Leverage is not a strategy. It's a tool. And like any tool, what matters is whether you're using it in the right application at the right time — or whether you're using it because everyone else is and the rates looked good when you ran the model.
We've seen both. The second one is expensive.
Where leverage actually works
There are three scenarios where leverage genuinely accelerates value creation.
Acquiring cash-flowing assets with predictable returns
If you're buying a business or a property with stable, contracted cash flows and your cost of debt is meaningfully below your expected return on invested capital, leverage amplifies your equity return without introducing disproportionate risk. This is the textbook case. It's also genuinely rare in practice — most deals involve more uncertainty than the model suggests.
Financing growth in a business with demonstrated unit economics
If you know your customer acquisition cost, your retention rate, and your contribution margin per customer, debt can be a cheaper way to fund growth than equity dilution. The key word is demonstrated. Model-projected unit economics don't count. Neither does revenue from customers you've had for less than 12 months.
Bridge financing with a clear exit mechanism
Short-duration leverage with a defined payoff — a sale, a refinancing, a capital raise with committed terms — can make sense when the alternative is missing a time-sensitive opportunity. The risk is real, but the timeline has to be equally real. "We'll figure out the refinancing when we get there" is not an exit mechanism.
Where it destroys value
The scenarios where leverage kills deals are less obvious and far more common.
Businesses don't fail because of leverage. They fail because of leverage applied to a thesis that was wrong, at a time the market stopped cooperating.
When the thesis depends on appreciation
We see this constantly in real estate. An operator buys an asset at a compressed cap rate, models 3% annual rent growth and terminal cap rate compression, and levers up to 75-80% LTV to make the returns work on paper. When the market doesn't appreciate on schedule — or when rates move 200 basis points in the wrong direction — the deal doesn't just underperform. It becomes a problem that consumes management bandwidth for years.
When it masks operational problems
A business that's growing revenue but struggling with margins will often reach for debt to fill the cash flow gap. The leverage buys time. It doesn't fix the margin problem. It just means the reckoning arrives with interest — literally.
We've worked with companies that raised debt rounds to cover deteriorating unit economics. Every one of them would have been better off confronting the problem at $5M in revenue than at $20M with a $10M credit facility outstanding.
When deal structure complexity creates misaligned incentives
In M&A, creative leverage structures — earnouts backed by debt, seller notes subordinated to senior debt, mezzanine layers with PIK features — often look like they solve valuation gaps. They frequently create principal-agent problems that undermine the post-close business. When the seller's incentive is to recognize revenue before an earnout date and the buyer's incentive is to invest for the long term, you don't have alignment. You have a lawsuit waiting to happen.
The cap rate trap
For real estate specifically: if your deal only works at current debt costs with a cap rate that assumes continued compression, you don't have an investment thesis. You have a bet on monetary policy.
We've helped clients unwind positions that made complete sense in 2021 and became serious problems by 2023. The deals weren't bad businesses. They were correctly underwritten for the rate environment they were structured in. That environment changed.
The lesson isn't "don't use leverage in real estate." The lesson is that your returns need to work across multiple points on the rate curve, not just the one that was current when you closed.
The stress test we run on every deal: What happens to equity value if revenue is 20% below projection, rates are 150 basis points higher, and the exit takes two years longer than planned? If the answer is "we lose the business," the leverage structure is wrong. If the answer is "we make less but we survive and recover," the conversation is worth having.
What to do instead
None of this means avoid leverage. It means structure leverage against what you know, not what you're modeling.
- Size debt to what existing cash flows can service — not pro forma cash flows, and not cash flows that require things going right
- Keep covenants loose enough to survive a down year — tight covenants on growth-stage businesses accelerate the bad outcome
- Align the duration of the debt to the duration of the bet — short-term debt on long-term assets is how liquidity crises happen
- Model the downside first, then size the upside — most deals are presented upside-first; the ones that work are structured downside-first
The businesses that use leverage well aren't the ones with the most sophisticated models. They're the ones who are honest about what they don't know, and who structure accordingly.