The Debt Decision: How to Finance Growth Without Risking the Business You've Already Built

There is a moment in the life of every growing business when the question of debt becomes unavoidable. An acquisition target appears. A new market opens. A competitor stumbles and there is a window to take share — but only if you move quickly. The bank is willing to lend. The terms look reasonable. And the entrepreneur faces a decision that will shape the next decade of the enterprise: borrow, or wait.

I have made this decision many times over the years at Manzanos Enterprises — across wineries, real estate developments, hospitality projects, and international expansion. I have made it well and I have made it badly. The pattern that separated the good outcomes from the bad ones is, in retrospect, embarrassingly clear. But in the moment, with a deal on the table and momentum in the room, the discipline that produces good outcomes is one of the hardest things in business to hold.

This is the framework I wish I had been handed twenty years ago.

## Why the Debt Question Matters More Than Most Entrepreneurs Admit

Most entrepreneurs treat debt as a technical question. They calculate interest rates, compare lender terms, model coverage ratios. They miss the deeper truth: the level of debt a business carries determines whether it makes decisions on its own timeline, or whether that freedom has been quietly transferred to its lenders.

A business with no debt — or with very modest debt — can survive a bad year. It can pass on a deal that looks attractive but does not fit. It can choose a longer time horizon than its competitors. It can absorb a mistake without compounding it.

A business carrying too much debt does none of these things. Its decisions are no longer fully its own. Every quarter becomes a test of whether the covenants will hold. Every recession becomes existential. The cost of an ordinary mistake — a slow launch, a missed harvest, a soft year in one division — can be the loss of the entire enterprise.

I have watched well-managed, profitable companies be destroyed by leverage that looked entirely reasonable when it was taken on. The bankruptcy of Toys R Us in 2017 is the textbook case — a profitable retailer brought down by the roughly five billion dollars of debt loaded onto it during its 2005 leveraged buyout. The interest payments alone consumed the cash the business needed to invest in stores, e-commerce, and the customer experience. A retailer that should have evolved instead suffocated. The business did not fail because consumers stopped buying toys. It failed because the balance sheet had no room left for the business to breathe.

The Spanish retailer El Corte Ingles faced its own near-death experience in the years after 2008, when a debt-fueled expansion left it with billions of euros of obligations as Spain entered its recession. It survived — but only after a painful decade of asset sales, family disputes, and the kind of strategic concessions that a healthier balance sheet would have made unnecessary.

The pattern is recurrent: businesses that take on too much debt do not fail when the debt is taken on. They fail when something ordinary goes wrong and the balance sheet has no resilience left.

## The Two Types of Debt — and Only One of Them Is Useful

Not all debt is the same. The most useful distinction I have learned to draw is between debt that finances productive assets and debt that finances anything else.

**Productive debt** funds investments that generate cash flow exceeding the cost of the debt over a defined period: a real estate acquisition with stable rental income, a winery expansion that increases production capacity at a profitable margin, an acquisition of a business whose cash flows comfortably cover the financing. The debt is, in effect, paid back by the asset it created.

**Unproductive debt** funds anything else: operating losses that cannot be turned around, distributions to owners, vanity acquisitions, prestige projects whose returns are theoretical, working capital gaps in businesses that are not actually generating cash. Whatever the rationalization, this debt is paid back from the rest of the business — not from the thing it was used to acquire.

The first category, used carefully, can accelerate the building of an enterprise. The second category is almost always a slow-motion mistake.

The honest question I ask before any meaningful borrowing decision: if this asset or initiative produced nothing for five years, would the rest of the business comfortably service this debt? If the answer is yes, the loan is probably reasonable. If the answer is no, I am betting the rest of the business on this single decision — and that bet is almost never worth making.

## The Four Tests Every Borrowing Decision Should Pass

Over time I have distilled the decision into four tests. A borrowing decision that fails any of them is almost always a mistake, regardless of how attractive the underlying opportunity appears.

**1. The downside test.** Can the business comfortably service this debt under a realistic worst-case scenario — not the base case, not the pessimistic case, but a real recession scenario in which revenues fall 25 to 40 percent and stay there for two years? If the answer is no, the leverage is too high. The business is being engineered for the world we expect, not for the world that occasionally arrives.

**2. The optionality test.** Will this debt limit our ability to make decisions over the next three to five years? Will it force us to sell assets we would rather keep, take on partners we would rather not have, or pass on opportunities we would otherwise pursue? Debt does not just cost interest. It costs strategic flexibility. The price of that flexibility is rarely visible on the term sheet — but it is the most expensive component of any loan.

**3. The cash flow test.** Is the debt-service-coverage ratio — earnings before interest and taxes divided by required debt service — comfortably above 2.0 in the base case, and still above 1.3 in the downside case? A ratio that is "fine" in the base case is dangerous. The base case is by definition the optimistic forecast. The downside is what tests whether the business actually survives.

**4. The character test.** Is the lender someone who will work with us if a problem arises, or are they a transactional counterparty who will enforce every covenant the moment they have the option? A relationship bank with a local decision-maker is a very different counterparty from a syndicated loan held by twenty institutions, none of whom know your business. The same euro of debt with two different lenders is, in fact, two different liabilities.

