02 Aug The Concept of Leverage in Business (And How to Use It While Keeping Your Risk to a Minimum)
Are you a business owner who wants to use leverage to grow your business? Make sure you read this advice before taking one step further.
Every business owner wants to scale for growth.
To do that, they need to know how to leverage their business to attract the right investors.
I’m going to get to that in a moment. First, let me share a story with you about a company that I’ve learned about and the investors that they attracted.
Protecting Yourself in Business
This company seemed to have a bright future ahead of them.
In fact, they were preparing to scale up their growth strategy and had started to attract investors.
They wanted to offer equity in return for funds.
This company used a stellar growth story and lots of blue sky opportunity to pull investors towards them.
And it worked as they attracted two major investors.
They convinced one set of investors to invest $2 million of equity into the company.
But the other investor put their money into the company using a convertible note. They also took a mortgage over a piece of the company’s real estate as a security over the note.
A couple of years later, the company hadn’t achieved the growth that it had aimed for. Due to bad strategy and a lack of control, the company was on the ropes.
Eventually, it failed and ended up in bankruptcy.
That caused problems for the first set of investors. They lost all of their money when the company failed.
The second investor shows us how to invest properly.
They’d secured an asset as part of their investment, which they took control of when the company failed. That asset ensured that this investor got their money back when things went badly.
The company lost the asset, which the bankruptcy trustee would have sold off to pay other creditors if it weren’t promised to the second investor.
So, what does this story teach us?
It shows us that simply knowing which leverage tools you have at your disposal isn’t enough.
You have to know how to use them properly if you’re to grow your business. Moreover, you need to have the right strategy in place to account for potential issues.
This company didn’t do that and they paid the price.
They gave up too much of their business in leverage. In doing so, they lost control and their strategy wasn’t strong enough to protect them.
The business failed because the company didn’t know how to use leverage.
What is Leverage?
The above story highlights two things:
- How a business failed due to not using its leverage tools properly.
- How you could end up losing control of your business because of how you use leverage.
Now, let’s answer the question of “what is leverage”?
Leverage is a set of tools that your business can use to help with growth. It involves giving up something as leverage for things that can help your company grow. For example, a company can leverage its limited resources to gain access to funds or assets that it uses for growth.
Many business owners see that and just jump right in. But if you don’t use leverage intelligently, you’ll end up like the client in my story.
For growth, you’ll usually use three leverage tools:
Let’s tackle investment first. In my example, the company allowed an investor to come in with a convertible note. Immediately, they had to meet certain conditions and KPIs to keep that investor happy. Plus, they sacrificed an important asset as security. In the end, they couldn’t meet those conditions and the business failed.
So, if you’re going to use investment as a leverage tool, you have to do it the right way. You need a structure in place and you need to attract the right type of investor. Otherwise, you dilute your control over your own company.
Then there’s debt.
By offering equity you’re putting your business into a debt position. That’s not always a bad thing. If you have a clear growth strategy in place, you can use this debt to help the business to grow.
But if the strategy isn’t in place, this leverage tool becomes a noose. Debt spirals out of control and takes with it your hold over your own business.
The final leveraging tool is the people that you bring in.
As part of your growth strategy, you may bring in new people and create a new leadership team.
This means you need to create solid hiring and human resources strategies.
If you don’t, you bring the wrong people on board. You’re not getting the outcomes you hoped for, which means you’re not satisfying your investors. Then you have to replace those people which costs even more money.
All of this eats into your growth strategy.
What You Need to Do
If used well, all of these techniques allow you to use your leverage to grow your business.
But if you get it wrong, you end up like the company in my story.
I’m going to offer two tips that every business owner should keep in mind when they’re looking to use leverage.
Tip #1 – Find the Right Mentor
You can seek advice to help with your growth strategy. But you have to know what you’re looking for before you start working under a mentor.
Credibility is the key thing. You’re looking for as much proof as possible that this is a person who offers sound advice. Check external testimonials and research their track records.
Have they achieved success elsewhere? Do they have a network that you can take advantage of? Does it feel right in your gut?
These are all questions that you need to answer. And that means taking your time and doing the research.
Tip #2 – Beware of Diluting Your Holdings
In your rush towards growth, you may forget about your own position in your business.
And that’s a dangerous thing. Forgetting about the importance of your own holdings leads to you taking on investors that could damage your business. Control slips away and you could even end up losing control of your own company.
Always make decisions with your own position in mind. If a leverage tool will damage your position, avoid using it and build a stronger strategy.
The Final Word
Using leverage correctly can be the key to growing your business. But so many business owners make key mistakes. They don’t put the right strategies in place. Instead, they just chase the money without thinking about the future.
They use leverage poorly and the business fails.
I can help you to avoid this situation. And it all starts with a business review.
During the 2-Hour Business Review Session, my aim will be to help you see hidden opportunities in your business. During the session we can discuss any aspect of your business in which you would like support, such as:
- Growth Strategies
- Sales and Distribution
- Pricing and Packaging
- Merger/Sale, Capital Raising, IPO
After 35+ years working with small and large businesses, buying, selling and growing them across a range of sectors, I can work with you on any level or area.
And it all starts with a no-obligation 2-Hour Business Review Session.