Notes for an Entrepreneur - On Debt

A friend called to comment that I seem to be rabidly opposed to debt and that this might be an unreasonable stance for new entrepreneur to take. I thought I would devote this post to clarify my stand.

I am not opposed to debt per-se, though I will admit my own personal preference to avoid it. My argument is that debt is best taken for setting up infrastructure that is required to run a business and perhaps to accommodate the first 3 months of working capital. For financing infrastructure, a term loan with fixed payment installments beats an open line of credit, if for no other reason than to engender discipline in paying back the debt in good time. Ongoing debt mechanisms such as credit lines often mask inefficiencies in the business, most often a poor credit cycle.

Here is a thumb rule that I would try to follow. Debt should be used to finance assets that appreciate; e.g. land and building in India. If you are considering taking on debt to finance assets that depreciate rapidly, such as cars or computers, you might want to think about that a little more. At the very least, ensure that gross margins are strong enough to compensate for the depreciation of the assets.