Is Debt Something to be Afraid Of?
Is debt something to be afraid of, something to be ashamed of, or a tool for faster growth and wealth creation? The answer lies in how you understand it and, and in how you use it.
Our immediate reaction to the word ‘debt’ is typically a negative feeling, like we’re living beyond our means, or like we’re not in control. For most people, the largest purchase we will ever make in our lives (buying a house) is only possible thanks to debt. We rationalize this in our minds because we need somewhere to live, we expect our house will appreciate in value, and because everyone else takes out a mortgage. The same is true of student debt, but that perception is rapidly changing with increasing tuition costs and diminishing return on investment. I’ve been there too.
I was saddled with over 40k of student debt when I first moved back to Winnipeg. I felt hopeless, like I was never going to be able to pay it off or even scratch the surface. I can only imagine now how students feel going into professions that leave them more than 100k in debt. For a lot of very well-educated people with good jobs, it still translates into spending 10-20 years paying off student debts. What? Have we taken a second to think about the return on investment of mortgaging 10-20 years of your life on your education? It’s one of those things that people seem to assume is always a good investment. Maybe this is not the case.
How did I pay my 40k off? I changed my perspective of how I felt about the debt and made it a priority. In the beginning I believed it was a burden, something I would be attached to for my whole life and never rid myself of it. My perspective change happened when I saw the debt in a new light. That debt allowed me to gain education, live my life in a new city with new experiences, and gain more wisdom. I realized that my debt was actually a gift!
Once I switched perspectives and became grateful for my debt, I began being able to make money and receive opportunities to help me pay it off. I stopped pushing and trying to make something go away that I didn’t want, and I began accepting it and integrating it into my life in a positive way.
I have never felt more gratitude than the day I paid it off.
That’s not where the story ends though. When I started Brows by G, I had the same anxiety about debt. I saw it as a cancer, something that would plague my business and weigh it down. Again, this was the wrong way of looking at it. Simply put, if you want to start or grow a business, and don’t have all the money in the world yourself to do it, you really have two choices: raise investment, or take on debt. There are so many articles written on this topic, so I wanted to pass on my specific experience with this. I’ve used debt for my business, and I’ve also been all the way through to the final signing of a venture capital deal to bring new investment money to my business.
The truth is that they are totally different tools. Debt is a tool. Debt is actually an amazing tool. Debt allows a business owner to move much more quickly, and to respond to opportunities in the market instead of simply re-investing profit. By using debt responsibly, you don’t have give up the valuable part of your business: that being ownership, and the upside potential.
The trick is to start evolving your perception with regard to what are smart uses of debt, and what are not. Here are a couple of things I think about and some key take-aways when looking at debt as an option for business (this works for any type of debt):
Am I confident it will help be generate more revenue/build value, get to an opportunity faster, or build a long-lasting competitive advantage? When buying a house, using debt seems like a no-brainer. We expect that the price of property to increase, although that’s not always the case. For business, if I see an opportunity in the market, or a way to improve or expand what I’m currently doing, debt can be a great tool. Should I open a new studio? Should I buy that new piece of equipment that will make my capacity or process time faster? Should I invest in a new service or product line?
Think of the interest paid on debt as the rental cost of money. It’s just like renting any other tool. If I’m confident I can rent $50k and turn it into $100k faster than re-investing operating cash flow, I’m happy to pay the cost. This means that you need to know your business, your industry, and the market opportunity you’re pursuing.
2. What is my margin for error? Bankers and finance people like to use a ratio called debt service coverage ratio (DSCR). This is how much additional free cash flow you have to cover the cost of debt. For example, if you expect to generate free cash flow of $10k per month, and the cost to service your loan is $2k, your DSCR is 5x. Lenders use this ratio to understand how risky a loan is. Say you had a bad month and your profit dropped by 50%. At $5k you still have more than enough to cover your debt service. The higher the ratio the better.
If you’re every applying for a business loan, have a financial model ready that looks at a low, mid, and high scenario and shows a healthy DSCR under each. What you’re saying to a lender is that even if your lowest reasonable scenario happens you can still cover our loan payments.
We all have debt. It’s almost certainly something that is going to be a part of your life at one point or another, regardless of your thoughts on the matter. So, on that note, I challenge you to think of three positive things that debt has brought into your life and what it has allowed you to do. Let me know below if you are comfortable with sharing!
Feel free to contact me if you want to learn more about effectively using debt.
Thanks for reading!