By Maurie Cashman
Debt Free! It is the mantra of Dave Ramsey, and one that I happen to believe in absolutely for most individuals. It is a goal that most people should be able to attain and is a worthy and ethical way to manage the financial part of your life. If you havenâ€™t listened to his show or read his book, I highly recommend both. However, as we discussed last week, there is a difference between prudent investment of your resources and wasteful spending. I see many business owners to whom I believe debt aversion is a curse.
â€œThink like a man of action, and act like a man of thought.” –Henri Bergson, French philosopher
How Can Being Debt-Free Be a Curse?
I realize that paying off debt is the goal of many if not most entrepreneurs and business owners. To their credit, many express great pride in achieving this goal. I tend to be very conservative and debt averse myself. However, I believe that there are times when the failure to strategically leverage your assets can curse the business to missed opportunity and low growth. Let me be very clear on my views of debt.
Strategic Deployment of Debt
First, debt should be deployed strategically and only when it can drive growth far in excess of the cost of capital to the company. Debt deployed simply to have the nicest house or business building on the block may not be the best strategic decision you can make. But with interest rates at historically low levels, it may be wise to lock down some debt to provide you with the liquidity needed to grow your business at high levels of return, so long as you can do so and be confident in your ability to pay off the debt if the economy turns against you.
One of the best examples I can point to is Ford Motor Company. Prior to the financial meltdown Ford took out a line of credit in the amount of $30 billion dollars. That is $30 billion with a B! Their investor base went ballistic. However, when the economy crashed, Ford was the only US auto company who did not request bailout funds from the taxpayers. Why? Because they had locked down a source of funds they could tap at a very low interest rate. All of the other car companies were cursed with the inability to borrow and forced into bankruptcy.
Second, I often see a phenomena with business owners who are debt free in which they refuse to take on new debt even though the payoff may be large and obvious. This is understandable and should be apparent to anyone who has bootstrapped a business startup and succeeded â€“ it is a select group and they didnâ€™t make it by luck.
They are often cursed by an inability to see themselves take on new debt to feed and nourish the growth of the business. Remember, what got you here wonâ€™t keep you here. Strategic investments are being made by competitors who are trying to knock you off of your perch. They are either trying to protect their market share or take yours. It is important to recognize this and to have a business plan to identify your market, the resources it will require to take and/or hold it and a plan for growing into adjacent or complementary spaces.
Taking Your Eye Off the Ball
Finally, one of the most obvious things I encounter with debt-free businesses is that there is a tendency to relax and not pay as close attention to detail in the business as you did when you were fighting to survive. The road is littered with businesses that were once strong and growing and woke up one morning to find that they were losing control. Three things tend to happen:
- Losing focus on costs. When you no longer have to service debt it is easy to get looser with cost controls. Employee counts often balloon as productivity drops. Benefits costs rise as the need to make debt payments drop off. Once these are in place they are very difficult to walk back.
- Building Monuments. It becomes very attractive to build or buy facilities. These are called either monuments or gravestones â€“ take your pick. This is often a favored strategy among CPAâ€™s who may advise their clients to buy real estate and pay for it out of cash-flow to gain a tax advantage. Vehicles fall under the same category. It is important to understand fixed assets as an investment â€“ one that does carry some tax advantages â€“ but one that only truly pays off if the investment increases in value with time.
- Cash Cow. Many owners will begin to see the business as a vehicle to fund a lifestyle by draining the business of cash-flow. This may be the right strategy if there are better investments available to the owner. However, often-times the highest and best return to the owner would be to re-invest in what she already knows â€“ the business! By taking the long-term approach of investing in the best in a strategic and responsible manner the owner can increase the value of the business exponentially and generate a huge return on borrowed capital. This is the premise that underlies all Private Equity Firms.
Just as the idea is to buy low and sell high in the stock market, the same should hold true in the debt markets. Right now you have the opportunity to buy debt at a very low rate. If that debt can be deployed strategically you may get the chance to â€œsellâ€ It at a very high rate of return.