Bad Business Debt – Part I

 

 

Is there such a thing as bad business debt?  After all, does not a business borrow so that it can create a product or a service that generates more or new income?  The answer here is clearly yes.  There is a need for businesses to borrow for certain business activities.  But often bad business debt also occurs.

 

Coming from the corporate world, I can tell you of faulty thinking firsthand.  During the boom and subsequent bust of the 90s, a common practice was to make large purchases via leasing contracts.  Virtually everything was leased.  Fleets of trucks, manufacturing equipment, buildings, and so on were all leased instead of purchased outright. 

 

This produced a couple of scenarios.  First, it encouraged buying even when no cash was available.  Second, it kept the “corporate debt” off the Statement of Financial Condition, commonly called the balance sheet.  Third, many assets owned outright by the company were sold for cash and then leased back from the new owner.  This supposedly freed up corporate cash for other things.  I saw great companies with substantial real estate and other corporate assets proceed to sell off the assets, receive the cash, and then watch the cash simply disappear over a short time period.  The company was left with long-term leasing debt and a huge burden to bear for many years to come.  

 

The bottom line of the leasing scandals I witnessed was that the greedy corporate executives boosted the value of their corporate parachutes, and boosted the value of their personal stock options.  They received unprecedented amounts of company bonuses because of their wonderful achievement of improving the corporate financial condition.  After many great personal bonuses and benefits, the executives would move on to other companies and new opportunities to do the same all over again.

 

The real sadness of going into corporate debt was that the investors never knew what was happening to the companies in which they had invested their lifesavings.  The leasing debt was never a part of the corporate balance sheet and because of loopholes in the law, the company auditors never disclosed the debt in the financial reports.

 

 

Your thoughts on this subject?  Your comments appreciated!

Content © Rich Brott, 2011

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