Debt, equity, and the right to survive

The cheapest-looking money can become the most expensive contract in the company. Price the claim, the timetable, the control, and the failure case together.

A lender offers fictional Kaveri Systems a facility at a quoted annual interest rate. An investor offers the same cash with no scheduled repayment. The loan appears cheaper. The equity appears safer. Neither comparison is complete until Kaveri asks what each provider receives, when they receive it, what happens if the plan is late, and which decisions move out of the founders’ hands.

Capital is not applause. It is a contract over future cash, assets, ownership, or control.

Know the claim you are creating

Every funding instrument can be examined through five questions:

1. Cash flows: what is paid, to whom, on which dates, and under which conditions? 2. Credit: who bears the loss if the business cannot perform? 3. Seniority: where does the claim rank if cash is insufficient or the company fails?

4. Transferability: can the provider sell or assign the claim, and to whom? 5. Optionality: who may convert, prepay, accelerate, redeem, veto, or force a sale?

Add two founder questions: what information and approval rights are granted, and what personal assets or relationships are exposed?

Debt usually creates a fixed or scheduled claim that ranks ahead of ordinary equity. Equity is a residual claim: owners receive what remains after employees, suppliers, tax authorities, and creditors are paid. Hybrid or convertible instruments can combine loan economics, preferred rights, and a route into equity. The label on the cover page never substitutes for the clauses. Remember the accounting distinction from Chapter 29. Supplier payables and customer advances are liabilities, but they are not automatically interest-bearing debt. They still carry obligations: the supplier must be paid; the customer must receive what was promised. “Non-debt” never means “costless.”

Use the capital ladder as a sequence of questions

There is no universal funding order, but there is a disciplined search order:

Customer funding is strong evidence because it accompanies demand, but it is not free cash. A deposit increases cash and a delivery liability. Retained profit preserves ownership, but using it concentrates more of the family’s wealth in one company. Debt preserves the ownership percentage, but payments arrive even when customers do not. Equity shares the downside, but also the upside and decisions.

Finance the gap before financing the company

Kaveri wins a fictional ₹24 lakh order that requires ₹12 lakh of components and installation capacity before final collection. The founders first redesign the cash terms:

• • a 30% customer deposit provides ₹7.2 lakh;
• • negotiated supplier terms defer ₹3 lakh until after the first delivery milestone;
• • ₹1.8 lakh comes from an approved operating buffer.

The initial ₹12 lakh cash gap has been covered without selling permanent ownership. The deposit remains attached to delivery, the supplier bill remains payable, and the buffer must be rebuilt. If the customer refuses a deposit, the company may examine a short-duration working-capital facility tied to the contracted receivable. If the order depends on unproven demand, uncertain acceptance, or a long product build, fixed debt service may be the wrong claim.

The lesson is broader than this arithmetic. Ask whether the cash problem can be reduced through contract design, billing, inventory, scope, supplier terms, or a staged pilot before raising an amount large enough to hide the underlying cycle.

The debt gate

Before borrowing, write one page that includes:

• • exact use of proceeds and the asset, contract, or cash-flow mechanism expected to repay it;
• • principal, stated rate, effective rate, processing charges, legal cost, insurance, commitment fees, and prepayment charges;
• • repayment dates, amortisation, moratorium, maturity, and refinancing dependency;
• • security, lien, recourse, cross-default, personal guarantee, and enforcement consequences;
• • covenants, reporting duties, lender approvals, and events of default;
• • interest-rate, currency, customer-concentration, and duration mismatch;

• • base, delay, margin-down, and severe-but-plausible cash cases;
• • the path if the funded project produces nothing.

Test debt service against cash available for payment, not accounting profit. Interest coverage can diagnose operating capacity, while a direct cash forecast tests actual instalments and principal. A ratio above a chosen line is no protection if one concentrated customer pays after the instalment date.

A personal guarantee changes the boundary of the bet. Limited liability may no longer protect the guaranteed assets. Never sign one from a summary or relationship conversation. Resolve the exact maximum exposure, duration, release mechanics, collateral, co-guarantor obligations, and enforcement rights with an independent lawyer and the relevant financial adviser.

The equity gate

Equity has no ordinary scheduled repayment, but it carries its own timetable. The investor may need a company large enough, fast enough, and liquid enough to satisfy a fund or mandate. A profitable, controlled regional company can be an excellent founder outcome and an inadequate institutional venture outcome.

Before issuing equity, model:

• • current and fully diluted ownership after this round and plausible later rounds;
• • board seats, reserved matters, vetoes, information and inspection rights;
• • liquidation preference, participation, anti-dilution, conversion, redemption, and transfer terms;
• • founder vesting, employment, salary, leaver treatment, and restrictions;
• • option-pool size and who absorbs its creation or top-up;
• • use of funds, milestones, follow-on dependency, and the no-next-round case;
• • exit expectations and whether they match the company you intend to build.

Chapter 32 does the arithmetic. The gate here is strategic: does permanent capital fund an engine that could justify permanent claims?

Price the total cost under success and failure

Debt is often cheaper when reliable cash flows arrive as expected. Its fixed cost lets owners keep the remaining upside. That same fixed claim can force sale, default, or personal loss when the schedule outruns cash. Equity can be economically expensive in a large success because the percentage participates without limit. It is more forgiving of operating losses because ordinary equity alone cannot trigger payment default. Do not compare annual interest with today’s percentage dilution. Model money outcomes and decision rights under at least four states: plan fails, plan is late, plan works modestly, and plan becomes exceptional. Include what happens at the next funding event. Include the value of survival and control; both can dominate the spreadsheet.

My son, raise while you can still say no. Capital negotiated under desperation usually buys less time, takes more protection, and narrows your choices further.

RED LINE Professional handoff. Have a qualified CA review cash capacity, accounting, and tax effects; a practising CS review corporate approvals, registers, and securities compliance; and an independent lawyer review enforceability, security, guarantees, investor rights, and exit clauses. Exact Indian requirements and regulated-lending rules must be checked at the official source on the transaction date.

· EF pp. 88–94 · TABLE pp. 56–59, 64–67 · RM pp. 57–60 · GE ch. 26. Mechanisms paraphrased; Kaveri Systems and its order are explicitly fictional. Contract, compliance, and professional-review judgments are qualified.