Financing growth through debt exposes the company to a major vulnerability because it amounts to accumulating two types of risks: an operational risk (linked to growth, competition, innovation or acquisitions) and a financial risk (linked to debt service).

Here are the specific mechanisms by which this strategy weakens the company:

1. The double hazard rule

The principle of financial prudence states that “financial risk should not be piled on top of operational risk”.

• Operational risk: Growth, especially when it is achieved through acquisitions (acquisitions), involves uncertainty about the integration of targets and the achievement of expected synergies.
• Financial risk: Debt creates a contractual obligation to repay (fixed financial costs) regardless of the level of activity. If the integration fails or the market turns, the company finds itself caught between declining operating revenues and rigid financial charges.

2. The loss of flexibility in the face of price wars (The Lafarge case)

Debt reduces the company’s ability to respond to competitive aggression. Financial expenses are fixed costs that raise the company’s break-even point.

• Mechanism: If a competitor (with cash or low debt) launches a price war, the indebted company cannot match indefinitely. It must maintain sufficient margins to pay its interest, or risk default.
• The Lafarge example: The cement manufacturer Lafarge financed its growth through debt to avoid diluting its shareholders. When its competitor Orascom attacked its market share via a price war, Lafarge, paralyzed by its rising financial costs, was unable to fight back effectively on prices. To defend itself, Lafarge ended up buying out the aggressor (Orascom) by taking on even more debt (an additional 6 billion euros) just before the 2008 crisis. This headlong rush led to a dilutive capital increase, emergency asset sales and finally to the loss of independence (merger with Holcim).

3. Destruction of optional value (Loss of opportunities)

Debt financing consumes the financial flexibility of the company.

• Opportunity cost: A company that is indebted to its maximum capacity (to optimize its cost of capital at a given time) loses its “power reserve”. It will not be able to seize new unanticipated investment opportunities (growth options), as banks will refuse to lend more.
• Advantage of under-indebtedness: Conversely, under-indebtedness is a strategic weapon. It makes it possible to strike fast and hard, like Danone (BSN), which was able to buy the subsidiaries of RJR Nabisco in one week thanks to low leverage, where more indebted competitors were unable to raise the funds.

4. The real growth vs. sustainable growth trap

Growth naturally consumes cash (increase in working capital and investments).

• If the company’s real growth is higher than its sustainable growth (the growth rate that the company can self-finance via its retained earnings), the debt ratio automatically increases.
• If this dynamic is not controlled by a capital increase, the company gradually weakens until it reaches a breaking point where banks cut off credit lines.

In short, while debt offers a tax advantage (interest deductibility) and can boost the return on equity (leverage) as long as business is good, it puts the company in a vulnerable position  as soon as the environment becomes volatile, depriving it of time and ammunition to react.