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Let Debt Lead you to Success

For decades, hundreds of thousands of people have been haunted by debt, whether big or small. For business owners, there is an optimal level of debt that if achieved, they can have a flourishing business. This is assuming that business owners use their borrowed money in a productive, efficient manner. Interest rates for loans are at an all time low, and it is becoming easier than ever (almost too easy) to borrow money to buy that fancy gadget for your business that you have had your eye on for a while.

In order to keep up with the ever-changing world, business owners, in particular small and medium sized business owners, must either take risks or leave the field. The real question, however, is how much to borrow. With these low interest rates now available, it is getting easier and easier to overextend your borrowing capacity and instead of moving up in the business world, you fall far behind. This is directly related to game theory as discussed in class. You are a medium-sized business, and all of your competitors around you are borrowing money and moving up in the professional ladder. One business specifically is becoming more powerful because they borrowed a reasonable amount of money at a low interest level, and therefore they are bringing in revenue and are able to expand their businesses at an exponential rate. On the other hand, there is another medium sized business that also took out a low interest loan. This business has borrowed more than they can handle and allocate efficiently. They are at the highest level of risk, and cannot handle the endeavor they have taken on. They are ultimately forced to sell at a huge loss. On the other end of the spectrum, there are businesses that do not take on any loans and therefore do not advance with the changing world. Despite the possibility of over borrowing, it is fact that the competitors who aggressively increase their debt are subsequently becoming more powerful.

Here is your dilemma: do you accept the challenge and join in the arms race or do you risk being left behind but fight with all of your current resources? This is game theory at its heart. If you and three relatively identical companies take out different amounts of money, there should be different outcomes. One company, business A, takes out a very small amount, the next company, business B, takes out twice as much as one, you, company C, take twice as much, and the last company, business D, takes out twice as much as you. Business D is clearly at the most risk, with now being in the most debt. According to Brad Cherniak (from the article), it is in good practice to invest in people, marketing, and technology. It is also good practice to go at least part way or as aggressively as the competition. On the other hand, the most conservative as well as the most aggressive are at the highest risk. Similar to the bidding strategies, it is always important to bid what you can afford/your own value. If you cannot afford to go into as much debt as business D, then it does not even matter how much business D is investing. Similarly, unless businesses A and B plan to invest in between your bid amount and your value, which neither of them do, their amounts are equally as irrelevant as D. By borrowing on the higher end of the spectrum, as your company has, can positively affect your payoff if you choose to sell the company down the road a bit. It maximizes opportunity for making a higher profit off of the sale. What matters here is that you take risks and invest but do not overextend your limit, which can lead to bankruptcy and a failed company. Always bid (invest) your own value, essentially regardless of what others are doing.

Sources:

http://business.financialpost.com/2014/06/02/what-is-your-optimal-position-in-the-borrowing-risk-spectrum/

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