By Todd Wegner, Partner
As a fractional CFO working with small and mid-sized businesses, I often see founders hesitant about debt financing—sometimes unsure whether it's a strategic tool or a financial trap. When used wisely, debt can be a powerful lever to scale your business, smooth cash flow, or invest in long-term assets.
Here are the basics of debt financing, including how to size it correctly, understand lender expectations, and plan for repayment responsibly.
What Is Debt Financing?
Debt financing means borrowing money that must be repaid over time, typically with interest. It can come from traditional banks, credit unions, online lenders, or even private debt funds. Unlike equity financing, it doesn’t dilute your ownership—but it does create an obligation on your balance sheet.
Common types include:
- Term loans: A lump sum repaid over a set period (e.g., 3–7 years).
- Lines of credit: Revolving access to funds, ideal for working capital.
- Equipment financing: Loans secured by specific assets.
- SBA loans: Government-backed, offering favorable terms to small businesses.
How to Size the Debt Appropriately
One of the most important questions a business owner must answer is: How much debt is too much?
1. Match the loan type to the use
- Working capital or seasonal expenses? Use a line of credit.
- Capital expenditures (like equipment or a facility)? Use a term loan.
- Growth initiatives? Be cautious—ensure the ROI is clear and timely.
2. Use debt coverage ratios
Banks and CFOs typically look at the Debt Service Coverage Ratio (DSCR):
DSCR = EBITDA / Debt Service (principal + interest payments)
A DSCR of 1.25 or higher is typically required. This means you should generate at least $1.25 in earnings for every $1.00 of debt obligation.
3. Avoid overleveraging
Keep an eye on your total debt-to-EBITDA ratio (generally, 3x or less is prudent for small businesses). Too much debt can strain cash flow and restrict strategic flexibility.
What to Expect: Bank Covenants
When you take on debt, lenders will impose covenants—essentially, rules you agree to follow during the life of the loan.
Common covenants include:
- Financial covenants: Minimum DSCR (e.g., must stay above 1.25x) Maximum leverage ratio (e.g., debt/EBITDA < 3.0x) Minimum liquidity or working capital levels
- Affirmative covenants: Things you must do (e.g., submit regular financials, maintain insurance)
- Negative covenants: Things you cannot do without approval (e.g., take on more debt, issue dividends)
Covenant compliance is monitored regularly—typically quarterly. Violations can trigger penalties, increased interest, or even loan recalls.
As a CFO, I help clients build forecasting tools to monitor these risks.
Understanding Repayment Plans
Debt is repaid according to a pre-agreed schedule. Here’s what to expect:
1. Amortization terms
- Fully amortizing loans include both interest and principal in each payment.
- Some loans are interest-only for a period, then amortize (e.g., 12-month IO + 4 years principal).
2. Prepayment penalties
Some loans penalize early payoff, especially in the first few years. Always ask about these terms up front.
3. Balloon payments
Be cautious of loans that defer a large final payment ("balloon"). You’ll need a plan to refinance or pay that lump sum.
Use Debt Strategically
Debt isn't inherently good or bad—it’s a tool. Used thoughtfully, it can help you:
- Fund growth without giving up equity
- Build creditworthiness
- Optimize your capital structure
But like any tool, it needs careful handling.
Work with a CFO (fractional or full-time) who can help you evaluate your business’s cash flow, project your repayment ability, and ensure you meet lender expectations.
As a fractional CFOs, The Florida CFO Group works with small and mid-sized businesses to design capital strategies, navigate lender relationships, and ensure financial stability. Whether you’re considering your first loan or refinancing existing debt, we help you make confident, data-driven decisions.
Todd Wegner is a seasoned Florida CFO Group partner and CFO of CPT Network Solutions, a national technology services provider specializing in multi-site implementation. Todd is an accomplished finance executive with extensive experience in corporate strategy, financial management, and operations. He has a proven track record of guiding businesses through growth, transformation, and complex financial challenges, serving as a trusted advisor to leadership teams and boards.
Ready to explore how debt financing can fuel your company’s growth? Contact the Florida CFO Group to connect with an experienced partner like Todd Wegner, who can help you design the right capital strategy, manage lender relationships, and strengthen your financial foundation. Call us at (877) 352-2367.