When used in the right amounts and for the right purposes, leverage -- or debt financing -- can be a critical part of your company's growth. Fundamentally, incorporating leverage into a company's capital structure offers one significant advantage: entrepreneurs can increase the value of their companies, without diluting ownership. However, there are also risks. If your leveraged company hits an unexpected rough patch and cannot make interest or principal payments, you may be forced to sell assets, take a cash infusion to retire debt or, worst-case scenario, lose control of your firm. The challenge lies in determining the prudent amount of debt your company can take on without jeopardizing its well-being and long-term growth potential.

Consider the case of FleetCor Technologies, an Atlanta-based company that provides smaller companies with fuel cards and other innovative ways to manage their vehicle fleets. Founded in 2000, FleetCor grew rapidly through its early years, using a $45 million private equity investment to upgrade both its technology and marketing capabilities.

In 2004, the company's management decided to pursue growth through acquisition. FleetCor did not have a publicly traded stock as currency, however, and could not finance its merger-and-acquisition (M&A) activities from cash flows. Instead, FleetCor's board advised the company to fund its M&A program with leverage, taking on modest debt to cover acquisitions. The beauty of this strategy was that FleetCor's ability to borrow was based on its cash flows. By buying complementary companies and managing those acquisitions so that customers were retained, FleetCor accelerated its own cash flow by benefiting from the cash flows of the acquired companies. As a result, the company's management was able to grow without relinquishing ownership -- and to fund interest payments partially from the cash flows of the acquired companies.

FleetCor used this strategy to make over 25 acquisitions, more than quadrupling its revenues. The company even expanded internationally into the United Kingdom and the Czech Republic -- all through prudent use of leverage. Today, FleetCor's fuel card programs serve more than 500,000 businesses with approximately 3 million active cardholders. The company processes purchases of over $12 billion of fuel annually, and its revenue has expanded nine times since its founding in 2000.

Despite FleetCor's success, many companies should take on little leverage, and a few should not borrow at all. How do you determine how much leverage your company can handle? Here are the main factors that you should consider:

Absolute earnings: In one respect, corporate loans are just like mortgages: how much you can borrow depends on how much you earn. The key metric here is the interest coverage ratio, which is calculated by dividing EBITDA (or earnings before interest, taxes, depreciation, and amortization) by the interest expense. Lenders will rarely approve ratios lower than 1.5; that is, your expected earnings must be at least 150 percent of your interest payments.

Earnings fluctuation: Lenders prefer predictability. They look for steady earnings, year-to-year and quarter-to-quarter. If your financial results fluctuate wildly -- even in a positive direction -- you will likely be credited with only a portion of earnings. For example, if your earnings suddenly doubled, banks might count only half of them in calculating your interest coverage ratio, which would result in a smaller loan amount.

Growth prospects: Unlike equity investors, lenders have no stake in whether or not you grow your company. Their return--in interest and in principal payments -- will be the same if your company remains the same or triples its size. For this reason, many lenders consider very rapid growth trajectories as a negative. Explosive growth is difficult to sustain, making future earnings hard to project. Moreover, expansion often requires capital expenditures--in plants, equipment, new systems, and technology -- which may hamper your company's ability to make its debt payments. Therefore, many lending agreements include covenants that cap the annual amount you can spend on capital improvements.

Type of debt: Debt comes in two forms, senior and subordinated. Senior debt is less expensive than subordinated debt, but may have restrictive covenants and require collateral. Subordinated debt, on the other hand, pays a higher interest rate. It generally results in dilution because the subordinated debt holders also receive equity in the form of warrants or common stock when they buy their subordinated debt.

Interest rates and terms: Loans to middle-market companies typically range from five to six years in duration. They are usually floating-rate, tied to LIBOR (the London Interbank Obligation Rate) or to the prime rate as the reference rate, and include a financing cost of several hundred basis points over the reference rate. As we have seen recently, LIBOR can fluctuate with changes elsewhere in the credit markets. Therefore, it can be difficult to project how LIBOR will behave.

Market conditions: Credit availability is cyclical. Currently, credit is tight because of the fallout from widespread subprime defaults. As a result, even high-quality growth companies with good, consistent cash flows may have more trouble than usual in obtaining financing. We are already seeing some recovery, however, and many banks are again willing to lend, particularly if they can share some of the underwriting risk with a syndicate of co-lenders.

All these factors will have an impact on how much your company can borrow, under what terms, and at what cost. Before finalizing a loan, you should carefully work through these issues with your lenders, investors, and board. By developing a strong relationship upfront with lenders, you can ensure that you are borrowing the right amount of money and building trust -- which will be beneficial if you encounter problems down the road.

Walter G. Kortschak is a managing partner of Summit Partners, a private equity and venture capital firm with offices in Boston, Palo Alto, and London. Since 1984, Summit Partners has invested in more than 290 growing, profitable companies across the United States and Europe. Walter can be reached at 650-614-6600 or wkortschak@summitpartners.com .