The advantages and limits of debt
Debt is cheaper than equity because interest is tax-deductible and the lender's required return is lower. Leverage, however, increases financial risk and constrains flexibility through covenants.
A company with stable, predictable cash flows can carry more debt than a company in early growth where revenue is volatile.
Metrics that guide the decision
Net debt/EBITDA below 2.5x is normally considered conservative for SMEs, 2.5–3.5x moderate and above 3.5x aggressive. Interest cover should not fall below 3x through a cycle.
These are benchmarks — sector, seasonality and capital intensity all affect what is sustainable.
When equity is the right answer
For investments with high uncertainty, long payback periods or strategic acquisitions, equity is often the right instrument. Debt funding of such projects can create an imbalance that later requires an expensive recapitalisation.
- Capital structure should match the cash-flow profile and stage of growth.
- Net debt/EBITDA is the starting point but not the whole picture.
- Interest cover provides a quick sensitivity indicator.
- Consider equity for high-risk projects with long payback.
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