1. Using borrowed capital or other financial instruments to boost the potential return on investment (ROI). Investors who use only their cash on hand can make a profit if they invest wisely and strategically. But if they borrow money to significantly increase their investment, the potential returns can be much larger.
As you can imagine, leveraging is risky. If you only invest your own money and an investment fails, you lose only that money. But if you leverage an investment that doesn’t pan out, you lose your own money and borrowed money, which can be difficult to repay.
2. Using debt to finance a company’s assets. When publicly traded companies want to raise capital, they may normally issue stock. But leveraging involves investing in business operations with borrowed money as a way of increasing shareholder value.
In short, leveraging is growing the company’s value through borrowed money rather than money raised from investors. In either case, investing more capital into the business allows it to expand and increase profitability (and shareholder value).
The downside to business leveraging is that if the borrowed money does not increase shareholder value, the company risks financial ruin (or at least serious damage) due to high interest payments and the risk of default. This could actually decrease shareholder value, further destabilizing the company. That’s why “highly leveraged” companies are not attractive to investors.
3. Everyday physics: The mechanical advantage needed to pry someone out of the chair that you were sitting in before briefly leaving to use the restroom.
Phil is an investor who strongly suspects that a new investment opportunity is really going to pay off. But his own funds are limited. Therefore, he decides to leverage his investment with borrowed money, hoping for a much larger return.