What is Financial Leverage and how does it help to Fix Inequality
When you’re first beginning a new business or business venture, it might be easy to grow from your own garage or home office. Plenty of businesses have started this way. How were the most successful companies able to grow to amazing heights? The key: financial leverage.
Financial leverage, simply put, is using debt to grow your company. A company that takes on financial leverage accrues debt, either in the form of loans or from bond funding. Investors or banks will take on the risk associated with a new venture if they can tolerate it, and reap the rewards on the loans or bonds that they take on.
Financial leverage. Can you imagine a world without Amazon, Facebook, Google and Apple?
Financial leverage is what makes small companies with good ideas into giant, world-changing organizations. Without financial leverage, a company would be left to develop on its profit, or on the investment of its owners and founders. Let’s talk about some famous companies and how they had some early financial leverage in order to grow their business.
Apple computer had been building Apple 1 circuit boards in the 1970s with great success. Steve Jobs was looking to expand his business but banks were reluctant to lend him money. Through a series of meetings with investor capitalists through his old boss at Atari, Nolan Bushnell, Jobs met Mike Markkula. Markkula was an angel investor and formerly worked at Fairchild Semiconductor. He invested $92,000 of his own money and secured a $250,000 line of credit (worth over $1,120,000 in 2019 dollars) to take the company to the next level. He received a one-third stake in Apple computer, in the newly incorporated Apple Computer, Inc. which bought out and succeeded in the partnership of Steve Wozniak and Steve Jobs.
Four months after the new corporation was formed, the Apple 11 computer went on sale with a price of $1,298, and the rest is history.
Amazon.com was started by Jeff Bezos, in his garage in Bellvue Washington, USA in 1994. Bezos had quit his job as a Vice President of a Wall Street firm in order to start an online business. He relocated to Seattle, Washington, because of the technical talent there, which is also where the corporate headquarters of Microsoft is located. He decided to sell books online after reading a report about the projected growth of the internet. What didn’t he have? Financial leverage to develop his site and buy the inventory he needed to start his company. Bezos’s parents invested $250,000 in his business to get it off the ground.
By July 1995, Amazon was operating as an online bookstore, and by the end of the summer, it was selling over $20,000 in books every week. By 1998, the company had it’s IPO, and in 1999, Bezos was Time magazine’s Person of the Year, all because of that initial financial leverage from Bezos’s parents of $250,000.
Google began as a dissertation subject at Stanford University in 1996 when Larry Page began to think about how to chart web relationships using mathematics. After putting their new search engine on the Stanford website and using up most of the university’s bandwidth, Page and Sergey Brin began looking for investors to provide them with financial leverage in 1998.
In September 1998, Andy Bechtolsheim, the founder of Sun Microsystems, and David Cheriton, a Standford investor and partner in Granite Systems with Bechtolsheim, provided $100,000 each to Page and Brin to begin Google, which wasn’t even incorporated yet. Bechtolsheim encouraged them to both incorporate and use the name Google, which they were already using, as the basis for their company.
Facebook was created by Mark Zuckerberg as FaceMash in 2003. His second venture, thefacebook.com, was a social network for Harvard students, where Zuckerberg was a student. Zuckerberg and Eduardo Saverin were funding operations out of their own pocket at that point. At first, only Harvard students were allowed to participate, but it expanded quickly to Stanford, Columbia, and Yale. By 2004, the rapidly expanding company needed financial leverage to continue its growth.
Its first round of angel investment came in 2005 and saw angel investors like Peter Theil, Reid Hoffman, and Mark Pincus invest. Thiel invested $500,000, and the financial leverage of the first round was converted to equity from a loan after Facebook nearly reached 1.5m users by the end of 2004, after starting only in February.
Financial leverage formula
Let’s talk about some financial leverage best practices. Leverage ratios are used to measure how much capital comes in the form of debt for a company. It’s used to assess whether a company can meet its debt obligations.
Some common ratios are the simple debt to equity ratio, the equity multiplier, consumer leverage ratio, and the degree of financial leverage formula. Financial leverage formulas tell you when a company has taken on too much debt, and whether or not it’s a safe investment. Financial leverage ratios also allow you to see whether or not a company’s growth is debt-fueled, or are they seeing a real profit from their operations.
Financial leverage and cryptocurrency
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