The Leverage Trap

Oct 29

3 min read

The numbers look great. Demand is strong. Customers are paying. Capital is available. The projections show exactly what everyone wants to see.

So the founder makes the obvious decision: Borrow money and grow faster.

And why not?

Debt can help a company enter new markets, build sooner, acquire assets, and capture opportunities before someone else does.

But here is what the spreadsheet conveniently ignores:

Debt is a fixed obligation attached to an uncertain future.

When Growth Becomes a Dependency

If sales slow, the payment does not. If customers take longer to pay, the lender does not give a damn about the projection. If costs increase, the project gets delayed, or the next funding round does not come, the obligation is still there.

Debt is not bad. In many cases, it is exactly what a business needs to scale. The problem starts when the entire financial structure depends on the growth story continuing exactly as planned.

Because it almost never does.

How a Loan Becomes a Trap

WeWork illustrates the danger of fixed commitments.

The company expanded aggressively, signing long-term leases and opening locations around the world based on the assumption that future demand would support the cost.

While growth was strong, the model looked impressive. More locations. More members. More revenue. Bigger valuation.

But the leases were real commitments. The growth was still an assumption.

Once growth and cash generation could no longer support the structure, WeWork had very little flexibility left. In March 2023, the company announced a restructuring agreement to cancel or convert into equity approximately $1.5 billion of debt and extend approximately $1.6 billion of debt maturities.

People will say the market changed. Of course it did. Markets always change.

That was the trigger, not the real problem. The real problem was that once the assumptions stopped holding, the financial structure left the business with almost no room to react.

That is the leverage trap.

Questions Every Business Owner Should Ask

Founders spend a lot of time asking:

How much can we build?
How quickly can we expand?
How much revenue can this generate?

Fair questions. But the more important one is:

What happens if we are wrong?

What if revenue comes in 20% lower?
What if customers pay 60 or 90 days later?
What if costs increase?
What if the project takes another year?
What if capital becomes more expensive exactly when the company needs more of it?
Can the business survive if no further borrowing is available?

Anyone can build a spreadsheet showing the upside. The real work is understanding whether the business can survive the downside.

Look Beyond the Growth Story

That means looking beyond the bullshit growth story and understanding the actual cash behind it.

How much cash does the business really generate?
How much capital does it continuously need?
What obligations has management already committed to?

And most importantly, how much room is left to make decisions when things do not go according to plan?

There is a major difference between using debt to finance growth and becoming dependent on growth to survive.

Debt can accelerate a strong business. It cannot fix a weak cash-flow model. It usually just exposes it faster.

Always look past the story, the bullshit, and the perfect spreadsheet to understand whether the financial structure can actually carry the ambition behind it.

Because growth is not strong if everything needs to go right.

The strongest businesses are built with the financial flexibility to adapt when circumstances change.

Wees Abraham