The Path Matters: Corporate vs Personal Finance Strategies

Today, let's unravel a topic that's often the subject of heated discussions in boardrooms and living rooms alike: the contrasting approaches to debt in corporate and personal finance. It's a fascinating contrast, especially for those of us who are able to play both games.

Corporate Finance: Embracing Debt as a Growth Lever

In the corporate world, debt isn't inherently a necessity; it's a common strategic choice. Traditional corporate finance wisdom tells us that to maximize the Internal Rate of Return (IRR), maintaining a significant level of debt is almost a given. This approach is rooted in the belief that the right amount of debt can fuel growth and enhance shareholder value. Think of it as a high-stakes game where companies balance on the tightrope of debt, aiming for greater heights.

The Transdigm Approach to Risk Management

Corporations often embrace this perpetual debt cycle. They're constantly re-leveraging, using debt as a tool to fund new ventures, acquisitions, or expansions. This strategy banks on the idea that the returns will outstrip the costs of debt. It's a bold move, and when it pays off, it can lead to impressive growth.  One of the most conspicuous examples of this sort of approach is TransDigm. TransDigm has consistently used debt to fund acquisitions, expanding its portfolio and market presence. This strategy is a textbook case of corporate finance's perpetual debt approach: taking on debt not as a burden, but as a tool for growth. Of course they combine debt with a cost synergy playbook and wait for a price that gives them an advantage, but without running 7x Debt to EBITDA, they would not be a household name among stock wonks. This feels very much like a “ladies and gentlemen, don’t try this at home” kind of strategy. TransDigm earns 50% of its profit from DoD contracts and they claim that US defense spending almost never gets reduced during recessions. They structured their debt payments such that their DoD revenues alone are enough to cover their interest payments.

Personal Finance: A More Prudent Path

Switching over to personal finance, the narrative changes significantly. Here, debt is often approached with a healthy dose of caution. KOLs like Dave Ramsey encourage cutting up credit cards and prioritizing a debt free life. Consider how most of us handle a mortgage, for instance. The goal is usually to pay it down steadily, rarely if ever considering the option to re-leverage our homes for additional financial risk. It's a more conservative, grounded approach, focusing on long-term security rather than immediate, high-risk gains. When it comes to a personal residence, I am squarely in the Ramsey camp, once paid off, it strikes me as highly unlikely that I would ever consider a cash out ReFi and throw the proceeds into another venture.

This difference in attitude towards debt in personal finance is partly due to the nature of our income sources. Most businesses have a diverse customer base, which spreads out their risk. In contrast, an individual typically relies on a single primary income source, making their financial situation much more susceptible to idiosyncratic risks.* Unless you feel your income is as certain as a DoD contract, high levels of debt are imprudent. This inherent difference in concentration risk exposure is a crucial factor in how debt is perceived and managed in personal finance. In the personal finance context, I prefer to keep my debt-to-equity ratio substantially below 45% (equivalent to a BBB rating, lowest IG). Once we get into junk land of 200%+ or tread into a negative debt to equity ratio situation like Transdigm, then we are just asking for trouble. Inflexible capital structures like this are not robust enough to survive life’s inevitable crisis periods.

The Path Matters

The principles guiding corporate and personal finance, especially regarding debt, are not interchangeable. In the corporate sphere, debt is a calculated gamble, often supported by thorough analysis and strategic foresight. In personal finance, however, the stakes are more immediate, with direct impacts on individual lives and futures. At least for me, anything higher than 50% debt to equity strikes me as uncomfortable and anything higher than 100%, is shackling. Running the negative equity playbook might work if you had extreme confidence in the certainty of cash flow, but these days, that seems like an overly optimistic perspective baring conspicuous counter examples like obtaining a tenure-based academic contract or a lifetime judicial appointment.   

While modern corporate finance tactics can offer some benefits to corporations (especially concepts like limited liability, not cross-collateralized, non-callable, etc.), they need careful adaptation - or should be IGNORED ENTIRELY - when applied to individual financial decisions. In summary, we only get to roll the dice a few times, and the path matters.

* Dual income, or multi-income households, where participants are in different sectors may be able to diversify human capital income risks, and could rationally prefer higher debt to equity ratios.