Myth-Busting: "Debt Is Cheaper Than Equity" - the Trade-Offs that Founders Miss

Every founder has heard it: “debt is cheaper than equity”. Interest is tax-deductible, coupon rates sit below equity return expectations, and, crucially, debt does not dilute your ownership. On a spreadsheet, the case might be compelling but in practice, it is incomplete.

What we want to surface are the legal, structural, and operational costs that sit beneath the debt finance; costs that founders may underestimate until they are locked into a facility agreement.

Why the Myth Persists

-        Debt lets you retain full ownership. Interest is tax-deductible

-        Repayment terms are predictable

-        Once the loan is repaid, your obligations to the lender are over, even if the company has grown tenfold in the interim

These are genuine advantages, and for a business with stable cashflow, debt can be an excellent tool. The difficulty arises when founders treat these advantages as the whole picture.

Restrictive Covenants: The Price of "Cheap" Capital

Debt financing comes with restrictive covenants, which are contractual provisions that limit how you can operate your own business. These may restrict you from taking on additional borrowing, impose financial ratios you must satisfy, and require the lender's prior approval for significant decisions (including acquisitions). Most lenders will also require you to comply with financial covenants focusing on revenue and profitability, and will restrict anything that could distract from the business plan, consume cash, or create further indebtedness. Some debt providers may even require a board observer seat.

These are not theoretical constraints. If you want to pivot into a new market, acquire a competitor, or make a significant capital expenditure, your lender may have an effective veto on these decisions.

Many founders choose debt precisely to avoid investor oversight, only to discover that a lender's covenants can be more prescriptive and less negotiable than the consent rights being requested by a VC. A well-negotiated shareholders' agreement gives you room to manoeuvre, whereas a standard-form facility agreement often does not.

Security and the Encumbrance of Your Assets

If the business fails, equity investors share in the downside. Debt works differently. Many lenders require secured loans, meaning the company grants the lender a security interest over its assets. If the company cannot repay the debt, the lender can take possession of the security.

Venture debt facilities are typically secured against all assets of the company, with lenders expecting first-ranking, senior security. Once you have granted a floating charge in favour of a senior lender, your ability to raise further debt, or even deal freely with those assets, is materially curtailed.

The Control Paradox

This is the heart of the myth. Founders choose debt to preserve control and, in a sense, they do, as debt does not dilute their shareholding. But control is not solely a function of shareholding percentage.

It’s true that equity investors will negotiate board seats, consent rights, and information rights. But these rights are all negotiable. A founder with strong leverage can limit investor consent rights and retain meaningful operational autonomy.

Debt covenants are often non-negotiable in their core structure, particularly for early-stage or mid-market borrowers. The restrictions can extend to dividend payments, further borrowing, changes of business, disposals of assets, and changes of control. Many facility agreements include mandatory prepayment on a change of control, effectively giving the lender a veto over M&A exits or new investors. In other words, debt introduces fixed obligations that create real financial pressure, even though it lets you keep your shares.

Default and the Risk of Losing Everything

Equity has no maturity date and no event of default. If your company underperforms, investors may be frustrated, but they cannot force you into insolvency or seize your assets.

Debt is different. A lender's remedies on default (which might be triggered by a missed payment, breach of covenant, cross-default, material adverse change or change of control) can include acceleration of the entire loan, enforcement of its security, and, in extreme cases, the appointment of an administrator or receiver.

The downside is asymmetric: the lender's upside is limited to interest and fees, but in respect of the company, a downturn could result in the loss of the business. Because startup lending is often underwritten on projected growth, a company that simply grows more slowly than the lender's model assumes may find itself in default, even though the business is far from failing.

Refinancing Risk: Cheap Today, Expensive Tomorrow

Debt must be refinanced or repaid at maturity. A founder who secures a three-year facility at favourable terms may face a very different market when it expires: higher interest rates, tighter credit appetite, or a deterioration in the company's own financial position.

The total cost of venture debt also extends well beyond the headline interest rate. Arrangement fees, exit fees, warrant rights, non-utilisation fees, and prepayment penalties all contribute to the true cost of borrowing.

Equity, by contrast, is permanent capital: no maturity wall, no refinancing risk.

The Bottom Line

Debt is not always the wrong decision for founders, but the decision to take on debt should be made with full knowledge of the trade-offs, not on a cost-of-capital comparison alone.

"Debt is cheaper than equity" is not wrong. But it is incomplete. The true cost of debt is measured in covenants that constrain your freedom, security that encumbers your assets, default provisions that can cost you the business, and refinancing risk that can turn today's bargain into tomorrow's crisis.

The question for founders should be which form of capital best supports your business at its current stage, allows you to preserve meaningful control, and positions you for what comes next. Sometimes that will be debt, sometimes equity, sometimes a blend of both. The important thing is to make the decision with your eyes open.