## What We Have Learned About Debt the Hard Way

At Manzanos Enterprises, the most expensive lessons in our history have not been the deals we missed because we declined to use debt. They have been the moments when we took on more debt than the conservative version of our own analysis would have justified.

The decisions I am proudest of, looking back, are not the bold leveraged expansions. They are the times we built a real estate project entirely with internally generated capital, even when the cycle was favorable to borrowing. They are the years we paid down debt aggressively when revenues were strong, even though every advisor was telling us we were leaving leverage on the table. They are the acquisition we passed on because the financing required would have left us vulnerable in a scenario we could not yet name.

That scenario eventually arrived, as it always does.

The discipline of conservative leverage is invisible during good times. It only matters at the bottom of a cycle, when the businesses that overextended themselves are forced into decisions they would never have chosen — and the businesses that did not are buying assets from them at a fraction of their fair value.

The most successful family businesses across centuries — companies in the Henokiens Association of bicentennial enterprises — are almost without exception conservative on debt. They use it strategically, sparingly, and on terms that preserve their freedom to act. They do not view a strong balance sheet as inefficiency. They view it as the precondition of everything else they want to do.

## When Debt Makes Strategic Sense

This does not mean debt should be avoided categorically. Used well, it accelerates the compounding that is at the heart of any long-term enterprise.

We use debt at Manzanos Enterprises in a small number of specific contexts:

- **Real estate development**, where the underlying asset secures the loan and produces cash flow that comfortably exceeds the financing cost

- **Long-cycle production investments** in wine, where there is a multi-year gap between the capital deployed and the revenue it eventually produces, and where bridging that gap with internally generated cash would unnecessarily slow growth

- **Acquisitions** in which the target's cash flows are stable, well-understood, and large enough to service the debt independently of the rest of the group

- **Working capital lines** that fund the predictable seasonal swings of an established business, not the optimistic projections of a new one

In each case we are using debt as a tool, not as a strategy. The underlying business does not depend on the debt. The debt is amplifying outcomes that would still happen, just more slowly, without it.

## The Conservative Balance Sheet as a Strategic Weapon

The most underappreciated strategic asset in any business is a balance sheet that is stronger than it needs to be.

A company that has unused borrowing capacity, modest leverage, and strong liquidity can move when others cannot. It can acquire competitors at the bottom of the cycle, when assets are cheap and sellers are motivated. It can invest in modernization while peers are conserving cash. It can attract talent during downturns because it can offer the security that leveraged competitors cannot.

Hermes, the French luxury house, is perhaps the most instructive modern example. When LVMH attempted to take it over in 2010 through a quiet accumulation of shares, the Hermes family had the balance sheet strength and the long-term orientation to organize a defense. They created a holding structure, ring-fenced family ownership, and ultimately forced LVMH to divest. The conservative financial posture of generations of Hermes leadership was the precondition that made independence possible. A more leveraged business would not have had the option.

Inditex, the Spanish parent of Zara, has run its global expansion almost entirely from internally generated cash, with negligible long-term debt for most of its history. The result is one of the most resilient retailers in the world — a business that absorbed the 2008 recession, the 2020 pandemic, and the current shift to digital commerce without ever facing a question of financial survival. Its more leveraged competitors did not enjoy that luxury.

## The Discipline of Paying Down Debt Fast

The decision to take on debt is not the only one that matters. The discipline of paying it down — quickly, when the cash is available, even when the interest rate is comfortable — is what separates businesses that use debt as a tool from those that gradually become its servant.

The temptation, when a business is generating strong cash, is to deploy that cash into new investments rather than reducing existing obligations. The math often supports it: expected returns on new capital exceed the cost of existing debt. So the leverage stays, year after year, and grows over time as new opportunities are funded with new borrowing.

The math is correct in the base case. It is wrong in the downside case. The businesses that compound through cycles are the ones that pay down debt in the good years, so that they have borrowing capacity available in the bad ones.

## Key Takeaways

- The level of debt a business carries determines whether it makes decisions on its own timeline or on its lenders' timeline — preserve that freedom carefully

- Most leveraged businesses do not fail when the debt is taken on but when something ordinary goes wrong and the balance sheet has no resilience left

- Productive debt finances assets that generate cash flow exceeding the financing cost; unproductive debt is paid back from the rest of the business and is almost always a slow-motion mistake

- Every borrowing decision should pass four tests: downside survivability, preservation of strategic optionality, comfortable coverage ratios under stress, and a lender of strong character

- A balance sheet stronger than it needs to be is one of the most underappreciated strategic assets in business — it lets you act when competitors cannot

- The discipline of paying down debt aggressively in good years is what separates businesses that use debt as a tool from those that become its servant

- The deals you declined to leverage into are rarely the ones you regret; the deals you took on too much debt to win are the ones that quietly haunt the rest of the business for years afterward

The hardest part of capital structure is not learning the math. It is holding the discipline to refuse the leverage that everyone around you is using. The cycle rewards aggression while it lasts, and the businesses that survive the next one are the ones that did not get rewarded for the aggression that the rest of the market did. That is a lonely position to hold while it is unfashionable. It is also the position that wins over decades.