Use of Debt and Leverage for Entrepreneurs

Alex Tabatabai is Co-founder of Fernbank Partners (alex@fernbankpartners.com). Here he discusses the use of debt and leverage for entrepreneurs. These tips will help small business owners when thinking about borrowing money for their business.

  1. Debt & leverage: money borrowed to use in your business
  2. Conservatively evaluate quality of the debt
  3. Borrow cheaply & for the long term
  4. Time borrowing with market cycles

Transcription

Debt and leverage are very important topics for business owners. It is one of the reoccurring pitfalls and common fatal flaws we see in businesses.

Debt and leverage are the same thing. It’s money you borrow to use in your business. I would say from a default stand point be conservative and very skeptical when it comes to the use of debt in your business. Now there is good debt and there is bad debt. It's important to realize the difference and that comes down to analyzing your opportunity cost and the terms of borrowing money.

As a general rule, you want to borrow cheaply and for the long term. For example if somebody offers you a loan for 50 years 1% interest, you probably want to take that loan 'cause you can probably beat 1% and you have 50 years to pay back. If somebody offers you a loan for 6 months at 15% you generally want to be wary of that because 6 months is a short period of time and interest payments are steep.

When you're looking to use debt in your business, you also want to be very cognizant of timing credit, markets have cycles. Sometimes credit is easy. Sometimes it's cheap and sometimes credit dries up. So, you want to try to take advantage of the credit markets when they're being very generous and when credit dries up if you're the person holding cash you can put that money to work intelligently and acquire things that distress prices.

The use of debt leverage in a business is a common pit fall. It leads to business failure quite frequently and it's because business owners aren't disciplined about when they borrow money. You need to analyze the cost of borrowing money. Think about how you're going to use the borrowed money and just be very careful and be very disciplined and even if everyone else is borrowing money and over leveraging their company, have the discipline to not do that.