Let's say Company XYZ borrows a million bucks by issuing some bonds. The company promises to pay 10% a year interest on the million dollars. XYZ needs to generate at least $100,000 per year to pay just the interest on its debt. XYZ only generates $50,000 in revenue for the whole year. But it's OK because XYZ promises to go into twice as many markets next year, so it issues another million bucks' worth of bonds.

Now it's able to enter some more markets and use some of the second round of bonds to repay its building debt. The next year, the company generates $120,000 in revenue and everyone holds a party because the company was able to generate so much incremental revenue. But XYZ wants to enter even more markets the following year, so it goes back to the bond market and issues yet another million bucks' worth of bonds. Here's where the whole house of cards begins to collapse.

Where the Trouble Is

XYZ sees its growth slowing, and it generates only $150,000 in revenue the third year. Suddenly, its bondholders realize that they might not get all of their money back. So a lot of them sell their bonds. The price of an XYZ bond falls, say, to where an investor can buy one for 50 cents on the dollar. The bond receives 10 cents in interest every year, so now the bond yields 20%.

The company needs to raise more money, though, because it can't possibly pay back even the debt's interest, which is now up to $300,000 a year. (XYZ raised $1 million three times at 10% interest.) But now, if the company wants to issue more bonds, it'll have to do it at a 20% interest rate. Uh-oh. That means the next million dollars will cost them $200,000 per year. Thus, XYZ can't afford to borrow any more money. Meanwhile, its stock is trading at $2.50, giving it a market cap of less than a million dollars, and it can't possibly push a secondary offering onto the equity markets to raise any substantial amount of money.

That's what it means when someone says the debt and equity markets have been shut off to XYZ.