Key Takeaways
Borrowing should be viewed as a strategic financial tool rather than something to avoid categorically, with the use of debt tied to clearly defined business objectives that support long-term value creation.
Maintaining a debt-free balance sheet is not always the most conservative financial choice, as preserving cash and borrowing prudently can enhance flexibility, support growth opportunities, and improve shareholder liquidity.
Directors should evaluate borrowing through the lens of governance by weighing the company's debt capacity, downside risks, strategic priorities, and shareholder expectations before making financing decisions.
For many family businesses, being debt-free is a point of pride. Prior generations may have worked hard to pay off loans, build up cash, and protect the company from financial stress. In that context, borrowing money can feel like a step backward.
That reaction is understandable. Debt creates fixed obligations, and lenders expect to be paid regardless of whether the business is having a good year or a bad one. For some family shareholders, borrowing may also carry emotional weight. They may associate debt with risk, loss of control, or a departure from the values that helped build the business.
But "we don't have to borrow" is not the same as "we shouldn't borrow." For directors, the better question is whether borrowing helps the business accomplish something worthwhile while keeping risk at a level the owners can tolerate.
In other words, debt should be viewed as a tool, not necessarily a step backward.
Debt Should Have a Job
Borrowing should begin with a specific business purpose, as it does not create value by itself. A family business might borrow to expand capacity, purchase equipment, pursue an acquisition, invest in technology, enter a new market, or provide shareholder liquidity.
Each use has a different risk and return profile. Borrowing to fund a measured redemption program is different from borrowing to satisfy an unplanned liquidity request. In each case, directors need to know what the borrowing is intended to accomplish.
For capital investments, the opportunity to borrow funds should be part of the company's financing strategy but should not be used to justify the proposed investments. Capital projects should stand on their own strategic and financial merits. Keeping the investment and financing decisions separate is a good rule of thumb.
The same "separation principle" can be applied to debt used for shareholder liquidity. Using debt does not fix a poorly designed redemption policy, nor will doing so resolve more fundamental shareholder agreements.
In short, debt can support execution of a strategy but should not serve as a substitute for a coherent strategy.
Cash Has a Cost Too
Borrowing money is not free, and interest expense represents the cost of debt. When the family business has cash reserves, should it use those reserves rather than incur interest expense on debt? In some cases, that may be the right answer. But using cash is not free either. Every dollar used today is a dollar no longer available for working capital, capital expenditures, dividends, or shareholder liquidity.
Using cash may avoid interest charges, but doing so can reduce flexibility when flexibility is needed most. The resulting debt-free balance sheet may appear conservative, but that appearance may be hiding real risks if a principled refusal to borrow funds leaves the company overcapitalized while attractive projects go unfunded or shareholders lack a reasonable path to liquidity.
Borrowing may allow the company to pursue an attractive opportunity while preserving cash for operating needs and unexpected events. It may also help match the financing of a long-term asset with the period over which that asset is expected to benefit the business. That does not mean debt is always preferable to cash.
There are no easy answers. Directors should evaluate the relevant tradeoffs rather than assuming that a debt-free balance sheet is always the most conservative answer.
Borrowing Capacity Is a Governance Resource
Family businesses are right to be cautious about debt. Borrowing increases fixed claims on future cash flows, and the company has less room to absorb surprises if conditions weaken.
That is why borrowing capacity should be treated as a governance resource, not just a financing option. Directors need to know how much debt the company can support in a normal year, what happens in a weaker year, and how lenders are likely to respond if results fall short.
Borrowing affects the company's ability to reinvest, maintain dividends, fund redemptions, and pursue future opportunities. Directors must balance not only whether the business can service the debt, but also whether the decision makes sense given the company's strategy, risk tolerance, and shareholder expectations in both normal and weaker years.
What Should Directors Ask?
When borrowing is under consideration, a few practical questions should come to mind:
What specific objective would the borrowing accomplish?
How does the borrowing support the company's long-term strategy?
Can the business comfortably service the debt in a normal year?
What happens if earnings decline or the project takes longer than expected?
Would borrowing preserve cash for higher priority uses?
How would the debt affect dividends, reinvestment, redemption capacity, and future flexibility?
How will the decision be explained to shareholders?
The last question is important. Family shareholders may not need or want every detail of the loan agreement, but they do need context. If shareholders only hear that the company is taking on debt, some may assume the business is under stress. If they understand that debt is being used to fund growth, preserve flexibility, or support shareholder liquidity, the conversation becomes more productive.
Conclusion
Avoiding debt may be prudent, especially when shareholder risk tolerance is low. But a debt-free balance sheet is not always the best evidence of financial discipline. In some cases, thoughtful borrowing can help preserve flexibility, fund attractive investments, and create shareholder liquidity without draining cash reserves.
For directors, the goal is not to borrow more or borrow less. The goal is to use capital wisely.