In this podcast, Seth discussed the practice of leverage and gearing. In business, we use leverages to acquire an asset of value by putting a small down payment while borrowing the rest. If the asset goes up in value after the acquisition, we can sell the asset, pay off the loan, and pocket the remainder as a nice sum of gain.
Leverages done right can benefit all parties, the seller of the asset, the person who acquires the asset, and the bank who finance the acquisition. Can something go wrong with such leverage? Yes, because leverage can only work if the acquired assets go up in value.
When the value of the asset declines, it may threaten the bank by putting its loan in a risky position. When the bank calls in debt, the borrower might not be able to pay off the loan because the asset no longer has sufficient worth. If there are enough leverage deals that go sour on the bank, the bank might not have adequate reserves to operate correctly.
In business, two things happen as a result of using leverage. Number one is leverage spreads. It spreads because, if we have a competitor who has leveraged, we might feel the need to be leveraged. Sometimes the market demands that we act like a company that is leveraging.
Number two is leverage works in both directions. When it goes the positive route, the gearing works beautifully, and more leverage makes things go up a little bit faster. And when it goes in the other direction, there is a cascade effect where every stakeholder involved in the asset loses, sometimes small and sometimes significant.
What can we do about all of this? The first thing is to develop the knowledge and the ability to see the leverage. The second thing is for us to speak up if things were going to fast and had to slow down. If we can slow down the turn of the gears, especially when they are going in reverse, it may be possible for us to reverse the direction. Get the wind to come back into our sails, so we can make the gears go forward again.
We need to think hard about the fact that it is our choice to do business with someone who is leveraged or not. Depending on our business environment, we may need to leverage it as necessary, but we must always build resilience.
Too often, we embrace a cycle of destruction because that is where the leverage pays off. We turn the gears in one direction and then switch to the next project. But we are not projects. We are people.
Instead of building a bunch of leverages just to enable capitalism, we should leverage capitalism to build the culture that we want to part of. Leverage capitalism not for making profits but for resilience instead.