Why startups raise debt: venture debt, credit lines, revenue-based financing and NCDs

The main reason is ownership. Selling shares means giving up a slice of the company. Borrowing means paying back a set amount with interest, and the founders keep their shares. If the business grows fast, that can be a cheaper way to fund growth.

The second reason is timing. Debt can bridge a short gap, such as paying suppliers before customers pay, or extending runway before the next equity round. It often arrives faster than a full funding round.

Debt also has a cost that equity does not: it must be repaid whether or not the company does well. Equity investors share the downside. Lenders do not, which is why they check cash flow, security and track record more closely than a venture fund checks a vision. A founder who expects to need more equity soon should weigh that too, since heavy debt can make new investors nervous about how much of their cash would go to the lender.

Venture debt is a loan for startups that have already raised equity from venture investors. The lender looks at the strength of those investors and the business, not just at assets. The loan usually lasts a few years and is repaid in instalments.

Lenders often take a small extra reward, such as the right to buy a few shares later. Our guide on venture debt covers the terms in more detail.

Because the lender is repaid first if the company fails, venture debt usually ranks ahead of equity. Equity investors often accept it only if the size is modest compared with the cash raised. Terms can include conditions called covenants, such as keeping a minimum cash balance.

A working-capital line is a loan from a bank or a lender that covers day-to-day costs, such as stock, wages and the gap between paying suppliers and getting paid. The company draws on the line when needed and repays it as customers pay.

This is the most normal form of business borrowing. A startup with steady sales and clear invoices is a better candidate. Lenders often ask for security, such as receivables or inventory.

Other forms include invoice discounting, where a lender advances money against unpaid customer bills, and term loans for equipment. Rates depend on the borrower's strength and the security offered, and can differ a lot between lenders.

In revenue-based financing, a startup receives money and repays it as a fixed share of its monthly revenue until a total amount is paid. If sales are high, the repayments are larger, and if they dip, so do the payments.

It suits companies with steady, predictable sales, such as subscription or direct-to-consumer businesses. Our guide on revenue-based financing explains the cost and the limits.

The cost is usually quoted as a multiple of the amount borrowed, such as repaying 1.2 times what you received, rather than as an annual rate. To compare it with a loan, work out the effective yearly cost based on how quickly it will be repaid. A fast repayment makes the same multiple much more expensive per year.

A non-convertible debenture, or NCD, is a bond issued by a company. Investors lend money and get interest, and the bond cannot be turned into shares. Some are privately placed with institutions, and others are listed on exchanges.

A startup issuing NCDs is usually larger and more established. It is a way to raise debt from several investors at once, not from a single lender.

Listed NCDs must follow SEBI's disclosure rules, and a credit rating agency usually rates them. A rating tells you how likely the issuer is to repay, in the agency's view. Lower ratings mean the issuer pays higher interest.

It is a good sign when the company has steady revenue, a clear plan to repay, and uses the money to grow something that already works. A lender that checks the books and agrees to lend is also a vote of confidence.

It is a warning sign when the company borrows because equity investors will not put in more, or uses debt to cover losses with no path to profit. Interest and repayments are fixed, so a company with falling revenue can quickly be in trouble.

One more clue is who the lender is and what they asked for. A lender that wants a promoter guarantee or a charge on all assets sees more risk than one that lends against future sales alone. Investors often read these details to judge how healthy the company is.

• Good sign: predictable revenue, clear use of funds, repayment well covered.
• Good sign: debt that comes alongside an equity round, not instead of one.
• Warning sign: debt used to cover regular losses.
• Warning sign: high interest or heavy security demands.
• Warning sign: repeated borrowing to repay earlier loans.

Lenders fall into a few groups: banks, non-bank finance companies, funds that specialise in venture debt, and platforms that offer revenue-based financing. Some are well-known names, but each has its own rules on who qualifies. A founder should compare cost, security and repayment terms.

Equity investors often like to see debt used for working capital, but dislike it when it limits future fundraising. Ask whether a lender's rights come before the new investors.

Founders should also check what happens if they miss a payment. Some loans let the lender take over assets or demand early repayment. A lender's rights on default are as important as the interest rate.

Check four details: the amount, what it will be used for, who lent the money, and whether it comes with a recent equity round. A ₹100 crore debt line for a profitable company is very different from the same amount for one that is burning cash.

Ask also whether the debt is the main news or a side note to a larger equity round, since a company that raises both is in a different position from one that only borrows.

This is general information, not financial or legal advice. Get professional advice before taking on debt.