What is equity funding?

Equity funding means selling shares in your company. You give up a slice of ownership. In return, you get capital you don’t have to pay back. 

It sounds simple. But the cost is real. Each new investor dilutes your stake. You share profits and future gains. You also share control.

How does equity funding work?

You issue new shares. An investor buys them with cash. That cash stays in the business. It funds salaries, product development, and growth.

Equity funding is especially common in early-stage startups (Pre-Seed, Seed, Series A). Many young companies have little or no revenue. Banks won’t lend to them because they lack a track record or product-market fit. So they look for investors willing to take a risk in exchange for potential high returns.

Who provides equity funding?

Equity funding can come from several places:

• Venture capital fonds: prefer startups with traction and big growth potential. They often push for rapid scaling.
• Angel investors: often invest earlier, when risk is highest and ideas are still raw. The expertise, network and knowledge they bring to the table are sometimes as important as the money they invest.
• Friends & Family: among the first believers, willing to back you when no one else will.

Each type has its pros and cons. Angels often come early and take big risks. VCs prefer more traction and push for rapid growth. Learn more about the different startup funding instruments and how they work.

A simple equity funding example

Say you run a SaaS startup. You raise €2M from a venture capital fund. In exchange, you give them 20% of your company. If you sell the company later for €50M, that VC’s stake will be worth €10M.

No monthly repayments. But you now own less. And you have new partners at the table.

What is debt funding?

Debt funding means borrowing money. Unlike equity, you don’t sell shares. You keep full ownership. But you must pay the money back, plus interest.

Debt is cheaper if you have cash flow. It’s risky if you can’t make payments on time. Miss them, and you can lose assets or go bankrupt.

How does debt funding work?

You take out a loan or a credit line. The lender charges interest. You agree on a schedule for repayments. Some debt is secured and therefore backed by assets. Some are unsecured and therefore the risk is higher for the lender, so higher interest for you.

Who provides debt funding?

Traditionally, banks are the main source of debt. But many startups don’t qualify for bank loans without assets to pledge. That’s where alternative debt options come in:

• Long-term loans: the most common source for debt financing from a traditional bank or other financial institution.
• Short-term loans: for emergency situations with high interest rates.
• Venture debt funds: Combines features of loans with some VC-like flexibility.
• Revenue-based financing providers: Repay a percentage of your monthly revenue. It is more flexible when revenue fluctuates.
• Flexible credit line providers: Draw down what you need, when you need it.
• Convertible debt: starts as debt but can convert into equity based on the specific agreement.

A simple debt funding example

A growth-stage startup wants to boost sales and marketing. They take €1,5M in a flexible credit line and can take on money as needed. The lender charges 10% annual interest. They repay the loan over three years.

Pros and cons: equity funding

Pros

• No mandatory repayments, capital stays in the business.
• Shared risk, investors lose money if the business fails.
• Investors bring strategic help, networks, and expertise.

Cons

• You give up a portion of ownership and future profits.
• Investors may push for growth at the expense of long-term sustainability.
• Decision-making can get complicated with many voices at the table.

Pros and cons: debt funding

Pros

• You keep full ownership and control.
• Interest payments are tax-deductible in many countries.
• No dilution, you keep all future upside.

Cons

• Must repay principal and interest on time, no matter what.
• Missed payments can lead to penalties, loss of assets, or bankruptcy.
• Harder for early-stage startups with little or no cash flow to qualify.

When to choose which: equity vs. debt funding

When does equity make more sense?

Equity is the better option if you’re early, risky, or aiming for massive growth. Young startups often have no steady income yet. They can’t pay back loans.

By selling shares, you bring in cash you don’t need to repay. You also get investors who want you to succeed. They may bring advice, contacts, and more money later.

Equity is also safer if your revenues are uncertain. If your business plan is built on a bold bet  (new market, new tech) you don’t want monthly repayments hanging over you.

