The Wall Street Journal recently had an article about how many midsize chain restaurants are struggling. The interesting commonality was that food costs were up for all restaurants and the ones that were affected most were those with too much debt.
Debt can be a great tool; as long as the borrower watches the amount of debt, what it’s used for and has adequate debt coverage ratios (which should usually be higher than the ratio required by the lender). Being over leveraged can work great as long as there is constant sales growth and expenses are kept in line. As in the article, when costs go up and revenue is flat (at best) the debt becomes a burden and affects operations.
When working with business buyers and sellers I encourage them to start out with a baseline of a a 2:1 debt coverage ratio. It’s fine to go lower and the larger the deal the further down the ratio can go. But get it down below 1.5:1 and trouble is on the horizon. In other words, watch your debt.