OPM – Other People’s Money
Other people’s money (OPM) is one of the most fundamental sources of OP Leverage that can be consistently utilized for massive financial profit. Building wealth is largely about money. The more money you have access to for building wealth, the more leverage you have in building your net worth and purchasing power. I 100% believe in leveraging other people’s money. In fact, I would almost make it a sin to never utilize other people’s money. It is that powerful of a tool at any stage of Wealth Building.
Other people’s money is a financing tool. It can enable you to take on ventures and investments otherwise out of your reach. It can turn an average yielding asset into a homerun. However, at the same time, it can also cause you to lose your shirt and be exposed to substantial legal risk. The second most important thing besides just using OPM is securing favorable terms on this capital. There are two classes of terms for receiving OPM. They are debt and equity. Debt is taking other people’s money as a loan where you agree to pay back the principle and interest in the future. Equity is giving an ownership stake in the asset to the investor in exchange for ownership of the money. There are an infinite number of points that people can demand in the terms on OPM within these two classes. You just want to thoroughly consider all of the costs and benefits of taking someone’s money and make sure that you are putting yourself in a good position.
Let’s look at a couple quick examples when it comes to leveraging OPM for greater results…
1) Buying Investment Real Estate with Debt Leverage
You are looking at buying a $1MM apartment house that yields $130k per year before debt service. You could put down $1MM of your own cash or you could put down just 20% or $200k of your cash and let the bank put down the other 80% or $800k. What would be wiser? Since you are a wise investor and you’ve done your research on the future economics of the property, I’d recommend putting down as little of your own cash as possible and letting someone else finance the rest. Let’s assume that your apartments are going to make the same $130k per year before on paying any property loans. If you put 100% down or $1MM of your own cash, then your annual return would remain at 13%. Nothing to get excited about. However, if you finance 80% of the purchase through a lender, then your annual return on investment shoots way up. Let’s say that the annual cost to finance 80% of the $1MM purchase is $60k. Therefore, the yearly earnings will be $70k instead of $130k. Looks worse, right? Nope, it is better to earn less money here. This is because you are earning more return on each dollar invested. It is all about the ROI (return on investment). Because, now you are able to take the rest of your cash supply and seek out more leveraged investments at awesome percentage yields. So, what is the return you get in this leveraged scenario? Your return here if you only put 20% down becomes 30%. If you took your $1MM and purchased five apartment houses in this leveraged fashion, then your annual earnings would be $300k compared to $130k if you don’t leverage with debt. Well worth the paper work.
2) Taking Startup Funding with Equity Leverage
You’ve got an awesome business that is ready for outside funding so current constraints can be relieved and it can take off and scale up to greater profitability. You currently own 100% of the business and it is making you $150k per year in net earnings of which most goes to feeding your family. However, you know that you could be making multiple millions per if you had more cash to go after new markets. You are willing to give up a chunk of ownership in your business in order to have the chance to achieve this. You agree to take $400k in investment capital from a group of three angel investors in exchange for 40% of your company. You take the capital and hire new staff, upgrade fulfillment infrastructure, and launch strategic marketing campaigns throughout several untapped markets. You are successful and within three years, your annual net earnings are now over $2MM. You are happy since you are now making $1.2MM per year. Your investors are happy since they are earning a significant return on their investment near 1000% in about 5 years time. Additionally, you are both happy because the business is worth significantly more because of appreciation due to infrastructural improvements and increased earnings. You want to make sure that you truly can take your business to the next level and that it is really worth it to do it with the terms you are agreeing to.
You can even combine debt and equity financing into one solution for your assets. However, different agreements with different stake holders can have various effects on each other. Make sure they all support one another and don’t ruin your opportunity to scale.
One of the biggest terms of agreement involved in obtaining OPM financing is the issue of a personal guarantee. I hate the idea of a personal guarantee. In the old days, I was fine with signing a personal guarantee, but since then I’ve learned too many ways to build extreme financial wealth without a personal guarantee to be okay with it anymore. It would take a huge amount of leverage over me to persuade me into signing a personal guarantee on a good-sized deal. It is almost always dumb and unnecessary if you take certain routes of building wealth. I’d hate to walk away from a dying asset but professional investors know that it is an inevitable part of a long career of investing. You win some and lose some, but overall you win. Keeping the liability strictly within the business entity and professional lives of the invested parties is how it should be. Otherwise people’s personal lives are in jeopardy and a lot less opportunities for bringing value to humanity will be pursued.
Many assets can be financed through both methods (debt and equity). So which one should you utilize? You will be limited at times due to supply and demand, however, here is my overall logic that I utilize for myself… Debt capital is usually much cheaper than equity capital if you have a well performing asset. So, I like debt from a sheer profit perspective. However, debt isn’t always going to be the best realistic solution. So, I am open to giving up equity for capital in certain situations. Since I primarily jumped from the entrepreneurship income class into asset acquisitions, I’ve become a lot more receptive of utilizing equity financing. This is because many of my entrepreneurial ventures are going to have a personal significance in my life that help me obtain my dream life. One of the biggest issues here is my personal brand as a public figure. Giving up ownership and control to other people in assets that directly impact these key parts of my life is not something I want to do. Achieving greater odds of making a lot more money is rarely worth jeopardizing these parts of my life by giving control over them to other people. However, in asset acquisitions, I am generally acquiring generic assets such as businesses or real estate that have no direct meaning in my personal life other than the financial resources that they bring to it. So, I am very open to leveraging equity here on a deal level in order to acquire and scale an asset. Overall, I view it as a matter of impact between gauging the hard financial benefits with the personal life perks that an asset of yours provides. Maintaining 100% ownership and control is important to me when the asset is important to supporting my personal dream life. Otherwise, I will look to maximize the assets earnings at almost any cost within the asset itself.
Remember that, fundamentally, there is always cost to taking OPM and that it is virtually always wise to do so if you can consistently outperform those costs. Researching many of the different markets of debt & equity capital, as well as understanding all of the different terms of agreement and how they integrate into the operation & goals of your asset is how you position yourself to continuously succeed by leveraging other people’s money.
Sorry I did not finish…your point on debt being less expensive may be correct if for example you purchase real estate and that real estates’ mortgage is paid for by OPM (i.e., income property: renters of residential property, commercial leases etc…the cost of debt to you or most likely your company is minimal. Equity capital, as you stated, has you give up a percentage or portion of your ownership,(but not neccessarily always the case), Equity can be a placed into a company on the terms of a convertible debenture, (usually private companies offer this), the investor will then receive an annual ROR and without the company having to give up ownership. There has to be a proven GP and the company usually does not have debt. But you might as well go public as well if a company takes on this type of equity.
Thanks Cheri, yes, hybrid deals can be implemented. I touched on this in principle, but didn’t really go into it. However, depending upon the terms, one may still be risking their equity, if it matters to the deal. Good insight here. Thanks again!
wow OPM huh? I think you have changed your views on this matter, No? You need to achieve your own financial success in order to become a philanthropist and levering OPM has it’s price as you stated. First off that is the old way of thinking and as you know now look what happened to the economy because of leveraging OPM. Huge corporations were in so much debt they went bankrupt or asked the government to bail them out!
Hey Cheri, nope, my views are the same as a general concept. Wise leverage helps produce greater results in life, whether with financial capital or all sorts of other things. Mitigating risk is still key though. A few bad apples doesn’t make a tool they used bad. It was a bad user of the tool, in my opinion.