Many business owners and individuals use the term “OPM” (Other People’s Money) but don’t really understand the full concept or beauty of putting this statement to practice fully. This article is designed to shed some light on why “OPM” can be one of the best concepts one can employ, especially in the business realm when considering future investments.
To begin, what does it mean when we say “OPM”? What we are saying is that we will use someone else’s capital, be it the bank, private lender, friends and family etc… For a defined period of time, toward an investment we have identified that will create a return above what the capital cost us. Let’s look at an example:
- A new truck will cost $50,000.00 but by buying this new truck you project that you will be able to generate $100,000.00 per annum residually. You may wish to borrow the capital from someone else to buy this truck. You borrow the capital for 1 year to purchase the truck and in return, you promise the entity you borrowed the capital from a 10% rate of return, or $10,000.00. So, at the end of the year, you will have to return a sum total of $60,000.00 to the entity you borrowed the money from. Because, you hit your revenue target of $100,000.00, your net profit is: $40,000.00 for the year. In this instance, you increased the revenue coming into your business in year 1 by $40,000 and for every proceeding year, you will have a $100,000.00 increase in revenue for as long as the purchased truck is operational.
This is a good example of the power of “OPM”, but there is more. “OPM” allows you to hedge your downside risk, in that, if the investment you make doesn’t pan out the way you anticipated that it would, your capital is not at risk, someone else’s is and while that someone will not be happy about the loss, at minimum, you lose the access to their capital, but you still maintain your own capital position, which at the end of the day is what is most important. Additionally, when investments are made, it takes time for them to bare fruit. Thus, by tying up your own capital into an investment you lose the value of time. Because, until that investment bares fruit, the capital used to make the investment is non-performing, meaning it isn’t growing and therefore you are losing valuable rate of return that could be garnered by having the capital placed somewhere else. Let’s look at an example:
- You use your own capital to purchase the truck (in the example above), in this instance, your money is tied up in a investment that may or may not yield the desired fruit you anticipate, moreover, the desired yield is 12 months off. You initially had this capital invested in an Index fund that was generating you a 10-12% rate or return per annum in a highly liquid vehicle that could be accessed in a very short period of time if needed to make other equally liquid, but potentially more profitable, investments.
In this instance, you have downside exposure because. If your capital is generating a 12% rate of return per annum in a highly liquid investment, such as an index fund, that means it makes 1% per month for you in a passive capacity (meaning you don’t have to manage it for it to do that). Once you move the money to another investment i.e. the truck investment, every month that the money does not perform you lose the value of the previous investment (1% per month), thus if it takes 12 months to see a return on your investment, you have lost 12% and (given that in the U.S. economy we see a 3% growth in inflation per annum) your true loss is 15%, therefore, you must now subtract the 15% loss from time value and inflation from your investment return and than you see the true value of your investment. So, essentially, if your investment does not pan out properly (even if it seems as though it made money), when you weigh the factors of time value and inflation, you could end up with a net loss overall.
When looked at it this way, one can see why using “OPM” rather it is in a well structured equity position or debt position with a favorable interest rate, could be an excellent way to hedge downside risk and drive revenue for the company. We at Veritas Loans are experts at looking at all of the factors involved in your financing and growth needs and will work with you to create a long term, sustainable plan that allows you to hedge your downside risk and create, consistent, sustainable, long term growth within your company!
If you would like to discuss these matters further with us, please contact us at: [email protected]