What is Debt Financing?

what is debt financing is a method by which a business raises money by borrowing it from external sources with a promise to repay the borrowed amount, typically with interest, over a defined period. This is one of the most common ways startups and established companies secure funds without giving away ownership.

In simple terms:

Key Features of Debt Financing

  • No Ownership Dilution: Unlike equity financing, you don’t give up shares.

  • Fixed Repayment Schedule: Repayments are usually monthly or quarterly.

  • Interest Cost: You pay interest on the borrowed amount, which becomes a cost to the business.

  • Legal Obligation: Repayment is legally binding — failing to repay can lead to legal consequences.

Types of Debt Financing

  1. Term Loans
    Borrow a fixed amount and repay over time with interest. Common with banks or NBFCs.

  2. Convertible Debt
    A loan that can convert into equity at a future date, typically used by startups.

  3. Lines of Credit
    Flexible borrowing, like a credit card for businesses. You pay interest only on the amount used.

  4. Invoice Financing
    Get money upfront based on unpaid customer invoices.

  5. Bonds and Debentures
    Used by more mature startups or companies to raise larger amounts from the public or private investors.

Advantages of Debt Financing

  •  Keeps control in the founder’s hands.

  •  Interest payments are tax-deductible.

  •  Structured repayment helps with financial planning.

  •  Faster to arrange than equity financing in many cases.

Risks and Considerations

  •  You must repay even if the business isn’t profitable.

  •  High-interest rates for early-stage startups.

  •  Missed payments can damage credit and reputation.

  •  Too much debt can reduce your future fundraising ability.

When Should Startups Use Debt Financing?

Debt financing works best when:

  • You have predictable cash flow.

  • You need funds for short-term growth like inventory, equipment, or marketing.

  • You want to retain ownership and control of your company.

Angel investors may also support a startup using convertible debt, as it gives a balanced mix of safety and future upside.

Final Thoughts

Debt financing is a powerful tool when used wisely. It can help startups grow quickly without giving up equity. However, founders must assess their ability to repay before committing. For angel investors, understanding a startup’s debt strategy is key to evaluating long-term sustainability.