Most capital structure debates treat debt and equity as interchangeable ways of getting money into a business. In the two years before a listing, they stop being interchangeable. What a company raises in that window, and in what form, is written into the offer document, priced by institutions reading it, and in some cases locked into the share register for months after listing.
The choice between debt funding and equity funding is therefore not only about cost. It is about what the capital table looks like on the day the draft red herring prospectus is filed, and how much freedom remains after that.
Why the Pre-IPO Window Changes the Calculation
An IPO is not a listing-day event. Practitioners generally date the process from 18 to 24 months before the DRHP is filed, which is when financial reporting, internal controls and the capital structure have to be put in order.
Two rules make the timing unforgiving.
First, convertible instruments cannot simply be carried into a listing. Under the third proviso to Regulation 5(2) of the ICDR Regulations, outstanding convertible securities must be fully paid up and mandatorily convert into equity on or before the filing of the red herring prospectus. In practice many companies insist on conversion at the DRHP stage itself. A convertible note issued eighteen months before filing becomes ordinary equity at exactly the moment the founder has least negotiating room.
Second, the share register freezes. Under Regulation 17, the entire pre-issue capital held by non-promoter shareholders is locked in for six months from the date of allotment in the IPO, with carve-outs for shares issued under an employee stock option plan and shares held by venture capital funds, foreign venture capital investors and Category I and II Alternative Investment Funds.
Anyone who takes equity in this window is committing to stay. That is worth knowing before the term sheet is signed, and it is the sort of sequencing question Lorvet works through with promoters well before a merchant banker is appointed.
What Debt Funding Actually Costs
Debt funding carries a headline rate that looks expensive next to a bank loan. Venture debt typically runs 12 to 18 per cent over 12 to 36 months. Privately placed non-convertible debentures to a credit fund sit at a similar level, and structured facilities from SEBI-registered AIFs are priced for the flexibility they provide.
The headline rate is not the real rate. Interest on capital borrowed for the purposes of business is deductible as a business expense, a treatment carried forward into the Income Tax Act 2025, which governs from tax year 2026-27. A company paying Rs 1.4 crore of annual interest on Rs 10 crore of borrowing at 14 per cent, taxed at the concessional corporate rate of roughly 25 per cent, saves about Rs 35 lakh a year. The effective cost falls from 14 per cent to around 10.5 per cent. No equivalent deduction exists for equity capital.
Two constraints deserve attention, and both are ones Lorvet tests before a structure is committed to. Where interest paid to a non-resident associated enterprise, or to a lender backed by an associated enterprise guarantee, exceeds Rs 1 crore in a year, Section 94B caps the deduction at 30 per cent of EBITDA. The disallowed portion can be carried forward for up to eight assessment years.
The Argument Most Founders Miss
Here is the asymmetry that matters in this specific window. Debt raised before an IPO can be extinguished with the proceeds of the IPO. Repaying or prepaying borrowings is a standard and accepted object of an issue, and a large share of Indian issuers list precisely to strengthen the balance sheet.
Equity issued before an IPO cannot be undone. The shares stay outstanding, the dilution is permanent, and the price at which they were issued becomes part of the offer document’s disclosed capital history.
A company that bridges an eighteen-month gap with debt and then retires that debt from issue proceeds has rented capital. A company that bridges the same gap with an equity round has sold a piece of itself permanently, at a private valuation, to fund a period that ends in a public one.
What Equity Costs, and When It Is Still Right
Equity is the correct instrument in several situations, and pretending otherwise would be dishonest.
A business that is not yet generating enough cash to service a fixed coupon cannot safely take on debt, whatever the tax treatment says. A company carrying heavy borrowings into the DRHP may find institutions marking down the issue for balance sheet risk. And where an investor brings genuine credibility, a pre-IPO round from a recognised institution signals confidence to the market in a way borrowed money never will.
Equity also buys time without a repayment clock. If the listing slips by a year, and listings frequently do, a fixed maturity falling due in that window becomes a problem rather than a footnote.
The Deciding Question
The useful framing is not which instrument is cheaper. It is how confident the company is about the timing and certainty of the listing.
Where the listing is close, the business generates cash, and the raise bridges a defined gap, debt funding is usually the better instrument. The interest is deductible, the obligation is finite, and the proceeds of the issue can retire it.
Where the listing is uncertain, the business is still loss-making, or the capital is meant to fund a multi-year expansion rather than a bridge, equity is the more honest answer. It costs more in the long run and it costs ownership, but it does not fall due at the wrong moment.
Most companies of any size end up using both. Matching each instrument to the part of the plan it actually suits, rather than raising one lump in whichever form is easiest, is where a capital structure either holds up under diligence or does not. That mapping, done against the filing timetable rather than in the abstract, is the work Lorvet does with founders in the run-up to a filing.
Frequently Asked Questions
- Is debt funding cheaper than equity before an IPO?
On a cash cost basis, usually yes, because interest is deductible as a business expense while dividends and dilution are not. Debt raised before a listing can also be retired using the proceeds of the issue, whereas equity issued in that window is permanent.
- Do convertible instruments have to be converted before an IPO?
Yes. Outstanding convertible securities must be fully paid up and mandatorily convert into equity on or before the filing of the red herring prospectus, and many issuers complete conversion at the DRHP stage. Founders should assume any convertible will become ordinary equity on the regulator’s timetable, not their own.
- How long are pre-IPO investors locked in?
Pre-issue capital held by non-promoters is generally locked in for six months from the date of allotment in the IPO, with carve-outs for ESOP shares and holdings of VCFs, FVCIs and Category I and II AIFs. Promoter lock-in is longer and is calculated separately on the minimum promoter contribution.
- Can too much debt affect an IPO?
It can. Borrowing levels appear in the restated financials that every institution reads, and a company carrying heavy obligations into a filing may face a harder pricing conversation. Interest paid to a non-resident associated enterprise above Rs 1 crore a year is also capped for deduction purposes under Section 94B.
- Which instrument suits a company eighteen months from filing?
That depends on cash generation and the certainty of the timetable. A cash-generating business bridging a defined gap is usually better served by debt funding, while a loss-making business or one funding a multi-year expansion is generally better served by equity.
