Today’s Idea is about an age old debate about debt vs. equity.  It is interesting to think back a couple of years ago when there really weren’t that many debt funds offering up an alternative investment,  in comparison to the amount of private equity funds, which was the signature source of alternative investing. As a fund manager of a debt fund I remember seeing a lot of raised eyebrows when explaining our fund to both investors and financial institutions back then, and I think that was due to a lot of people thinking that the good times would roll forever.  Debt is obviously getting a lot of attention right now and it is sometimes hard to distinguish the good debt from the bad debt. This will end up being a full blown article on www.investingsymposium.com but here is a sample of what I am talking about.  There are so many different debt vehicles that we can’t cover them all but let’s talk about the principles that most of them share. In its most simplistic form, bad debt is debt that won’t be repaid without adequate collateral. Good debt is either a loan that will be repaid or a loan that will not be repaid that is backed by adequate collateral.  In essence, with good debt if the loan pays off or not you still get paid in the end.  In this cycle, an entity whether it is corporate or otherwise is issuing equity to bring more money into the coiffeurs and that is basically bringing in additional collateral to cover their debt.  The greatest factor around collateralized debt is that the borrower needs to pay you before paying out their equity partners, be it in a private equity setting as an alternative investment or in a corporate scenario as bonds.  This is the basis of asset based lending, and the reason why this is becoming the alternative investment of choice.  Asset based lenders understand the need to over collateralize hence providing the security needed to be good debt. So you need to ask yourself one simple question. Would you rather be holding equity paper that is valued by revenue after paying debt, or would you rather be holding the debt that gets paid before the equity paper?

You can read more about the basics of asset based lending by clicking here.

Copyright: Dominic Mazzone, Regent Global Funds 2008