Debt is BAD...or is it?

Sometimes it can take years for the light to go on, for me to grasp a concept.

I was brought up to believe that debt is bad. Don’t spend more on your credit card than you can afford to pay off each moth. Don’t buy and finance a new car unless you have the ability to make the payments for the four or five years and then drive the vehicle for another four or five years after it is paid off. Don’t buy a house unless you can afford the 30-year fixed. Pay off all debts as quickly as possible. Make extra payments where you can. Pay off debts as fast as possible to save money on interest.

I never understood, until now, why it is better for a business to carry debt. I remember in my undergrad finance class my professor telling us that debt can be good I flat-out didn’t believe him. I answered the questions the way he wanted, got a decent grade in the class, but his lectures didn’t change my fundamental belief system.

I don’t claim to have a complete understanding of why businesses should carry debt, but the light is starting to come on. I am taking a class right now called “Maximizing Shareholder Wealth”. I am currently reading about capital structure and how to determine the ideal amount of debt for a firm. Interest on debt decreases a firm’s taxes, therefore increasing the overall value of a firm. However, there is a point at which this ceases to be true. With debt comes added risk. The more debt a firm has the higher their risk of default.

The bottom line is to find the balance between a capital structure of debt and equity. I am learning how to compute that “break-even point” but I’m still trying to figure it all out. The light is coming on though. This is a tough topic for me because it goes against my personal belief system. As I learn, I grow.

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Corporate Takeover Jargon

I just came across a funny section in my Corporate Finance book. It is a sort of glossary of business jargon relating to corporate takeovers and ways to avoid them.

In my many years in business I have never heard these terms. It might be because I am from the world of small business and have never dealt with a merger or acquisition, but I would think I might have at least heard the terminology somewhere...maybe in undergrad? If these terms were ever mentioned I certainly don't remember.

1. Golden parachutes - Some target firms provide compensation to top-level management if a takeover occurs. This can be viewed as a payment to management to make it less concerned for its own welfare and more interested in stockholders when considering a takeover bid. Alternatively, the payment can be seen as an attempt to enrich management at the stockholders’ expense.
2. Crown jewels - Firms often sell major assets—crown jewels—when faced with a takeover threat. This is sometimes referred to as the scorched earth strategy.
3. Poison pill - Poison pill is a term taken from the world of espionage. Agents are supposed to bite a pill of cyanide rather than permit capture. Presumably this prevents enemy interrogators from learning important secrets. In finance, poison pills are used to make a stock repellent to others. A poison pill is generally a right to buy shares in the merged firm at a bargain price. The right is granted to the target firm’s shareholders, contingent on another firm acquiring control. The right dilutes the stock so much that the bidding firm loses money on its shares. Thus, wealth is transferred from the bidder to the target.
4. White knight - A firm facing an unfriendly merger offer might arrange to be acquired by a different friendly suitor. The firm is thereby rescued by the white knight.
5. Lockup - A lockup is an option granted to a friendly suitor (perhaps a white knight) giving the right but not the obligation to purchase stock or a portion of the assets (perhaps the crown jewels) of the target firm at a fixed price in the event of an unfriendly takeover.
6. Shark repellent - A shark repellent is any tactic that makes the firm less attractive to a potential unfriendly offerer.
7. Bear hug - A bear hug is an unfriendly takeover that is so attractive that the target firm’s management has little choice but to accept it.

Excerpt taken from Corporate Finance (2004 Edition) by Stephen Ross, Randolph Westerfield, & Jeffrey Jaffe

These cracked me up! I think shark repellent is my favorite. This would also be a great term for avoiding lawyers or other legal action.

They don't exactly embody what I would expect for "high class" corporate lingo. I guess people get creative, not only with tactics, but with describing those tactics when they feel their business or livelihood is threatened.

Does anyone else have examples of quirky corporate lingo? If so, please add them to the comments. I'd love to expand my vocabulary!

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