You have likely heard the saying, “the rich keep getting richer.” One of the reasons often attributed to this is their ability to access debt easily and use borrowed capital to expand their businesses and investments efficiently.
In the world of finance, debt is not merely an obligation; it is a strategic business tool. When properly structured and responsibly used, debt can accelerate growth and optimise a company’s capital structure. However, in Nigeria, debt has traditionally carried a negative connotation. Many people view debt as something to be avoided at all costs. Yet the real issue is not whether debt is inherently bad, but how it can be used strategically without becoming a financial burden.
In this edition of The Deal Talk, we shift the conversation from fear to strategy. We explore the concept of financial leverage and consider how individuals and businesses can use debt as a tool for growth rather than a trap that leads to financial distress.
The Concept of Financial Leverage
Leverage is the use of borrowed capital to increase potential returns on investment. At its core, it means doing more with less. Imagine you run a dealership that imports used vehicles from abroad. With the capital you currently have, you may be able to import a small number of cars, perhaps one container every quarter. While the business is profitable, growth is slow because your ability to import more cars is constrained by limited capital. However, with a bank loan, you can import more cars at a go. In the event of good sales, profits may exceed the cost of the loan. In that case, the borrowed money helps the business grow faster than it could have using only its own capital; as such, borrowed capital becomes a catalyst for growth rather than a financial burden.
This, dear reader, is the age-old principle that High Net Worth Individuals and large corporations have used for decades to scale businesses, acquire assets, and build long-term wealth. An excellent example is Dangote’s USD$ 19,000,000 (Nineteen Billion Dollars) refinery. The refinery was financed through a combination of sixty per cent (60%) equity and forty per cent (40%) debt from local and international lenders. By leveraging borrowed capital alongside its own funds, the Dangote Group was able to undertake one of the largest industrial projects in Africa, a venture that may have been significantly difficult to execute using equity alone.
The lesson here is simple: debt, when used wisely, can amplify opportunity. But when mismanaged, it can just as easily magnify losses.
Understanding Bad Debt vs. Good Debt
The question of whether debt is bad or good ultimately depends on why the debt was taken and what it is used for.
Generally, good debt is debt used to acquire assets that have the potential to appreciate in value or generate income over time. Examples include borrowing to acquire productive equipment for a business or purchase real estate that can yield rental income. In these cases, the borrowed funds are deployed in a way that can create future economic benefits.
Bad debt, on the other hand, refers to borrowing used primarily for consumption rather than investment. This often includes high-interest loans used to finance lifestyle expenses, luxury consumption, or purchases that rapidly depreciate in value. When debt is incurred without a clear path to generating additional income, repayment becomes dependent solely on existing cash flow, which can quickly become financially burdensome.
When leveraging, the central question is therefore not simply “Can I borrow?” but rather “Will this borrowing create value that exceeds its cost?”
A useful rule of thumb in finance is that the return generated from the borrowed capital should exceed the cost of the debt. If a business borrows at an interest rate of 15% and deploys that capital into a venture that consistently yields a 25% return, the difference represents value created through leverage. Conversely, if the returns fall below the cost of borrowing, the debt begins to erode value rather than create it.
Leverage in Practice
- Real Estate: Real estate is one of the most common examples of leveraged investing in Nigeria. Property developers and investors frequently rely on mortgages, construction finance, or bank loans to acquire land and build residential or commercial properties. For instance, a property developer may obtain a loan to finance the construction of an apartment complex, and once completed, the developer can sell the units or generate rental income that helps repay the loan while retaining ownership of a valuable asset. Over time, as property values appreciate and rental income grows, the investor builds equity in the property despite initially contributing only a portion of the total project cost.
- Oil and Gas: Nigeria’s oil and gas sector is another industry where leverage plays a central role. Exploration, drilling, and production are highly capital-intensive, often running into hundreds of millions or even billions of dollars. Oil companies frequently obtain reserve-based lending (RBL) facilities from banks. In these arrangements, lenders provide financing secured against the company’s proven oil reserves and expected production revenue. The loan is then repaid from the proceeds of crude oil sales. This financing structure enables indigenous oil companies to acquire oil blocks, develop wells, and fund operations without having to raise the entire capital from shareholders.
- Telecommunications: Nigeria’s telecommunications sector is another capital-intensive industry where leverage is commonly used. Telecom operators invest heavily in infrastructure such as fiber networks, base stations, and data centres, as applicable. To finance these investments, telecom companies often raise funds through a combination of bank loans, bonds, and vendor financing from equipment manufacturers. By using borrowed capital to build network infrastructure, telecom operators can expand coverage, increase subscriber numbers, and generate higher revenue over time.
Across industries from infrastructure and oil and gas to agriculture and telecommunications, leverage remains a critical tool for financing large-scale economic activity. Without access to borrowed capital, many of these investments would either be delayed or remain entirely unviable.
Signs that Debt has Become too Much Debt
- Debt Servicing Consumes Most of Your Cash Flow: When a significant portion of income or operating revenue is used solely to repay loans, it leaves little room for reinvestment, operational expenses, or unforeseen costs. Once debt repayments begin to dominate cash flow, financial flexibility becomes severely limited.
- Borrowing to Repay Existing Debt: A major red flag is when new loans are taken primarily to repay existing obligations rather than to finance productive investments. This often signals that the borrower is struggling to meet existing commitments and may be entering a cycle of unsustainable borrowing.
- Declining Returns on Borrowed Capital: Leverage only works when the returns generated from borrowed funds exceed the cost of the debt. If investments funded by loans consistently generate returns below the interest obligations, the debt begins to destroy value rather than create it.
- Increased Exposure to Economic Shocks: Businesses that rely heavily on debt become more vulnerable to economic downturns, interest rate increases, or unexpected revenue declines. High leverage reduces a company’s ability to absorb financial shocks.
- Loss of Strategic Control: Excessive debt can also lead to increased influence from lenders. Loan agreements may impose restrictive covenants that limit business decisions, restrict further borrowing, or require asset pledges. In extreme cases, failure to meet obligations may result in loss of key assets or control of the business.
Final Thoughts
Debt, in itself, is neither inherently good nor bad. It is simply a financial instrument. The difference lies in how it is structured, deployed, and managed. Across industries and economies, leverage has enabled businesses to undertake projects of significant scale, acquire productive assets, and accelerate growth far beyond what would have been possible using equity alone. However, leverage must always be approached with discipline. Borrowing should be guided by a clear strategy, realistic projections, and a careful assessment of risk. When used wisely, debt can amplify opportunity and create lasting economic value. But when taken without foresight or structure, it can quickly transform from a tool of growth into a source of financial strain.
In the end, the most successful investors and businesses do not merely avoid debt, nor do they accumulate it recklessly. Rather, they understand its power and deploy it strategically. That, perhaps, is the real difference between debt as a burden and debt as a catalyst for growth.
The Finance and Projects Team at Tope Adebayo LP comprises of seasoned, commercially savvy finance professionals well-positioned to assist clients in structuring and executing complex financing transactions.
