Debt vs Equity Funding: How Startups in India Can Choose the Right Capital?

Your company is growing and now you need capital and down to 6 months of runway.

A VC offers ₹ 3 crore for 15% equity. A bank offers a ₹ 1 crore loan with collateral. Your gut is telling you to “hold on to ownership”.

So, what’s the right move? Debt vs Equity?

Choosing between debt and equity funding is a defining moment in every startup’s journey. At Master Brains, we’ve worked with 50+ Indian startups to build capital structures that balance growth with control. This guide gives you a clear framework to decide in today’s funding climate.

1. Why Capital Structure Matters

A company’s capital structure is the mix of debt and equity used to finance its operations and growth.

Choosing the right mix is a matter of:

1. Cost of capital: the costs to raise money.
2. Ownership: Control is shared or diluted.
3. Risk: Exposure to financial risk.
4. Flexibility: Ability to respond to new opportunities or downturns
5. Taxation Implication: Startup Taxation and interest on debt is deductible, dividends offer no tax shield.

Like Zomato relied on equity from Info Edge, Sequoia Capital and Ant Group.

2. Debt Funding: Borrowing with Interest

Debt funding means borrowing money that repaid with interest. Indian venture debt is offered by SIDBI, InCred, NABARD, Mudra loans, Northern Arc, Trifecta and more.

Why choose debt for Indian startups?

1. Predictable Repayment Schedule: Fixed interest and principal repayments help with financial planning.
2. Builds Creditworthiness: Timely repayment improves your credit score for future borrowing.
3. Tax benefits: Interest payments on debt are allowed to be claimed as generally deductions under tax laws, reducing overall tax burden.

What are the risks with debt?

1. Repayment Pressure: Repayment is mandatory regardless of business performance.
2. Collateral Requirements: Banks demands security of any asset.
3. Limited Availability: Early-stage startups without collateral or steady revenue find it hard to secure loans.

3. Equity Funding: Sharing Ownership for Capital

Equity funding means selling a portion of your company to investors in exchange for capital. Some active equity investors are Sequoia Capital India, Accel Partners, General Atlantic, Everstone Capital GIC (Singapore), SoftBank Vision Fund.

Urban Company raised equity in early startup funding for customer acquisition and service partner training.

Why choose equity for Indian startups?

1. No repayment pressure: No repayments to equity investors if you have no sufficient profit.
2. Access to expertise: Investors often bring mentorship, networks and strategic guidance.
3. Higher capital amounts: Equity investors may provide larger sums compared to loans.

What are the issues with equity?

1. Dilution of ownership: Giving away equity means giving up some control and future profits.
2. Investor expectations: Investors expect growth and returns, pressuring founders to scale rapidly.
3. Higher Cost Compared to Debt: Equity is expensive than debt because dividends are post-tax and higher risk bearing. SEBI AIF Guidelines also apply.

4. The Hybrid Approach: Combining Debt and Equity

Many startups find that a blend of debt and equity is the best approach.

1. Seed equity funding helps to develop the product and gain users.
2. Debt financing later supports scaling operations and capital expenditures.

Nykaa combined equity and venture debt to fuel inventory and marketing growth.

5. Decision Framework for Funding: Debt, Equity or a Combine?

To decide between debt, equity or mix, Master Brains have built an 8-step thinking framework for company leaders, startup founders:

1. Business Stage: New startups with little money usually choose equity. Growing startups use both equity and debt. Big, stable companies mostly use debt. Companies in trouble may pick equity or fix their business first.
2. Cash Flow Stability: If cash flow is steady and predictable, take debt. If cash flow is uncertain or volatile, equity is safer.
3. Valuation and Dilution Risk: When a company has a high valuation, issuing equity causes less ownership dilution. Low valuation makes equity expensive because of greater ownership loss. Valuation advisory services help to evaluate this.
4. Cost of Debt vs Cost of Equity: Compare debt interest rates with the expected returns equity investors want. Use the Weighted Average Cost of Capital (WACC) to find the optimal mix.
5. Market & Investor Sentiment: Strong equity markets make IPOs or share issues easier. Low interest rates and available credit reduce the cost of debt.
6. Legal and Tax Environments: Laws around debt-to-equity ratios, tax rules and securities regulations impact financing choices.
7. Strategic Uses of Funds: Long-term goals like acquisitions or R&D suit equity or long-term debt. Short-term needs such as working capital may be better served with debt.
8. Risk Tolerance: Evaluate how much debt burden can the company carry. You should have reserves or backup plans.

Talk to an expert startup consultant to help you analyse.

6. Hybrid Instruments & Alternatives

Companies often use hybrid forms that lie between pure debt and pure equity.    

1. Convertible Debt starts as a loan but can convert into shares later, delaying ownership dilution.
2. Preferred Equity gives investors priority for dividends and is less dilutive than common equity.
3. Mezzanine Financing is a high-risk loan with equity-like features, used when conventional loans aren’t available.
4. Venture Debt is for growing startups and offers less dilution than equity but comes with strict terms.

CureFit used convertible notes in early rounds to defer valuation discussions.

7. Recent Trends in Debt & Equity Markets

Funding strategies are evolving rapidly in India.

1. Venture debt is growing, especially as equity funding slows. In India, it has risen sharply while equity deals declined.
2. Private credit is expanding, with more firms turning to non-bank lenders and private debt funds. In India, it reached $9 billion in early 2025.
3. ESG-linked debt is gaining traction, with tools like green bonds and sustainability-linked bonds used to fund socially responsible projects.

8. Metrics & Tools: Capital Structure Toolkit

Metrics used in capital structure optimization:

1. Debt-to-Equity Ratio: Total Debt/Equity, it depends on your industry benchmark, generally it should below be 2:1.
2. Interest Coverage Ratio: EBIT/ Interest expense. Above 3 is considered safe
3. Debt Service Coverage Ratio: EBITDA / (Principal Repayment + Interest Expense), should be >1.
4. WACC: Combines cost of debt and equity, weighted by their proportions. The goal is to minimize WACC to increase firm value.
5. Return on Equity (ROE) vs WACC gap: If ROE > WACC, the company is generating value for shareholders.

9. ESG & Sustainable Funding

ESG (Environmental, Social and Governance) is now a key part of funding.

Green Bonds raise money for clean energy. Sustainability-Linked Bonds change terms based on ESG targets. ESG-linked equity is also growing, as investors want companies to meet ESG standards. These reduce costs and improve trust with clear reporting (SEBI BRSR) to avoid greenwashing.

Greenko Group raised $ 940 million through green bonds to expand its renewable energy projects across India

10. The Role of Financial Planning and Advisors

Building capital structure is a critical process, it requires sharp understanding of internal and external factors from lens of technical knowledge and experience. It is the matter of your company’s future.

Financial advisors and planners bring valuable expertise to analyse options, optimize the capital structure and foresee potential challenges. Working with trusted professionals can help you make informed decisions, balance risks, reduce costs and position your company for sustainable growth.

To Founders,

We understand behind every funding decision lies a founder’s emotional journey.

Wrestling with the fear of losing control, debt repayments burden, disappointing investors. Faced pressure from family, from investors and from himself to deliver hypergrowth at all costs.

These emotional realities shape decisions as much as financial metrics.

Being open about these feelings, seeking mentorship and choosing startup advisors like Master Brains who understand your vision can help gain clarity and confidence.

You want us to build your customised capital structure for your startup?

Reach out to Master Brains for advisory and strategic support. It’s time to get the right capital mix that power up your growth journey in India.

Call us today:+91-8595867402

Email us now: masterbrains.office@gmail.com