Selecting the right growth capital is a important decision that shapes a company’s expansion potential, ownership control, and long-term stability. While equity funding has long been a preferred option for startups, two prominent debt-based alternatives Venture Debt and Bank Loans are increasingly being used as supplements or substitutes to equity.

Although both are forms of borrowing, they differ in eligibility, structure, repayment terms, collateral requirements, and legal compliance. Making an informed choice requires a clear understanding of business objectives along with the regulatory framework governing each funding option.

In this article, CA Manish Mishra talks about Venture Debt vs Bank Loans: Choosing the Right Growth Capital.

Venture Debt

Definition and Purpose

Venture debt is a specialised form of debt financing designed for venture capital-backed startups or growth-stage companies with proven revenue traction. It is typically offered by Venture Debt Funds or Non-Banking Financial Companies (NBFCs). Unlike traditional loans, venture debt often comes with warrants or the right to purchase equity at a later date, aligning the lender’s upside with the company’s success.

Legal and Regulatory Framework

• Governed primarily by private contractual agreements under the Indian Contract Act, 1872.

• Borrowing powers are regulated by the Companies Act, 2013:

  • Section 179(3)(d): Requires Board approval for borrowing.

  • Section 180(1)(c): Requires shareholder approval if borrowing exceeds paid-up share capital and free reserves.

  • Section 71: Governs issuance of debentures (if structured as such).

  • Section 77: Mandates registration of charges with the Registrar of Companies (RoC) within 30 days.

• If the lender is overseas:

  • Must comply with the Foreign Exchange Management Act (FEMA), 1999.

  • Subject to RBI External Commercial Borrowings (ECB) Guidelines for eligible borrowers, lenders, end-use restrictions, and repayment terms.

• NBFC lenders must comply with RBI’s Prudential Norms for NBFCs and sector-specific exposure limits.

Bank Loans

Definition and Purpose

Bank loans are the most traditional debt financing route, offered by commercial banks, cooperative banks, and development financial institutions. They can be secured (backed by collateral such as property, receivables, or fixed deposits) or unsecured (based on creditworthiness).

Legal and Regulatory Framework

• Governed by the Banking Regulation Act, 1949.

• Regulated by RBI’s Master Directions on Loans and Advances and sectoral lending policies.

• Borrowers must comply with:

  • KYC Norms under the Prevention of Money Laundering Act (PMLA), 2002.

  • Submission of audited financials, projected cash flows, and security documents.

• Enforcement rights under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 for secured loans allowing banks to recover dues without court intervention.

• Corporate borrowers must adhere to:

  • Section 179(3)(d) & Section 180(1)(c) of the Companies Act, 2013 for approvals.

  • Section 77 for RoC registration of charges.

Key Differences Between Venture Debt and Bank Loans

Legal Approvals and Compliance Checklist

For Venture Debt

1. Board Resolution – Section 179(3)(d): Under the Companies Act, 2013, the Board of Directors must pass a resolution approving the borrowing of funds. This resolution authorizes the company to negotiate and finalize terms with the lender, ensuring the borrowing is officially sanctioned.

2. Shareholder Approval – Section 180(1)(c), if applicable: If the proposed borrowing exceeds the company’s paid-up share capital, free reserves, and securities premium, shareholder approval through a special resolution is required. This acts as a safeguard for investors.

3. Debenture Issuance Compliance – Section 71: If the venture debt is structured as debentures, the company must comply with Section 71 provisions, including issuance procedures, creation of a debenture redemption reserve, and following SEBI regulations (if applicable).

4. Charge Registration – Section 77: When assets are used as security for the loan, the charge must be registered with the Registrar of Companies (RoC) within 30 days of its creation, ensuring transparency and protecting lender rights.

5. FEMA & ECB Compliance: If the venture debt is sourced from a foreign lender, it may qualify as an External Commercial Borrowing (ECB) under FEMA regulations. In such cases, the company must comply with RBI guidelines, report the borrowing, and meet repayment and interest norms.

6. Contractual Covenants: Venture debt agreements often include clauses restricting further borrowing, significant capital expenditure, or change in ownership without lender consent. These protect the lender’s interests and ensure financial discipline.

For Bank Loans

1. Board and Shareholder Approvals – As above: Just like in venture debt, borrowing from a bank requires a Board Resolution under Section 179(3)(d) of the Companies Act, 2013. If the borrowing exceeds the limits specified under Section 180(1)(c), a special resolution from shareholders is also required. These approvals ensure corporate governance and transparency.

2. Execution of Security Documents: Banks usually demand security for loans, which involves executing legal agreements such as:

• Hypothecation Agreement: Charges movable assets like inventory or receivables.

• Mortgage Deed: Creates a charge on immovable property.

• Pledge Agreement: Pledges shares or other securities.
  These documents must be stamped and executed as per the Indian Stamp Act and state-specific laws.

3. RoC Charge Registration- Section 77: When the bank loan is secured by company assets, the charge must be registered with the Registrar of Companies within 30 days. This ensures public notice of the lender’s interest and protects the lender’s priority rights in case of default.

4. Adherence to RBI Lending Norms: Banks must comply with the Reserve Bank of India regulations, including:

• Loan classification (priority sector, term loans, working capital).

• Exposure limits to single borrowers and groups.

• Sectoral caps (e.g., limits on lending to real estate or capital markets).
  These norms safeguard the stability of the financial system.

5. KYC & PMLA Compliance: Under the Prevention of Money Laundering Act (PMLA), 2002, banks must conduct strict Know Your Customer (KYC) checks. This includes verifying the borrower’s identity, ownership, and source of funds, preventing financial crimes such as money laundering and terror financing.

