Thursday, May 10, 2012

The Pooling Group: An Unconventional Source Of Capital

We now would like to introduce a very unusual approach often used to raise short-term capital in the Caribbean. This is a method mostly used to save money for special events, such as the purchase of a car. It has become so popular in the US now, that banks use it as an acceptable way to finance the down payment for the purchase of a home. We believe that in certain circumstances, it might be a great capital formation strategy for a small business buyer. The following are the most important characteristics of this technique:

- It is initiated by a Group of five (5) or more people
- Each member of the Group is employed or is a business owner
- The Group is supervised by a manager (usually the organizing member)
- There is a solid commitment by all members to carry out the entire "round" (to be discussed shortly)
- Group members are required to contribute an affordable monthly (or whatever contribution frequency they agree upon) amount, usually 0 or more

To carry out the task of helping its members raise needed capital, a Group can be defined by the following:

- Number of members
- Group head: the person in charge of collecting contributions and disbursements to members. This person is also responsible for keeping track of the logistics of the Group. That is, s/he keeps track of members that have received their round, those that are missing contributions, etc.
- Contribution amount
- Frequency of contribution (usually monthly)

Such a Group is basically a twisted version of an investment club. Members, usually friends and/or family, unless there is an independent Group Manager, agree to pool money by contributing monthly to the fund. Each month, one member gets the entire amount contributed by all members in a round robin fashion. The cycle continues until everyone has received a pay-out, also called a "take" or hand. Note that this is simply a way to get a lump sum at a specific time based on your position in the queue. For a business buyer, the best position in the queue is probably the first one, because the first person in the queue receives the first "take". This would then allow for his/her future contributions to be drawn from the operations of the acquired business.

Please note that this is not a savings account. In the end, contributions and pay-outs cancel each other, such that members do not gain or loose any money at the end of a round. (See table below). In addition, money contributed by the Group's members is never deposited in a bank account, hence earns no interest. To illustrate, let us create a fictitious Group of three members (Member 1, Member 2, and Member 3). Let's assume that each member contributes 0 weekly. There are as many cycles (or rounds) as there are members, in this case three cycles (Week 1, Week 2, Week 3). The total amount of each member's take when his/her turn arrives is 0, which is also equal to the total amount of money contributed.

Week 1

Member/Contribution/Payout
Member 1/0/0
Member 2/0/
Member 3/0/

Week 2

Member/Contribution/Payout
Member 1/0/
Member 2/0/0
Member 3/0/

Week 3

Member/Contribution/Payout
Member 1/0/
Member 2/0/
Member 3/0/0

So, if a buyer can manage to create one of these Pooling Groups around the time that the closing is scheduled to take place, s/he can use this very simple technique to raise the necessary funds to close on an acquisition.

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