When equity is better

• Early stage, pre-revenue
• Weak credit rating
• Big, risky growth plans
• No steady cash flow yet
• You need money for investments with an unclear ROI

When does debt make more sense?

Debt works when you have money coming in regularly. If you can forecast cash flow, you can pay lenders back on time.

With debt, you don’t lose ownership. You keep your shares and control. That means if your company’s value soars, you keep the upside.

There’s also a tax advantage. Interest payments reduce your taxable profit.

Example: a SaaS company is close to breaking even. They want to grow into profitability and seize opportunities along the way. They get a flexible credit line of €1M and use the money once they see an opportunity that fits. 

When debt is better

• Predictable, steady revenue
• You want to keep ownership
• You need money for investments with a clear ROI
• Your company is profitable or close to it

How to decide between equity and debt funding?

There is no universal rule to answer this question. It is highly dependent on what you need and want and sometimes a very basic question of how you want to run your company. But there are smart ways to weigh your options:

When deciding between equity or debt funding, you look at your stage, risk, cash flow, growth plans, and how much control you want to keep. 

Then you can run the numbers, see the cost of capital for each option, and can evaluate what you want to do.

Let’s break this down with simple scenarios founders face all the time.

1. You have no revenue yet

You have an idea. Maybe an early prototype. But no paying customers. A bank won’t touch you. If you borrow money, you can’t repay it. Debt is not an option. 

Better choice: Raise equity. Bring in investors who bet on your vision. They know they may lose their money if you fail and they hope to multiply it if you win big.

2. You have predictable cash flow

Your startup sells software on yearly contracts. You have steady subscription revenue. You need €200,000 to hire more sales reps. A debt funding instrument might be perfect. You keep all your shares. You repay from your incoming cash.

Better choice: Use debt. It’s cheaper than selling equity you can never get back.

3. You need a lot of money for a big bet

You want to launch in five new countries. The plan could triple your market or flop. If it works, you’ll be worth ten times more. If it fails, you may earn nothing for two years.

Debt would be dangerous here. You can’t guarantee repayments. One bad quarter and you’re stuck.

Better choice: Raise equity. You share the risk with investors. If it goes well, everyone wins. If not, you don’t owe money you can’t pay.

4. You want to stay in control

Maybe you’ve bootstrapped for years. You’re profitable. You don’t want new investors telling you how to run your business. You need cash to buy new equipment. But you can repay over time.

Better choice: Take out debt. You get the money. You keep the shares and stay in control.

5. You Have Weak Credit

Your business is seasonal. Revenue swings up and down. Banks see you as high risk. They’ll ask for collateral you don’t have.

Better choice: Consider equity. If you find investors who believe in your industry, you won’t need to bet the farm.

Simple rules of thumb

• If you can’t repay, don’t take on debt.
• If you want partners who bring network, choose equity.
• If you want to keep control and can handle repayments, use debt.
• Always compare the cost of giving up shares to the interest you’d pay on debt.
• Funding is never just about money. It’s about who sits at the table and what happens when things don’t go as planned.

Real-life examples: equity vs. debt funding

Abstract pros and cons are useful. But real examples make it tangible. Here are three funding paths startups actually take and what each means for risk, control, and payoff.

VC-backed: Trade Republic

Trade Republic is a prime example of an ambitious, venture-backed fintech. The Berlin-based neobroker raised over $1.25B from VC investors like Sequoia Capital, Accel, and Founders Fund to fuel rapid expansion across Europe and diversify its products. 

Its biggest round, a $900M Series C, valued the company at $5.3B and gave it the firepower to scale into new markets and outpace traditional banks. The trade-off? Ownership dilution and investor expectations for long-term growth and profitability, with an IPO likely to come later.

Debt-backed: Cloud86

Cloud86 took €1.2M in debt funding from re:cap to fuel its growth. The Dutch company invests in customer acquisition through focused marketing and enhanced service, all while maintaining full control – no dilution, no loss of independence.

