Here's an example that helps explain how this works. When people talk about financing engineering, a lot of the nuance is figuring out how to manipulate the "capital structure" like this.
A) Imagine buying a $100,000 house and borrowing $80,000 from the bank to finance it. Then you rent out the house for a bit more than the total cost of the mortgage, taxes, and other expenses. Eventually the value of your $20,000 investment will grow based on a combination of (1) more ownership from the house and (2) potential market appreciation on the total value of the house.
B) Compare this to buying a $100,000 house but getting someone to co-invest $80,000. In this case, your equity is fixed at 20% (vs 80% for the co-investor). The value of your investment will depend on your share of any intermittent cash flows from rent and market appreciation of the house.
Debt (A) is attractive if there is certainty you can finance the debt payments, but that's obviously not the case for many startups.
A) Imagine buying a $100,000 house and borrowing $80,000 from the bank to finance it. Then you rent out the house for a bit more than the total cost of the mortgage, taxes, and other expenses. Eventually the value of your $20,000 investment will grow based on a combination of (1) more ownership from the house and (2) potential market appreciation on the total value of the house.
B) Compare this to buying a $100,000 house but getting someone to co-invest $80,000. In this case, your equity is fixed at 20% (vs 80% for the co-investor). The value of your investment will depend on your share of any intermittent cash flows from rent and market appreciation of the house.
Debt (A) is attractive if there is certainty you can finance the debt payments, but that's obviously not the case for many startups.