What might be an appropriate middle ground between debt and equity financing?

Debt financing is more risky than equity financing, but equity financing is more expensive.

It really depends on what you're looking for and how much you need. I don't know if I definitely agree that debt financing is more risky and equity more expensive. In a startup situation, it really depends on the entrepreneur--what kind of credit background do you have, how much capital do you have, what is the market potential, etc.

Usually, an appropriate middle ground is a balance between the two. Obviously, in a high risk situation like a start up, the risk inherent to debt exists mostly when the borrower must use his or her home or possessions as collateral. If that's the case, it's probably better to go solely with equity. If the venture is less risky, say for example a franchise, then borrowing is also less risky, and therefore probably better. In either case, you'll want to borrow from whomever you can get the most favorable terms--usually family, friends, and fools, if they can put up the money--and get equity from the people with the most experience and contacts since equity investors will take a direct role in the company. You should chose equity partners not only for the money, but more importantly for the experience and contacts they add. If you don't do so, you're getting a bad deal and you're competition will be one step ahead. I'd be happy to discuss this with you further if you're interested; feel free to send me an email.

One possibility might be a hybrid instrument, such as a convertible bond. The bond is essentially an issuance of stock, but with a floor from the coupon rate of the convertible. The stock portion allows for a lower than normal interest rate so there is a reduced cash interest payment, which would increase the interest coverage ratio.

The cost is the dilution of the shares later on if the buyers want to convert.