Recent Regulatory Developments

RBI Digital Lending Guidelines (2022–2023)

The Reserve Bank of India introduced detailed rules to ensure transparency and protect borrowers in digital lending. These norms apply to loans offered through digital platforms by both NBFCs and banks. Key requirements include:

• Loan disbursals and repayments must be made directly between the borrower’s and lender’s bank accounts, avoiding third-party pass-through accounts.

• All charges, fees, and interest rates must be disclosed upfront in a Key Fact Statement.

• Borrowers must have a clear grievance redressal mechanism, and data privacy must be ensured.
  For venture debt or bank loans processed digitally, these guidelines impact loan structuring, documentation, and disbursement processes.

Companies (Acceptance of Deposits) Amendment Rules, 202

The amendment clarified that certain borrowings by startups, including specific venture debt arrangements, are not treated as “deposits” under the Companies Act, 2013. This exemption reduces compliance burdens such as filing deposit returns and meeting deposit-related reserve requirements. Startups raising funds through venture debt can thus avoid being categorised as accepting public deposits, making the process more straightforward.

Credit Guarantee Scheme for Startups (CGSS)

The CGSS, run by SIDBI, offers partial credit guarantees to banks and NBFCs lending to eligible startups without requiring collateral. This helps early-stage and growth-stage startups access bank loans and even structured venture debt at better terms. The guarantee reduces lender risk, which can result in lower interest rates and more favourable repayment conditions.

When to Choose Venture Debt

You have institutional investors backing your business

Venture debt providers generally prefer lending to startups that already have the backing of reputed venture capital (VC) firms or institutional investors. This backing acts as a validation of the startup’s potential and reduces perceived risk for the lender. It also signals that the company has access to follow-on funding, making repayment more likely.

You want to extend runway without equity dilution

If you’re between equity funding rounds or don’t want to give up additional ownership, venture debt is a useful bridge. It helps extend operational runway giving you more time to hit growth milestones without impacting your shareholding percentage.

You need quick growth capital for marketing, expansion, or inventory purchase

Venture debt is often used for specific, high-impact initiatives that require immediate funding. Examples include scaling marketing campaigns, expanding into new geographies, purchasing inventory for seasonal demand, or accelerating product launches. Since venture debt can be disbursed faster than equity, it’s ideal for time-sensitive growth needs.

You have predictable revenues and positive unit economics

Lenders look for stable cash flow and strong unit economics (such as customer acquisition cost vs. lifetime value) to ensure that the startup can meet interest and principal repayment obligations. If your business generates predictable revenue and operates efficiently, venture debt becomes a viable and less risky funding option.

When to Choose Bank Loans

You can provide collateral or strong guarantees

Bank loans typically require security in the form of collateral such as property, equipment, receivables, or personal/corporate guarantees. If your business has sufficient assets to pledge, securing a bank loan becomes easier and may also help in negotiating better interest rates and terms.

You have stable cash flows to service fixed EMIs

Unlike venture debt, bank loans have fixed monthly instalments (EMIs) that must be paid on time, regardless of revenue fluctuations. If your business generates steady, predictable cash flows throughout the year, servicing a fixed repayment schedule becomes manageable without disrupting operations.

You prefer lower interest rates over flexibility

Bank loans generally come with lower interest rates compared to venture debt or other private financing options, especially for businesses with a good credit history and collateral. If cost of capital is your priority and you can accommodate less flexibility in repayment, bank loans are advantageous.

You need longer repayment tenure for capex projects

For large capital expenditure (capex) needs such as setting up manufacturing facilities, buying machinery, or constructing infrastructure banks can offer repayment periods ranging from 5 to 15 years. This longer tenure spreads the repayment burden and aligns with the long-term returns from such investments.

Conclusion

Venture debt and bank loans are both effective ways to raise growth capital, but the right choice depends on a company’s maturity, cash flow strength, and long-term goals. Venture debt offers quick access, repayment flexibility, and avoids equity dilution, though it often carries higher costs and shorter repayment periods. Bank loans, on the other hand, provide lower interest rates and stability but require collateral and stricter compliance.

For many Indian startups, a blended strategy works best using venture debt for fast, opportunity-driven scaling and bank loans for steady, asset-backed growth. This balanced approach can optimize the capital structure while meeting both financial needs and regulatory requirements.

Frequently Asked Questions (FAQs)

Q1. What is the main difference?

Ans. Venture debt is for VC-backed startups with flexible terms and no collateral; bank loans require security, have lower interest rates, and involve stricter eligibility.

Q2. Are legal approvals needed?

Ans. Yes. Board approval under Section 179(3)(d) is required; shareholder approval under Section 180(1)(c) applies if borrowing exceeds limits. Charges must be registered under Section 77.

Q3. How is repayment structured?

Ans. Venture debt allows flexible terms and interest-only periods; bank loans require fixed EMIs, impacting cash flow if revenues fluctuate.

Q4. Is venture debt regulated like bank loans?

Ans. No. Venture debt is by NBFCs/alternative lenders under RBI/SEBI norms; bank loans follow RBI’s Banking Regulation Act.

Q5. Can startups without VC get venture debt?

Ans. Rare, but some NBFCs and fintechs offer it to revenue-generating companies with strong cash flow and stricter covenants.

Q6. What happens if a company defaults?

Ans. Venture debt terms may allow IP seizure or accelerated repayment; bank loans can invoke SARFAESI Act to sell collateral.