BOBC Podcast #126 Transcription: Let’s Talk Leverage
INTRODUCTION:
At a certain point, change in circumstance demands change in behavior, and we need to appreciate what leverage means to all of us, especially those who have never been here before.
BODY:
So up until now, I’ve definitely talked all about running your business and being internal to your business and creating structure that is intrinsic to you and, and valuable to you. I appreciate that external circumstance does impact what you do, but have been really been focused on your internal processes and telling your business story and I stand on that.
And so I very much want you to continue that work. And of course it is going to be the mainstay of what we talk about here, but I want to take a quick detour for this podcast, to really talk about what leverage means and how to go through it. And the reason is particularly in the United States that since March of 22 until now, and so a little more than a year, um, not quite a year and a quarter or something like that, um, interest rates have gone with, the federal reserve sets the borrowing rate at, has gone from effectively zero to over 5%. Which doesn’t sound like a lot, but it is a tremendous amount.
And for clarification, the last time that interest rates, and when I’m saying interest rates, that’s the barring rate set by the Fed, was over 5% was in 2007. So literally 15 years ago, and the highest it’s ever been, you know, in that 15 year span is 2. 4%. So Hedy and all the rest of that. But what that means is that for most of you, right, who have been in business for, let’s call it less than 15 years and are in your thirties, in your business career, you’ve never really experienced the cost of leverage. You know, when I was a kid, you know, it was considered to have a cheap mortgage if you pay, you know, 11 or 12% because it was a standard to have that high of interest rates. And we had the effects of what happened in the seventies and eighties and all of those economic, you know, kind of ways of being.
And nobody ever thought that the fed funds rate would ever go down as low as it ever did, but it’s effectively to zero. And there’s a whole lot of reasons for that and no need to be discussing that. But what is really important is to make sure that you are paying attention to what that impact has on your business. Because the way I view leverage is especially if you are carrying materials and or labor and you borrow money, you have lines of credit, right? You’re experiencing possibly for the first time how expensive that is to rent the money that you need to rent. Um, and that’s the way I view. Credit, right? Is you are literally renting money.
And so, yes, you have to pay back the money. But really, it’s the cost of that, the cost of doing those things that are that’s really important. And so when that cost is effectively negligible, right? Then you can really experience the idea that, hey, I can fund my business operations with not really costing a whole lot of money. And you get used to that, not having that expense to basically fund your business, to fund your inventory, to fund, you know, whatever lull you might have. If you run a seasonal business and so many creative businesses do, they run seasonal businesses. So you borrow right. In order to, to carry your way through and then you easily pay it back.
Well, not so easy to pay it back when all of a sudden your interest rates just skyrocketed because they don’t just skyrocket 5% for you. And there’s a reason which we’ll discuss at that happens, right? And it has everything to do with risk, right? Is that now you have to carry much more significant borrowing costs, which raises your costs.
And so what do you do with that? Right? Because you’ve never experienced it is certainly as part of your price and you got really kind of hooked to the drug of the line of credit, which were incredibly available. Because money was very loose, right? That’s what it means when it’s available to you, you can have it.
And your borrowing costs are really low. And now all of a sudden in basically a nanosecond, when you have experience, if, if, if for 15 years, they were never higher than 2. 4%, and then in less than a little more than one year. They went up effectively actually about one year, they went up five points. That’s like literally in a nanosecond for you, right?
So something you’ve never had to deal with in your entire career. Now, all of a sudden you’re confronted with, and it has a massive impact on, of course, your business, because now you have, what to do. How do I make sure that I can either absorb those, borrowing costs, right, or try to pass them on to my clients, which who don’t want to pay for them.
Because wait a second, if you were relying on these borrowing costs and you weren’t aware of that, then why should they have to pay for these additional expenses that have nothing really to do with them? So, which is fundamentally different from inflation. I get very frustrated when people confuse an inflationary environment right to what we’re currently experience.
