What does leverage mean to you? Some executives think about the amount of debt they are servicing. This would be called financial leverage. In this case, leverage allows for greater potential returns to the investor that otherwise would have been unavailable. The down side is the potential for loss is also greater because if the investment becomes worthless (your business), the loan principal and all accrued interest on the loan still need to be repaid.
Other execs may think of a leveraged buyout. Wikipedia’s definition is as good as any … A leveraged buyoutoccurs when a financial sponsor acquires a controlling interest in a company’s equity and where a significant percentage of the purchase price is financed through leverage (borrowing). The assets of the acquired company are used as collateral for the borrowed capital, sometimes with assets of the acquiring company.
Still other execs will think about David Maister’s definition of leverage from his classic book “Managing the Professional Service Firm.” Maister suggests the only way for service firms to be successful is to leverage their high cost partners with their lower cost associates. This concept is most closely tied to the legal and accounting world, but many management consulting firms and IT services firms use a similar model. A tried and true use of leverage.
So if leverage is good for business, what is the right amount? This is where the science of management and the art of leadership need to cozy up and consider the long term ramifications of their actions. Too much leverage and you may not be able to service your debt. Too much leverage and you may become unbalanced and no longer able to satisfy your customer obligations. Too little leverage and you are missing opportunities. You may be leaving deals on the table by not utilizing all your available business resources.
The trick may be in the wisdom of Aristotle. Although Ben Franklin is known for the quote “Moderation in all things — including moderation”, it was Aristotle that really introduced the modern world to moderation. The phrase, “Moderation in all things,” is a common extrapolation of Aristotle’s Doctrine of the Mean (as presented in his Nicomachean Ethics). Moderation in this context doesn’t suggest a less aggressive approach to business. It’s about finding the mean, or middle ground, between excess and deficiency.
To much leverage … you’re increasing risk.
To little leverage … you’re missing opportunities.
Moderate leverage …. Just right!