Leveraging is a way to generate capital using borrowed money. Most of the time, it entails using loans or ‘borrowed capital’ to invest in potentially profitable assets with high returns.
There’s definitely risk involved when leveraging, since it’s possible to drown in debt and suffer from losses that are impossible to recover from. However, the potential payoff can make the risk worth it.
Is it a smart idea?
All’s fair in love, war, and finance—since there’s no guarantee regarding any decisions made in these situations. You can make an educated and calculated guess and more often than not, fortune favors the brave.
Using borrowed capital to invest in assets is often done in the hope that over time, the asset will pay itself off. That is to say that the asset will increase in value and generate recurring revenues instead of becoming redundant.
Think of leveraged assets as a one-time or initial investment that’s going to be around for a while.
But how will these assets be of any use if they drive you into debt?
Well, an asset’s value is determined on how its leveraged: the more debt than equity it has, the more leveraged it becomes. Typically, assets purchased using leverage are high-value assets that can help with a business’s operations and profitability. For instance, a company that wants to retain control of its assets and operations can opt for leverage instead of selling shares on the stock market.
This way, you’re paying off people, banks, and firms you’ve borrowed from but not paying long term dividends or facing interference from investors. This can actually increase shareholder value because fewer people will be receiving dividends from the company.
The asset acts as a safety net too; if things don’t turn out as planned, the company or business owner can sell off the asset and recover part of their costs instead of losing out completely.
Want to learn more about leveraging assets and how leveraged finance works? Read our blog!