Debt financing: A founder’s guide

What is debt financing?

Debt financing is when a company borrows money from a lender with the promise to repay the borrowed amount, known as the principal, plus an additional cost for borrowing, called interest, over an agreed-upon time. This method of funding allows founders to raise capital for their business without giving up ownership in your company. Instead of exchanging ownership, the company borrows money, which it will pay back on a set schedule, with an agreed upon interest rate. Debt financing options include loans, lines of credit, and bonds. As a founder, this is one of the two main paths for startup funding, the other being equity financing.

For many founders who are used to thinking about funding in terms of priced equity rounds, debt financing represents a different but powerful tool for growth, with the venture debt market alone reaching $62.4 billion in 2025.

Unlike equity financing where investors become part owners, debt financing creates a lender-borrower relationship that typically ends once the loan is fully repaid. This distinction is fundamental for founders who want to maintain control over their company's direction and capital structure. Understanding how to use debt strategically can provide the capital you need to scale while preserving the equity you've worked so hard to build.

How does debt financing work?

In a debt financing, a company borrows money that it must pay back, according to the repayment terms of their agreement. In addition to paying back the principal (the money borrowed), the company will also owe interest, which is the cost of borrowing money for the company.

Interest rates offered by financial institutions vary based on the borrower’s creditworthiness (including credit rating and credit history), as well as macroeconomic conditions, including the rate set by the central bank of a country, which in the United States is the Federal Reserve.

The core choice you face is between taking on a repayment obligation, which is debt, and giving up a piece of your company, which is equity. With debt, you borrow funds and agree to pay them back on a set schedule. With equity, you sell ownership stakes to investors in exchange for cash, making them partners in your business.

Understanding this fundamental tradeoff is the first step in building a smart fundraising strategy for your company. Each path has significant implications for your control, your financial obligations, and your overall capital structure.

Debt financing vs. equity financing

For founders, the choice between debt and equity financing comes down to a few key tradeoffs. Each path has significant implications for your ownership, control, and financial obligations. A simple comparison can help clarify which approach might be right for your company at its current stage.

In an equity financing, startups sell ownership interests in the company in exchange for capital. During an equity financing, the existing business owners—including founders and existing investors—will have their ownership diluted. Types of equity financing include raising money from angel investors and venture capital firms.

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Types of debt financing

There are several ways to raise capital through debt financing, including different types of loans, credit lines, bonds, and notes. While many types of debt financing exist, the startup world has its own unique set of tools. As a founder, you're most likely to encounter a few specific options designed for high-growth companies. Understanding these will help you navigate conversations with lenders and investors and choose the right instrument for your stage.

Bank loans

Companies can receive loans from financial institutions based on their business’s credit status and needs. In a bank loan, a company borrows a set amount of money, which it receives in a lump sum. The business then pays back its debt, along with interest, in set periodic installments (often monthly payments).

Private credit

Companies can also obtain debt financing through private credit. Private credit, also called private lending or direct lending, involves loans that are not issued by banks. Instead, the loans are issued by other types of companies, including private equity firms, business development companies, or alternative asset managers. Private lending is typically a good fit for companies that cannot qualify for a typical bank loan, which may include some early stage startups. Private credit has been around since the 1980s, but became more popular after the 2008 financial crisis and has boomed since interest rates shifted in 2022.

Private credit issued to startups is often referred to as venture debt. Venture debt financing is often issued at the same time as an equity funding round, to provide further capital to the startup without further dilution. The primary use for venture debt is to provide extra working capital to extend your company's runway between equity funding rounds. This additional time can allow your startup to hit more significant milestones, potentially leading to a higher valuation in your next fundraise. A common feature of venture debt is the inclusion of warrants, which give the lender the right to purchase a small amount of equity in the future, so it's important to track these on your cap table and monitor your debt-to-equity ratio.

Small business loans (SBA loans)

The U.S. Small Business Administration (SBA) helps small businesses, including startups, secure funding with reduced risk for lenders. The SBA partners with lenders (banks, credit unions, or other financial institutions) to help businesses obtain loans from $500 to $5.5M through a number of programs, with varying eligibility requirements. These preferred lenders issue the loans, rather than the SBA itself (which only issues loans directly in the case of a declared disaster).

