I’ve been offered debt secured against my shares. I can use the debt to buy a house or buy more shares in my company. I really believe in my company, it’s growing fast. What should I do? — Bob
There’s no such thing as free debt. It always has a catch. In this case, the catch is that if you don’t pay back the debt, then you lose all the shares in your company that you’ve worked so hard to build.
In other words, if your share value doesn’t go up, then you will lose the shares you have.
Maybe you don’t think that’s possible, and maybe you’re right. But you never know what black swan is swanning your way. The president could be assassinated. Russia could declare war on America. North Korea could send a nuclear missile to Japan. There could be another credit crisis.
All of these things would have massively negative impacts on the economy and sentiment.
The economy affects your profits (sales drop). Sentiment affects your ability to sell your shares (no confidence = no buyers).
Suddenly you find yourself staring down the barrel of a debt repayment deadline, and BOOM! You’ve lost your company and your wealth.
That’s not to say you should never take risks. When you’re young you have to gamble a bit. Roll the dice. Just beware of debt. Debt kills.
The only legitimate reason for taking debt to buy shares is if your partner wants to exit the business. Maybe she’s met the love of her life and wants to move to Tahiti, and if you don’t buy her shares then someone else will and you’ll find yourself in bed with a stranger.
If you don’t have the cash then you need debt. Fair enough. But be very careful. Debt kills. I can’t emphasise this enough.
It’s best to live life imagining the shares in your company are worth nothing. That way you won’t live beyond your cashflow. And you won’t take debt against your shares.
If you’re still tempted to get debt, ask yourself, “Do I love what I do?” If the answer is “No,” then definitely do not take any debt. Debt will simply yoke you to something you don’t love. Debt will make you a slave.
Generally speaking, debt is driven by greed. Greed, greed, greed.
And greed always ends in tears.
I want to build a property empire, but every time I buy a new property I’m forced to sell my existing property because the bank refuses to give me two bonds. At the moment I’m struggling to cover my bond repayments with rental income. Advice? — Phumlani
First thing first, read Rich Dad Poor Dad by Robert Kiyosaki. This book will tell you everything you need to know.
In summary, it’s about using the bank’s money to make you rich. Borrow money, buy property, use rental income to pay off mortgage, you’re left with asset and income stream. Boom! What could possibly go wrong?
Here are some rules of thumb:
- Buy commercial property. A tenant that relies on his premises to generate income will look after those premises more than a simple residential tenant. In other words, you’ll spend more money maintaining your residential property.
- Location, location, location. Pick an area with low risk of property prices failing. It might be more expensive but your first priority is always “Don’t lose money.”
- Yield is everything. Divide the annual rental income by the property value. If more than 7%, go for it. If less, don’t. You want the yield to be close to prime rate.
- Don’t take more than 50% debt. You never know what will happen. If the tenant misses her rent for a few months you want to have a safety cushion so you don’t get caught short of cash when your monthly mortgage repayments are due.
- Never sell. The transaction costs for buying and selling properties will eat away your profits. Buy to hold. Never sell.
Remember, there’s nothing wrong with growing without debt. Many property moguls never ever used debt to grow their empire. It’s slower, but safer.
Debt is a shortcut. Sometimes it works, but most times it ends in tears.
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It’s easy to be an entrepreneur. It’s also easy to fail. What’s hard is being a successful entrepreneur.
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