Hybrid-backed: heycater!

heycater! first raised venture capital to get off the ground and grow fast. The early equity funding paid for product development and market entry. Later, the team faced a choice: raise more equity or use debt to keep scaling.

They chose debt funding from re:cap. This gave them extra capital to grow into profitability, without giving up more shares. By avoiding dilution, the founders kept more ownership and control while pushing the business forward.

Can you combine equity and debt funding?

Yes, you can. Many successful startups diversify their capital structure. Mixing equity and debt gives you flexibility. It spreads risk. It can keep your cost of capital lower than relying on just one source. 

Equity gives you a safety net. You don’t have to repay it. Debt can be cheaper in the long run if you have steady cash flow. Together, they help you raise more money without giving away too much ownership or taking on too much repayment risk. 

Scenario 1: You Raise Equity First, Then Add Debt

You close a €5M Series A round. This money fuels your team, product, and market entry. A year later, you have stable revenue. Now you want to scale faster but don’t want more dilution. 

You take €1M in venture debt. Your investors are fine with this since your risk profile is better now. You boost growth without giving up more shares.

Scenario 2: you use debt for working capital

Your business is solid. You raised equity years ago. You now run a healthy operation but face cash flow gaps each quarter that are a threat to your cash balance. Instead of raising more equity, you use working capital. Your ownership stays the same. Your investors stay happy because you’re not diluting their stake either.

Scenario 3: you plan ahead for a bigger round

Sometimes you use debt to buy time. You know you’ll raise another equity round later at a better valuation. A small debt facility now helps you grow to that milestone. When you do raise equity later, you get a higher price per share.

How to decide between equity and debt: a framework for founders

Equity or debt? It’s not a coin toss. It’s a business decision. The best choice depends on what stage you’re in, how steady your cash flow is, how much risk you can handle, and how much control you want to keep. 

Key factors to weigh

1. Stage

Are you pre-revenue or profitable? Early-stage startups usually need equity. If you can’t repay debt yet, don’t take it.

2. Cash flow

Do you have predictable income? If yes, debt can be cheaper than giving up shares. If not, equity is safer.

3. Risk

How much risk can you stomach? Debt means regular repayments. Miss them and you’re in trouble. Equity means partners for the long haul, but they share the upside and downside.

4. Investor appetite

Can you find good investors? Not every company is a good fit for venture capital. Some industries rely more on bank loans or revenue-based financing.

5. Control

How much do you want to keep? Equity means more voices at the table. Debt means you stay the boss as long as you pay up.

A simple checklist to decide

Ask yourself:

• Do I have enough cash flow to handle debt repayments?
• Am I okay giving up part of my company forever?
• Does this money get me to a clear milestone?
• Will more equity now save me money later?
• Do I know my real cost of capital for both options?

Common mistakes to avoid

Raising money can feel like success. It isn’t. It’s a trade. You give up something to get something. Do it carelessly, and you pay for years. ​​

Taking debt you can’t repay

Most reputable lenders won’t give you money if your business model can’t support repayments. They’ll check your forecasts, run stress tests, and ask for collateral or covenants to protect themselves. 

But the danger comes when founders overestimate their cash flow just to get approved. Or they accept overly optimistic revenue projections because they want the deal done fast. 

It also happens with newer or less experienced lenders. Some providers may take more risk to win deals. You get the money, but the repayment burden may be higher than you can handle in a downturn.

The trap isn’t taking debt. The trap is taking debt on shaky assumptions. A delayed launch, a lost customer, or a market slowdown can turn manageable repayments into a crisis.

Always stress test your numbers. What happens if revenue drops by 30 percent? Would you still meet repayment terms comfortably? If not, fix your plan first or choose another funding instrument instead.

Overlooking hidden terms

Not all money is equal. Some equity deals look good on paper but hide traps in the fine print:

• Convertible notes with heavy discounts.
• Investor veto rights on new funding rounds. 
• Covenants that restrict your spending or hiring.

