Cheap Debt!
Philosopher Michael Gerard Tyson famously noted that “Everyone has a plan until they get punched in the mouth.” Debt’s similar: rates seem cheap and covenants manageable – right up until variance, uncertainty, and entropy throw a wrench into things.
I’ve heard from bankers that we at Permanent Equity are leaving growth on the table at our portfolio companies by not borrowing more. Perhaps. But since we can call capital to invest in anything we think makes sense, the way we look at it is: why would we do with debt what we wouldn’t do with equity?
Yes, debt costs less than equity, but crucially only if things go right. If things go wrong, that’s game – and losing is expensive.
So if we’d pass on something at our cost of equity but it “works” at the bank’s rate, we pass. That’s because we try to traffic only in no-brainers – doing things because they make sense, not because a lower cost of capital might enable us to pull them off. (But if we can do something with a lower cost of capital that we would do with equity, then we absolutely will take your money.)
A trade-off of this approach might be slower near-term growth, but since all of the value is in the terminal period anyway, you need to make sure you get there.
– Tim
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