A related side effect of being highly leveraged is the unwillingness of lenders to provide more debt financing. In this case, a firm that finds itself in a jam may have to issue stock on unfavorable terms. All in all, being highly leveraged is generally viewed as being disadvantageous due to the increased risk of bankruptcy, higher borrowing costs, and decreased financial flexibility. On the other hand, using debt financing has advantages. Stockholder's potential return on their investment is greater when a firm borrows more.
Borrowing also has some tax advantages.
The optimal capital structure for a company you invest in depends on which type of investor you are. A bondholder would prefer a company with very little debt financing because of the lower risk inherent in this type of capital structure. A stockholder would probably opt for a higher percentage of debt than the bondholder in a firm's capital structure. Yet, a company that is highly leveraged is also very risky for a stockholder. When a firm becomes over leveraged, bankruptcy can result.