Good Debt, Bad Debt: How Contractors Should Handle Borrowing in Their Business
Ask most personal finance gurus about debt and you will get a one-word answer: avoid it. For the owner of an HVAC, plumbing, or electrical company, that advice sounds safe, but it ignores how businesses actually grow. As Waterford Business Solutions points out in its video, Debt with your company: is it good or bad?, debt mismanaged can put a business in a bad spot very quickly, and it happens to owners all too often. Managed well, though, debt can help a company grow faster than cash flow alone would ever allow.
The real question is not whether to carry debt. It is whether the debt you carry is working for you or against you.
What Makes Debt “Bad”
Robert Kiyosaki, author of Rich Dad Poor Dad, sums it up simply: “Good debt makes me rich and bad debt makes me poor.” In an interview with SmallBizLady, he explained that the difference comes down to who pays for it. Bad debt comes out of your own pocket. Good debt is paid off by the income the asset it financed produces.
Bridgewater Associates founder Ray Dalio makes a similar point on a much larger scale. In Principles for Navigating Big Debt Crises, he describes credit as buying power today in exchange for a promise to repay later, and argues that borrowing is only healthy when the money generates enough income to service the debt.
For a contractor, that turns into a practical test. A loan on a new service van that lets you run two more calls a day can pay for itself. A credit card balance that funds payroll month after month, or a cash advance used to survive a slow season, cannot. Those debts do not produce revenue. They consume it.
Common examples of bad debt in trade businesses include:
What Legendary Investors Say About Leverage
Peter Lynch, who ran Fidelity’s Magellan Fund, made balance sheet strength a core part of how he picked stocks. In One Up on Wall Street, he made the point that companies with no debt can’t go bankrupt. He treated an equity-to-debt split of roughly 75 to 25 as the norm for a healthy company, and he was especially wary of bank debt that a lender can call in on demand. That last point hits home for small businesses, where a line of credit can be cut or frozen exactly when you need it most.
Warren Buffett has been even more direct. In his 2010 shareholder letter, he warned that leverage “all too often produces zeros”, even when very smart people use it. In his 2018 letter, explaining why Berkshire Hathaway avoids heavy borrowing, he wrote that rational people don’t risk “what they have and need for what they don’t have and don’t need.” Buffett has also repeated his late partner Charlie Munger’s line that a smart person goes broke in only three ways: liquor, ladies, and leverage.
There is an upside to that discipline. In his 2017 letter, Buffett noted that market declines create extraordinary opportunities for those not handicapped by debt. For a contractor, that might mean buying out a retiring competitor, hiring good technicians during a slowdown, or picking up equipment when a supplier is clearing inventory.
None of these investors claim all debt is evil. Berkshire itself carries debt at its railroad and energy businesses, which are asset-heavy and generate steady cash. The lesson is that debt should match the stability of the cash flow behind it.
How to Handle Bad Debt
If your business is already carrying debt that is working against you, here is a practical way to get it under control:
Using Debt the Right Way
Good debt has a clear purpose, a measurable return, and a repayment plan that does not depend on everything going right. Before signing any loan, ask three questions: What revenue will this generate? How long will it take to pay back? Can the business still make the payment in a slow month?
The gurus who say avoid all debt and the ones who say borrow as much as you can are both missing the point. Debt is a tool. Used with discipline and good financial records, it can help your business grow. Used carelessly, it can take away everything you have built. The difference is knowing which kind of debt you are carrying and having a plan for every dollar of it.