A friend of mine is doing a deal that will mean taking on a lot of debt. On the surface, that sounds like a bad thing. And it will impose discipline via the payback schedule. But looking at cash flow, it seems likely that the debt can be serviced. So at least the deal doesn’t look crazy.
But this thumbnail analysis also misses the point. The question really is what will happen over time. There are a few possibilities. The business might take off which will make this investment look relatively small. As Fred Wilson puts it, the value that can be found may grow considerably. That is the hope. The business may not take off and things may run along as they are now. In this scenario, debt service will always be a headache. Finally, the business may crater, which will lead to a garage sale of assets.
In this case, the hope that the business will take off has some foundation. There are reasons to believe that this could happen by expanding the pool of clients and products. But as Fred points out, one has to factor in the risks that it will not before you decide that this is a good deal.
The above is pretty standard thinking. But things get a bit weird when you try to figure out the human element in developing opportunities and managing risk. How creative are the key actors? How motivated are they? Are they in this for the long haul? Tough questions. And in my experience, the human element plays a huge role in determining potential value.