Investing and accounting books everywhere say that too much debt is bad. One can resonate with this mantra. After all, debt holders are the real owners. They are the ones who dictate the terms of the loan and how the loan will be paid back. Many loans even have special clauses that force payback if certain ratios exceed given thresholds -- that is, exactly when the situation is bad for the company. In other words, debt holders are those who lend you an umbrella when it's shining but demand it back the moment the rain shows up on the horizon.

There is no hard and fast rule about how much debt is bad. Certainly, a debt-to-equity ratio of 100 to 1 is pretty bad, no matter how one tries to spin it. But then there are those who think that 2:1 is already pretty bad. These are the likes of Warren Buffett and similar conservative investors. "The least the best" they say. I don't recriminate them. After all, I too don't appreciate gratuitous debt or companies that must take on debt because they have heavy fixed expenses or need too much reinvestment into fixed assets just to stay afloat (case in point: airlines, car manufacturing and some mining companies).


But there's a subtle kind of debt that is not at all bad. That is private debt with the owners.

A common way to fund a startup is by giving it equity -- owners put in cash in exchange for shares. Another common way to do it is to lend money to the company. In many ways, an owner lending money to his or her company is a smart way to fund it and yet keep first dibs on any cash left over in case the company goes under.

I currently hold a tiny cap company that has a 4:1 debt-to-equity ratio and is about to take on more debt. And yet, I'm not at all worried about it because the only reason this debt load is high is because of accounting reasons -- the owners prefer to fund the company that way, but are otherwise convicted of its success and so am I.

So, there you have it. There's bad debt and there's just accounting debt. Differentiating them can provide investing opportunities that are typically overlooked by even the deepest of the value investors.


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