess your financial situation before it becomes unsalvageable. "You need to not spend more than you're earning," he says. "If that's not possible, you need to look at your lifestyle, and how you can reduce your outgoings and increase your income.
"Before you get into a situation where there's no way out, you should think about changing." firstname.lastname@example.org