December 11, 2012, 5:00 am

What You Get From Leverage Part 2

by: The Financial Blogger    Category: Leveraging Strategies
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Yesterday, I started to talk about my experience with leveraging. Today, I have a third story about borrowing and how we deal with leverage in our business right now. If you have any questions, please send them my way!

 

The Third Loan Really Consolidated Our Positions

 

Maybe it was a mistake, maybe it was because we were super optimistic but we didn’t pay back our second loan right away. During that year, we were raking in the cash and using a part of it to fund other projects. At the same time, we were paying our line of credit to give us some room but we didn’t touch the private loan. We decided to pay only the interest. After a while, we wanted to buy a new site. We had some liquidity in our account and the goal was to buy it cash (and then focus on paying off our second loan). But the price went wacky and yet we still decided to buy it. This was before The Google PR Slap. We weren’t affected by the slap directly but the business has changed since then.

 

It’s Always Scary Isn’t?

 

Although the third loan wasn’t different from the others; we were scared to borrow again, especially enough money to buy a nice car! Well… as long as we don’t borrow enough money to buy a house, it shouldn’t hurt, right? Hahaha!

 

But seriously, before ploughing more money into the company, we setup a payment plan. We didn’t want to keep borrowing and bury ourselves with debts.

 

However, buying these two sites was a very, very good idea. It helped us diversify our sources of income and without those two loans; we would have not been able to weather this storm as well as we did. In fact, our business would have dropped under the 6 figure mark for 2012.

 

Paying Back Our Leverage Loans

 

At the beginning of the year, especially due to what happened in the web industry, we decided to pay back our business loans. We implemented an aggressive debt payback policy where we drop our business loans by $3,000 per month. So far, it has been somewhat challenging to reach it but it is quite interesting to see the debt going down so fast. The third loan will be paid in full early in 2013 and in two years, the business will be 100% debt free and we will be able to benefit from our hard work. The goal is to put back the company back on track to give it the flexibility for the future.

 

The Main Problem With Leveraging – When It Doesn’t Go As You Thought It Would

 

I like the basic principle of leveraging: you borrow at X% interest rate when you can make X+Y investment return. As long as your “Y” is positive, then you are making money faster than expected. The problem is when things go the other way around; when “Y” is negative, you are losing on money that is not yours.

 

The moves we made over that past 18 months was done in a known environment. We knew that we could make more money and that our “Y” was going to be positive. It turned out well as our investment projects have always been positive and we are still making a lot of money on all of our sites. However, the “Y” we calculated in the first place didn’t happen this year. We were expecting to continue making money with private advertisers at the same time as growing our other sources of income.

 

When you leverage and revenues are not coming as expected, you automatically lose flexibility. If things turn sours, you can even end up in a dire financial situation very fast. Imagine if one of the sites that we bought would have busted the next week and dropped earnings down to 0. This would have created a situation where you have a debt over your head but no engine to generate cashflow. In such a situation, you better have some money put aside to reinject and keep your project in the black.

 

Leveraging is Not for Everybody and It’s not a Money Matter

 

There is also the psychological aspect of money that you should consider before leveraging. Some people can’t stand debts or can’t stand paying interest. If you borrow $25,000 today to invest in a project, it is very possible that you won’t see the fruit of this for a while. This is why you must be able to live with a debt of $25,000 while you only have an asset on paper that may be worth at least the same amount.

 

But this asset on paper is not cash in your bank account. You need to either make it produce cash flow to pay off the debt or consider selling it. So if the asset is not producing up to your expectation, it’s normal that you feel stressed and disappointed. These feelings are definitely motivation killers and won’t help your situation at all. This is why I would not advise anyone to start with an important leverage loan as you don’t know how you will react with debts.

 

Will I Leverage Again?

 

My partner would probably take a serious look in my direction if we were asked this question at the same time ;-). Honestly, I would not borrow right now to grow my business. The environment has changed a lot and I don’t feel that I have a complete grasp of this “new playground”. I would like to make sure I understand the new parameters and that I master the system completely. After that adaptation period, I’m sure I’ll be up to borrow money again if it means that I could grow my company to another level.

 

The last step of this venture is to produce enough income so we can both retire. So you can guess that our next leveraged project may be worth the price of a house ;-) hahaha!

 

In the meantime, I’ll focus on paying off corporate debts and gain back our flexibility. The fun part with a business is to do whatever you want whenever you want. If it’s not that, it’s simply a job!

 

Have you ever considered borrowing to invest in one of your projects? Do you think it’s reasonable?

 

 

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Comments

Debt gets a bad name, people associate debt as bad because most people don’t understand how to use it in a productive manner.

Selling debt is better than selling equity, when you sell equity you are selling the right to make decisions to the buyer, selling debt doesnâ??t relinquish any control. Problems arise from debt when people take on more than they can afford, so people characterize debt as bad, with a few exceptions (mortgages and education mostly). There are many times when mortgages and education loans are bad debt and when an auto loan can be a good deal, each situation is unique.

Leverage is a tool which can amplify both returns and losses, so like anything make sure you do your due diligence, but donâ??t rule out debt carte blanch.

Well, if you are still able to get your money back within 2 – 3 years with sites, simply by pocketing in the advertising revenues, then leveraging makes sense. The thing that is scary however is if you paid 2 – 3 times earnings for a site, and then earnings drop by 50%.

Then you need 4 – 6 years to pay off the loan, and would probably start losing hair at that point ;-)

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