Archimedes

When to Use Leverage

What is leverage…..

First of all, there are different types of leverage that can aid the investor and the entrepreneur alike.  You can leverage your strengths, leverage other people, leverage systems, or leverage debt.  What leverage really means is that you’re pinpointing how to ideally position yourself such that your effort results in the greatest amount of output possible.

“Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.”

-Archimedes

In biology they call it anatomy and physiology.  The way something is designed affects how efficiently or inefficiently it functions for a specific task.  So what about business?

Go big or go home….

The reason small businesses stay small is because the owners tend to be leverage adverse.  They like control so they won’t trust systems or delegate to other people.  They have to do everything themselves, meaning weaknesses can’t be outsourced for an overall stronger, more competitive business.  Small business owners also tend to use more of their own capital.  This means even if they have a winning formula, it won’t be nearly as explosive as it would be if fueled with borrowed capital.

Leveraging your strengths….

Let’s start with leveraging your own personal strengths.  One of the biggest fallacies about business is that anyone can succeed at any business.  The truth is that human beings are wired very uniquely having their own talents, passions, obsessions, and instincts.  You wouldn’t put a husky in a dog race, and you wouldn’t strap a grey hound to a sled.  They’re built different.  Instead, entrepreneurs and investors alike usually succeed by getting extremely clear on where their sweet spot is.

Here’s something I always ask myself when I try and determine whether I should handle a task vs. delegate it out.  Will the task keep me so enthralled and energized that I can literally spend the day on it and feel like only minutes went by?  If you answered yes, you should be doing it because chances are your competition will have a hard time keeping up.

Leveraging human capital…

This brings us to leveraging other people. If you answered no, then you should be steadily looking for people who can complement your weaknesses to start taking over those tasks.

For example, I absolutely love writing.  I can sit down for hours and probably write 5 or 6 posts.  My friends periodically compliment me on my writing and my posts even when I don’t solicit feedback.  I like learning about copy writing and find it far more fascinating than uptight formal writing.

But what I absolutely hate is prospecting.  I’m an attraction marketer more than a networker.  But since I recognize that the ability to solicit relationships is vital, I handle it as adequately as possible until I can find someone who can affordably do it better.  That’s what frees me up to do more of what I’m good at and make a lot more profit.

Leveraging systems….

Systems is the third type of leverage, and has become far more critical in today’s highly competitive digital world of business.  Every year more people gravitate towards researching, and purchasing primarily through the internet.  This is a beautiful thing for somebody who uses systems because it means your market is more used to communicating and doing business through digital media such as email, social media, or web cam.

It used to be that if you wanted a business, you needed a lot more human capital to accomplish necessary business functions.  You would need a person to present your product, a person to close the sale, a person to provide support, a person to manage the transaction information, and so forth.

In today’s world you can create and  run a click ad campaign where social media puts your message in front of a highly targeted audience.  You can have them view a squeeze page that never tires out in exciting each prospect that views your video.  If they opt-in, their information can instantly be forwarded to an auto-responder email service which will timely address your new client’s inquiry.  And they can pay you using an on-line billing system which can keep charging monthly dues automatically, and can do all your bookkeeping for you.

In one business, you needed to pay about 4 or 5 people minimum.  In the other you just need you, and maybe a virtual assistant overseas who can be paid far less than local help.  That’s it.  This is the beauty of living in today’s world, and being able to leverage the miracle of modern technology.

Leveraging debt….

And of course, the last type of leverage is debt leverage.  Being able to borrow and invest other people’s money to increase your overall returns.  This type of leverage carries the most risk.  People use leverage all the time to buy unnecessary luxuries with money they haven’t yet earned.  And we’ve seen how destructive this undisciplined spending can be.

Even if you borrow to fund your business or investment, you have to be right.  Otherwise you magnify your loss just as easily as you do your gains.  Here’s our take on leverage.

First, it’s best used when you have strong consistent metrics or track record to back up your strategy.  Consistency is far more important than growth once leverage comes into play.  Let’s say that you’re in Real Estate, and you borrow money for the costs of buying a property, rehabbing it, and selling it.  And let’s say that the property can sell at a 20% profit margin over cost.  You could use your own money to make 20% ROI.  If you borrow half, your ROI goes to 40%.  If you borrow three quarters, your ROI goes to 60%.  If you borrow 100%, your ROI becomes infinite because it cost you nothing to make a profit.

But let’s say you’re wrong.  You wind up selling the property for $180,000.00.  If you lost your own money, that’s bad enough.  But let’s say you borrowed because you didn’t have any.  You now owe your investor $20,000.00, and you don’t have it.  Not good.

This brings me to my second point about debt leverage.  Not only should you have a very consistent track record.  You should arrange your leverage such that your down side is limited.  One way is to have the proper entity structure.  Having a corporate shield, which protects your personal assets from business matters, and business assets from your personal matters, is vital.  Investors and lenders understand the risk involved with lending to businesses.  But if you give them the opportunity, they will try to recoup their losses from your personal holdings whenever possible.  Strong contracts and appropriate insurance coverage are also important.

One of the reasons we love our more advanced options strategies is because that’s one market where it’s incredibly easy to define your risk and limit your down side.  We find partners in the options market that will cover the majority of our costs to enter a position, but allow us to make a proportionately higher percentage of the profit.  We risk less to make more.

The bottom line is that you don’t have to be a savvy mogul to start applying the concept of leverage.  It can start simply by learning more about who you are, and what you’re built for.  Everything else can grow out of knowing where your sweet spot truly is.

Still not sure how to get started?  Check out our free investment strategies here.

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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