Why is DEBT commonly known as LEVERAGE?

We all know what debt is. We also know what a lever is. But how in the world are these two linked?

Many of us were taught that debt is something you incur when things are not going that well. Sometimes, access to money becomes tight precisely when we are operating on a shoestring budget. Other times, we just need that little extra to keep on supporting our lifestyle. In any case, debt usually is deemed a resource of last resort, or at least a somewhat undesirable one.

Debt is also usually associated with being the cause of all evils. For instance, it is painful when your neighbor’s home is repossessed by the bank for lack of payment on the mortgage, or when your friend’s business closes down and is torn to pieces due to insurmountable debt. In macro terms, it is painful to people when governments are forced to reduce pensions or unemployment benefits to service their debt obligations.

So…is this the only side to debt? Have we been taught incorrectly?

Well, the truth is, ugly or not, this IS debt, at least the dark side of it, but with an enormous caveat we all should start embracing: it only hurts when mismanaged. Like everything else that needs careful consideration and proper tending, debt is not child’s play (though we would like it to be some day :)). Your neighbor should not ask for a mortgage to live in Buckingham Palace; neither should your friend ask for debt without a properly structured business plan; nor should the government raise debt beyond the tax capabilities to ensure debt payments.

That’s enough negativity! Let’s talk about the bright side of debt, shall we?

Could your neighbor have bought the house in the first place without debt? Could your friend start a great business with just her money? Should she helplessly empty her pockets and assume all risks? What if the government didn’t build that vital infrastructure network just to avoid debt? The answers seem to point that debt should also be seen as a bridge towards opportunity and fulfillment.

And this is where the leverage part comes in: debt acts as a lever to push yourself further from your actual state. One should be able to use or advance future growth in order to improve present and future well-being, and this is exactly what debt helps accomplish. Debt is not a tool for yolo’ing irresponsibly, but a pathway for realistic growth and opportunity.

So, how do we operate within the realm of “realistic” without falling into mismanagement and irresponsibility?

After identifying the problem through effective communication and collaborating between teams on a solution plan, discipline is required to execute it with excellence. At this stage, coordination across teams is critical to prioritize important tasks. In our experience, (close to) flawless execution comes when critical tasks are planned ahead. In our FX Hedge project, we prepared a schedule to test, correct bugs, and present demos to our closest partners. The effort was put on contemplating mitigating actions for extreme scenarios rather than a milimetric Gantt diagram. When it was time for the rollout, everything went smoothly, and we delivered the expected functionality to our most important clients without affecting our previous services.

As Jeff Bezos famously said, “Be stubborn on the vision but flexible on the details.” While we often highlight the first part of this quote, the ability to be flexible on the details is equally important. At Vaas, we rely on the pillars of Communication, Collaboration, and Coordination to become more flexible in the details every day.

Well, don’t get more than you can possibly expect to repay along each step of the way. Procuring debt capital today should improve your ability to repay debt in the future. Consider the potential income stream and returns from debt-financed investments. Compare those returns with the cost of debt. Do you have a project that returns 10% while debt costs 7%? Use debt power. In a different example, even if you have enough money to afford a home, the obvious choice isn’t necessarily to use only your money: if the mortgage costs 4%, and you have investment alternatives that return more, then go ahead and lever yourself up. Be smart about it, be conscious. Advancing future growth has costs and repercussions, and you have to weigh them all in. This is how you get into debt responsibly, in order to raise your potential. This is how debt becomes responsible leverage.

Now that we have stated that responsible debt is the pathway to opportunity, let’s have a sneak peak into the other half of the coin: the lenders providing capital resources.

Lending is a risky business. And nobody would take on any risk, if not for an adequate reward. Some lenders even avoid certain risks despite the rewards. Others specialize to play in niche spots that the others avoid, and design specific and thorough mechanisms through which debt is provided, recycled, and carefully monitored. In any case, risk considerations and the relative abundance and type of lenders help determine the suitable debt structure, how much it costs, and the complexity associated with managing it.

On the one hand, debt management should not astray people from their core business. When complex debt facilities deviate resources towards its management, it becomes harder to lever up and to keep up with managing various debt obligations. On the other hand, tailored debt solutions should also become increasingly available, and complexity should not be an obstacle to scale them.

A world without responsible debt means a world with unfulfilled dreams and potential. It means a world where the few Goliaths always win. We need to let more Davids into the game, and equip them well. We need to level out the playing field. Let’s keep on easing and opening the debt markets together!

By: Martin Strauss

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Martin Strauss

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