The fed doing what it’s did has had an effect of slowing down our economy in the United States and has done its work in such that inflation has gone down and many, many metrics of things are getting, not only it’s not about them getting cheaper, it’s about their prices becoming consistent. It’s about making sure, and in a lot of cases cheaper, right?
So we’re not worried about, Hey, your money not being worth as much as it is tomorrow. It is today, right? Because the cost of goods and services are exploding, right? Faster than your, basically your wage increases, right? So now things, because the labor market is still hot in the United States. So inflation itself is less and less and less of an issue. And it’s certainly, you know, maybe not at some point last year, but certainly at all the way through where we are in 2023, inflation is not the issue. It’s the cost of deleveraging for so many businesses that we just don’t know what to do with it.
And while this might seem heady and not, it just means that the cost of doing business has exploded for so many creative businesses who have had no wherewithal to do these things. And that’s why when I was saying that effectively, if you could have borrowed money long term, as crazy as this is during the COVID era, and you did, and you borrowed and effectively your own line of credit because you borrowed money that was maybe more than you needed today, but what you thought you might need when the business came back, which is what those, those loans were for, right? Was to basically fund your ability to come back, right? You would be borrowing at rates far lower than you could borrow today for your line of credit. Because remember, if the fed funds rate goes up 5%, your business becomes riskier, which means your banks need to make more money on that 5% in order to justify lending to you. So it’s not just that ,your line of credit went up 5%. It probably went up 7%, right? So all these things are just so incredibly important to you because they have a dramatic impact, not only on you who may not necessarily be providing those materials of goods and services, but have to explain to clients why that has gone up.
And then the question is, is how do you manage that? How do you go through those kind of things? And what do you do? Well, you know, just as easy to say, Hey, I’m not going to pay for those price increases in cost of leverage, but you’d be hard pressed to find anyone who hasn’t been addicted to the line of credit and those businesses that are seasonal because they didn’t have to, right?
Because for the last 15 years up until March of 22, they didn’t have to deal with it, right? So, yeah, we have to, you know, give everybody a pass, but then the question becomes, what do you do with it now? How do you deal with it now as a creative business and what are you about? Well, circle back to what I put aside for the moment of like, well, if you haven’t become agnostic to price, if you’re the value of your intellectual property, the value of creation, the value of design, the value of what it is you provide is separate and apart from what it costs. . Then you are less susceptible to these fluctuations in the borrowing costs and how that would go along. And you’re more and more able to separate out and say, look, I am not going to, cause the thing is, is like, if somebody has to pass on a price increase for whatever that is, and you make a percentage on that price increase, but you’re basically doing the same work, the only thing you’re going to be confronted with as a pissed off client.
Because you’re doing the same thing with the same product that now costs more and you’re making more, right? But you’re not doing anything more. However, if you are agnostic to price, meaning that you get paid to do what you do no more, no less, then you don’t have to have that conversation. And that is a Very big deal, which then puts you in a much different position because then you’re in the sense of saying, Hey, let’s go find those businesses that are the least leverages and the least able, you know, to really have to suffer the consequence of leverage.
Now there are going to be few and far between, but there are the people that have run their business well. Maybe they borrowed well during COVID. Maybe there have been, maybe they, when they had the heyday of the 2021, you know and 2022 years, right after, after things kind of cooled down and then heated all the way up, they put money aside, they have a working capital.
So they’re able to keep their prices consistent, right? Those are the kinds of businesses that we all should be looking for. And if you can find them fantastic, right? But if you can’t, then the idea is going to go to them and say, Hey, I need you to lock in a price, right? So what it means is like, Hey, those prices might be higher, right? Those prices might be what it is, but they’re locked in, right? So if interest rates continue to go up, hopefully they won’t, but you don’t know. Is that, they’re able to absorb those extra costs and maybe say, here’s the cap, right? Here’s where we are. You’re not able to change, right? So I just want you to be able to be in that position that you understand fundamentally that the world we live in is crazy different that the cost of doing business has truly exploded.
