I frequently come across the issue of borrowing in discussions, talks, and seminars and the sense I get is that people are afraid of debt. It seems to be a case of once bitten, twice shy. It is a feeling I totally identify with. I come across many uncompleted blocks of flats that need a couple of millions of naira to finish and bring in tenants but are left to lie fallow for years on end while the owner looks for saves up to finish it to his taste.
There is a couple of almost completed buildings close to where I live that have been virtually abandoned for more than 8 years. This is tens of millions of naira left in the idle mode because the owner is allergic to debts. Invested in treasury bills etc, that money would have more than doubled by now. I have met some businessmen running profitable businesses unable to cope with demand, but have vowed not to touch debt with a ten-foot pole. Rather than borrow, many are willing to wipe out their savings and investment which still comes up short. To them, bankers do not mean well – they give loans to folks that don’t need them and deny those that do, and the few they give, the suck life out of you. This mentality makes many rule out going to banks no matter how desperate the need. They rather pester friends and family.
Good debts and bad debts
The mistake we often make is that we stereotype debts the way we do people from other tribes. However, not all debts are the same. Like cholesterol, they are broadly two types of debts – good debts and bad debts. Good debt is good for you while bad debt is bad for you. Good debts make you rich while bad debts make you poor. What determines whether the debt is good or bad is actual cash flow, not your original intention. You can borrow to buy something you thought will make you more money but it does not work out that way. An intended good debt can end up being bad debt due to poor management/implementation.
Good debts are debts you incur to acquire assets while bad debts are debts you incur to acquire liabilities. I am referring to assets and liabilities from the context of cash flow. If an item you own puts money in your pocket, it is an asset. If an item you own takes money away from your pocket, you have a liability. The key issue is the direction the cash is flowing.
Good debts are debts you incur for things that pay for themselves, often with a profit. That means you borrow the money and someone else pays for it. One example is borrowing to buy a car for car hire. If the monthly returns are such that it repays the loan and puts extra money in your pocket during the tenor of the loan, that is good debt. This is not the type of debt you run away from. It is the type of debt you acquire more because the more you have, the more money in your pocket.
In this illustration, the car is the asset IF it is run profitably. If it is not run profitably, it becomes a liability. So actually the skill to run it profitably is the real asset, not the car itself. Years ago I bought a second-hand car for a friend who had no job running a car hire business. I thought it was a win-win. My friend gets a job while I get daily returns. It was a pipe dream. I did not see one kobo. Each day, I got a brand new excuse – car trouble, unions, police, council, you name it. When I got fed up with the daily dose of excuses, I retrieved the car and sold it at a loss. The car became a liability (actually my poor management skills recruiting based on sentiment plus dabbling into what I knew nothing about). So it is not the item that determines if it is an asset or liability, but the cash flow around it.
We are used to bad debts – debts you incur and/+ pay for them by yourself. The money comes from your pocket. When the load becomes too much, you start to default and creditors come after you. After a while, if your phone rings and you don’t recognize the number, you almost have a heart attack. When you run into your creditors, you start giving excuses when none is demanded. It is not a good place to be. This is the only type of debt most people know.
Using other people’s money (OPM) is a useful skill.
There is nothing wrong with growing your business using your money. It is a slow and steady process and is doable. Using other people’s money gives you leverage. If you run a profitable business, it allows you to scale up fast. If you don’t know what you are doing, it also sinks you fast.
Borrowing is very risky when you don’t know what you are doing. Imagine I borrowed to buy the car in the example above. My loss would have been magnified as interest charges pile up. Many businessmen buy more equipment because they want to grow their businesses. They don’t buy new equipment because their business is growing and the existing equipment cannot cope with demand. In the first instance, hope is the strategy – if I produce more, I will sell more. In the second instance, the demand is already knocking on the door – orders are in, and more equipment is required to meet existing demand. If you are a bank, which one will you give a loan to?
Many people avoid going to banks to borrow because they know they will not qualify or are afraid to try due to the experience of others. Their business strategy is hope – if you build it, they will come. Since banks don’t buy that story, they go to whoever will – friends, family, and fools (FFF).
If you avoid debt in all forms, there is a limit to how much funds you can raise to grow your profitable business. If you are into real estate, how long will it take you to save up N500Million to buy a property in Ikoyi for example? By the time you finish saving, you are using a walking stick, and the property, now worth N15Billion is off the market.
Why would a billionaire borrow money from a bank to build a new factory rather than use his funds? He does not want to deplete his reserves. He understands the principle of asset allocation and knows that it is unwise to ask your goalkeeper and defenders to join attackers simply because you want to score a goal. While attacking, you leave your defenses intact, ready to handle a possible counterattack. You don’t go to war and leave your base unprotected.
If you don’t know what you are doing, you are better off not borrowing at all. You are in a much stronger position financially than the person who borrows to buy jewelry, clothes, shoes, phones, change cars, throw a party, go on vacation, etc.