SBA loans tend to have lower interest rates and longer repayment schedules compared to other debt financing methods.

Lines of credit

A line of credit is another way startups can borrow money. Unlike a loan, a line of credit is not a lump sum. Rather, a company borrows money as needed, and then repays the financial institution through a mix of interest and principal payments. For this form of debt financing, the company is approved to borrow up until a certain limit, but is not obligated to take out any amount of debt. One familiar type of line of credit is a credit card, although not all lines of credit need to come with a physical card.

Lines of credit are “revolving” types of financing, meaning that as companies pay back in, they can reborrow the same money. Generally, credit lines have higher interest rates than lump sum loans.

Bonds and notes

Companies can also obtain funding by issuing bonds or notes. The company sells bonds to investors and then must pay back the money by a certain date, called the maturity date, and make interest payments, called coupon payments, along the way. Interest rates for bonds are often lower than those for bank loans or lines of credit.

Convertible instruments: SAFEs and notes

Convertible securities, such as Simple Agreements for Future Equity (SAFE) and convertible notes, are a hybrid form of funding extremely common in early-stage fundraising like seed funding. While they are not traditional loans, they often behave similarly to debt in a liquidation structure by being senior to existing equity holders. However, they are not strictly equivalent to debt as they can be junior to other debt instruments. These securities are ultimately designed to convert into equity during a future priced round. Data from recent seed rounds on Carta shows that from Q4 2023 through Q3 2024, about 64% of seed rounds raised on Carta were SAFEs, while convertible notes made up about 10%.

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Advantages and disadvantages of debt financing

As with any type of fundraising, there are advantages of debt financing, as well as disadvantages to keep in mind.

Benefits of debt financing

Founders often turn to debt financing for its distinct advantages over equity. When used strategically, it can provide the fuel for growth without requiring you to give up a piece of your company. Understanding these core benefits is the first step in deciding if debt is the right move for your startup.

• Ownership is not diluted. Unlike with equity financing, during a debt financing, you are not giving up any ownership, or control, of your company.

• Tax deductions. The interest paid on debt is deductible as a business expense.

• Lowered cost of capital. Because interest is tax-deductible, debt can often be a more affordable way to scale compared to giving up equity.

• Build credit. When you take on debt and then pay it off on time, you build credit-worthiness for your business, which makes it easier to obtain other debt financing in the future.

Risks of debt financing

While debt offers clear benefits, it's important for founders to understand the associated risks before borrowing money. Unlike equity, debt comes with a firm obligation to pay it back, which introduces a new layer of financial pressure and responsibility. Being aware of these potential downsides will help you make a more informed decision.

• You must pay the money back. Even if your company fails, the principal and interest is owed to the lenders. If your company goes bankrupt, you will need to liquidate its assets to pay back lenders. In the event of company failure, lenders are often paid back first, before any preferred or common shareholders.

• High interest rates. Depending on macroeconomic conditions, interest rates fluctuate. During times where interest rates are high, the borrowing costs may make debt financing more difficult.

• Requires regular income. In order to make regular debt payments, your business needs to have cash flow. Businesses that have irregular cash flow or are pre-revenue are not a good fit for debt financing.

• Credit score impact. While managing debt well can increase your credit score, missing payments will negatively affect your business’s score.

When to use debt financing in your startup journey

The right time to use debt financing depends on your company's stage. The options available to you and the strategic reasons for taking on debt will evolve as your startup grows from an idea into a mature business. Aligning your funding strategy with your company's lifecycle is key to using debt effectively.

Seed and setup

At this early stage, your business is often pre-revenue and seen as high-risk—a period notoriously difficult to fund and often called the 'valley of death'—making traditional debt rare. Lenders typically look for a history of revenue or tangible assets, like real estate, as collateral, which most new startups don't have. The most common form of debt-like funding here is convertible instruments, such as SAFEs or convertible notes, from angel investors and pre-seed funds.

Early growth and team building

Once your startup has found product-market fit and is generating some revenue, you may become eligible for a small business loan or a line of credit. Product-market fit means you have found a set of customers who value your product. This revenue history can give lenders the confidence to provide capital for managing working capital or purchasing essential equipment to support your growing team.

