This week, I listened to an entrepreneur share how he took out a loan to buy out his cofounder about a year ago. The good news is that the founder now owns 100% of the company and all its upside. The bad news is that revenue has declined slightly, the company is breakeven (no profit), and the monthly debt payments are affecting the founder’s decision-making. He’s now worried about what will happen if the business can no longer generate enough cash to service the debt payments.

I don’t have enough context to say whether debt was right for that founder, but I think about taking on debt in a business using a simple framework. Here are the steps:

• Do I have a clear plan to invest the proceeds, and can that investment generate a return? If not, I won’t take on the debt. For example, I’m not comfortable taking on debt for consumption, but I’ll take on debt to invest in a project that will allow the business to generate more revenue and cash flow.
• If I use the proceeds to invest in something that generates a return, will the percentage return be higher than the interest rate on the debt? If not, I won’t take on the debt. For example, the loan has a 10% interest rate, but the project I’m planning will likely generate a 5% return. That’s not something I’d take on debt for because the return isn’t sufficient to service the debt payments.  
• Can the current business cash flows support the debt payments? If not, I’d think harder about taking on debt and be less inclined to do so if my conviction about my plan to invest the proceeds isn’t strong.

Debt is a form of leverage and a tool. It provides you with more financial resources than you typically would have from customer revenue alone. Like any tool, it’s not good or bad. How you apply the tool makes all the difference.