Yes, you might save money. Hey, with whatever here, there and everywhere. But the reality is, is that A lot of people are still addicted to the lines of credit that they have to fund their businesses. And that has become problematic for so many and creative businesses not untouched by this. And so really now the idea is, is like, you have to be able to understand that you can operate in this environment too.
Does it mean that it’s going to stay here forever? No, of course not. Right. And maybe interest rates will go straight back down once things are, and maybe they’ll go back to nothing, but that’s a very bad business strategy to hope and pray , that the world returns to what it once was, maybe it will, but you have no earthly idea of when that might be.
So until then you have to appreciate that the cost of borrowing is now a risk factor that has to be taken into consideration and that has to have a deep impact on how you approach business. And then, Oh, by the way, yeah, you hear it all before is like, if your creative element of your business is not all that compelling, well, now you have the threat of AI.
Now you have the threat of the AI doing what you do as a creative business, basically in its sleep, right? And so, cause it doesn’t get tired and it will keep searching the universe all the way through and it will keep on improving and improving. So now you’re forced to say, Hey, the value of what I do is based on the creativity of what I do and what I need to do what I do is regardless of what it costs, right? And so what it costs is what’s necessary for me to do what I do, no more, no less. And we don’t really pay attention to what those fluctuations, other than to make sure that we’re dealing with people that have absorbed the lessons of leverage, right, and are suffering the pain of deleverage because make no mistake, the pain of deleverage and tightening of money and everything else is meant to do what it’s doing, which is to make things more expensive in the short term and that making those businesses contract and figure out how to do basically, more with less. It is not a pretty story, but it is something that you all have to deal with and appreciating that if you’re in the position of recommending those vendors and you make money on those vendors and you’re not a pure retailer, then you know what? You’re gonna have to deal with that.
And yet it is it pervasive, not just in the United States, but actually pretty globally, that this is a part of doing business. And what we see then is that price rises and prices that are happening. And you are not also allowed to get away with as a creative business saying that it has to do with inflation.
And the very reason is because those people on the other side that you’re talking to, they know it has nothing to do with inflation. That is their world. Your client’s world is in this, this not just necessarily finance, but they appreciate what this is about. So if you say, Oh, it’s about inflation when it’s not, that strikes your credibility, what it’s about is deleveraging and the cost of doing business has in fact gone up, right?
And so how do you manage that with them and not just pass this on to clients who may or may not be having the wherewithal to do that and the way it is, is that you find your way through to say, Hey, the price might be higher, not as high as you want it to be, but this is the price and you have to absorb some pain because the lesson of leverage is a beautiful thing on the way up, but it’s a cruel thing on the way down.
And the ultimate place is to say, you don’t really have to do that. You don’t have to be in that leverage position unless you really, really have to. And that’s a challenge, right? And it’s a challenge that all businesses that run inventory and go through these things have to deal with. But you know what you want to deal with those people that are running a very, very smart and borrowing as little as they possibly can.
And if they are borrowing, they’re borrowing incredibly smart and long term, even if it’s just to fund short term operations. And they had borrowed, meaning that they had done that in the past. And so now they’re renting their money at a far less rate than people are renting their money today. And in that way, you can react and become better in terms of advocacy, in terms of clarity, not transparency, clarity as to this is what we can.
And the idea would then be certainty, certainty and consistency to win the game and focusing on your value as being a creative force, which has nothing to do with what it costs. And so that is just another lesson about how the price fluctuations in the world, external world should definitely be separated.
And those that have been addicted to leverage are probably also those that have been addicted to making money on a percentage of what things cost, right? Because it fuels the idea of, Hey, things cost 10 because leverage doesn’t exist. And therefore me making three on that 10 is exactly right. Well, when the real price is 15, there’s a problem.
And so I hope that if you are in that place, you work diligently to separate yourself out from it and to extract that value of creative, because that’s what’s going to win the day. So I hope this helps until next time. Thank you so very much.