For debt, watch for fees that add up: 

• Arrangement fees
• Early repayment penalties
• Personal guarantees

Never sign a term sheet you don’t fully understand. Bring in your CFO, lawyer, or a seasoned founder. Sleep on it. Negotiate what you can.

Not planning for the next round

A good funding decision should make your next round easier, not harder. Some founders take on too much debt now and scare off future investors. Others sell too much equity now, leaving no room for fresh investors later.

Every funding choice should fit into a bigger plan. Ideally, you should think 12-24 months ahead. What milestones will boost your valuation? What proof points will attract better investors or better loan terms?

Treating funding as the goal

Raising money is not the ultimate win. Building a profitable, sustainable company is. Funding just buys you time and resources to get there. Keep your burn rate sane. Spend new capital where it makes the biggest impact. Protect what you’ve built.

Conclusion: equity funding vs. debt funding

How you fund your company shapes everything that comes after: from who sits at the table to how much freedom you have when things get tough. 

There’s no single right answer, only the one that fits your stage, your risk appetite, and your vision for control. Take the time to stress-test your assumptions, weigh every trade-off, and map each funding move to where you want to be in one year, three years, ten years.

In the end, smart funding is about using both equity and debt wisely, at the right time, with your eyes wide open. Keep your options flexible, protect what you’ve built, and remember: every euro you raise should help you build the business you actually want to run.

Q&A: equity funding vs. debt funding

What is cheaper: equity or debt?

Debt is often cheaper if you have predictable cash flow and can make repayments on time. With debt, you pay interest, but you keep all your future profits. Equity can cost more in the long run because you give up ownership and share future gains with investors. Always compare the true capital costs: interest vs. dilution.

Can you mix debt and equity?

Yes, and many companies do. Combining both can give you flexibility, reduce risk, and lower your total cost of capital. Equity gives you a safety net with no repayments. Debt adds extra firepower without further dilution if you can handle it. The mix depends on your stage, revenue, and growth plans.

What happens if you can’t repay debt?

If you miss repayments, you could face penalties, extra fees, or even bankruptcy in severe cases. Lenders might claim your assets if the debt is secured. That’s why it’s crucial to stress-test your forecasts and only take on debt you can comfortably repay – even if things don’t go as planned.

Does equity funding require collateral?

No. With equity, you don’t pledge assets or property. Investors give you capital in exchange for shares. If the business fails, they lose their money — but they don’t get to claim your assets. In return, they get a stake in your future profits and a say in how you run the company.

When is equity funding better than debt?

Equity is better if you’re early-stage, pre-revenue, or taking big risks you can’t predict. You don’t have to make regular repayments, so you’re not squeezed for cash if growth takes longer than expected. Investors share the risk – and they often bring advice, contacts, and future funding too.

When does debt funding make sense? 

Debt works well when you have steady, predictable revenue and want to keep full ownership. You get capital without giving up shares, and interest payments are often tax-deductible. Just be sure you can handle repayments even if revenue dips temporarily.

Is venture debt the same as bank debt?

No. Traditional bank loans are usually more rigid and require strong assets or collateral. Venture debt is more flexible and designed for startups with recurring revenue or fast growth. It can fill the gap between VC funding rounds without adding more dilution, but interest rates are often higher than banks. 

How long does equity funding take?

Raising equity can take longer than getting a loan (if you’re with a traditional bank you might experience something else). You’ll need to pitch investors, negotiate terms, and complete due diligence. It can take several months, sometimes longer. With the right provider, debt can often be arranged faster, but only if you qualify and have good cash flow to back it up. 

How do investors and lenders see risk differently?

Investors take a stake in your success – if you win, they win; if you fail, they lose their money. Lenders want predictability. They care less about huge upside and more about steady repayments. That’s why they want to see proven revenue or assets they can claim if things go wrong.