Growth and operational maturity

After raising a Series A or later round, venture debt becomes a powerful strategic tool, especially as more companies are staying private longer and need short-term capital to bridge the gap between funding rounds. During periods of falling rates, some investors prioritize venture debt funding so startups can lock in attractive borrowing terms instead of raising additional equity at less favorable moments. At this stage, you have a proven business model and are focused on scaling. Venture debt can be used to accelerate growth, extend your runway to hit key milestones, or finance a major initiative before the next equity round.

For instance, the financial planning software provider Forecastr used debt funding to finance a major product relaunch, allowing them to respond to customer demand and rebuild their platform without immediate equity dilution.

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How debt financing impacts your cap table

A common question for founders is how debt financing affects the company's cap table. The answer depends entirely on the type of debt you take on, and it's an important, often overlooked aspect of equity management.

Traditional loans, which often act as senior debt, like a term loan or a line of credit, are recorded as a liability on your company's balance sheet and do not appear on the cap table itself. However, if the loan includes warrants—the right for the lender to buy equity in the future—those warrants absolutely must be added to the cap table to accurately reflect potential future dilution.

On the other hand, convertible instruments like SAFEs and convertible notes must be tracked on the cap table from the moment they are issued. Because they represent future shareholders, failing to account for them can lead to serious errors and disputes down the road. As Heather Hartnett, chief executive officer and general partner at Human Ventures, explained during Carta’s Mastering Fundraising Strategy webinar: "You have to be really realistic about how much money you need to get you to the next milestone, and then probably double that." Proper modeling is essential to prepare for these scenarios.

This is where a tool like Carta's scenario modeling software becomes invaluable. It allows founders to model exactly how these instruments will convert in a future priced round, providing a clear picture of dilution through a pro forma cap table. This empowers you to negotiate a term sheet with confidence and maintain a clean, accurate cap table that investors can trust.

How to prepare for debt financing

Getting ready to apply for debt financing is similar to preparing for an equity round. Lenders, much like VCs, need to see that you are organized, professional, and have a clear handle on your company's finances. This means having clean financial statements, a solid business plan, and an accurate, up-to-date cap table.

A messy cap table managed on a spreadsheet is a major red flag that can slow down or even kill a deal. It signals disorganization and creates uncertainty about your company's ownership structure, which is a risk most lenders are unwilling to take. Any confusion about who owns what can create legal and financial liabilities that make your company un-investable.

This is where a platform solution becomes essential. Using Carta’s cap table management software provides a single, trusted source of truth for your company's equity. It ensures your ownership records are always accurate and professional, giving lenders the confidence they need to invest in your company.

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Frequently asked questions about debt financing

Is debt financing a good idea for a startup?

Debt financing can be a strategic tool for growth if your company has predictable revenue or is close to its next equity round. However, it is generally too risky for pre-revenue startups seeking pre-seed funding with an unproven business model.

What is an example of debt financing for a business?

A common example is a startup taking out a term loan to purchase essential equipment for its lab. The company would then repay this loan in fixed monthly installments over an agreed-upon period of several years.

Does debt financing affect ownership?

Traditional debt, like a bank loan, does not affect ownership. However, convertible instruments like a SAFE and any warrants associated with venture debt will eventually convert into equity and cause dilution in the future.

What are covenants in a loan agreement?

Covenants are rules and conditions set by a lender that a company must follow to avoid defaulting on its loan. These can include requirements like maintaining a minimum cash balance or providing regular financial reports to the lender.

Can a pre-revenue startup get debt financing?

While traditional bank loans are unlikely for pre-revenue companies, startups often use convertible instruments like SAFEs. These act as a bridge to a future equity round, providing necessary capital without an immediate need for revenue.

How does venture debt affect my next equity round?

Venture debt can be a positive signal to VCs that your company is financially sophisticated, but the debt itself will need to be addressed. It is typically either repaid from the new funding or refinanced as part of the new round's terms.

What is a warrant and why do lenders ask for them?

A warrant is the right to buy a certain amount of company equity at a set price in the future. Lenders often require warrants as an equity kicker to gain some potential upside for taking on the risk of lending to a startup.

Does taking on debt make my company look weaker to VCs?

Not necessarily, and in many cases, it can be a sign of strength. Taking on venture debt to hit specific growth milestones is often a sign of sophisticated financial management, not distress.