What is non-dilutive funding?
Non-dilutive funding refers to capital that doesn't require you to give up equity in your company in order to receive funding. It's the opposite of venture capital (VC) investment where you typically sell a portion of your equity in return for working capital.
With non-dilutive financing, you can receive funding based on other business factors. Non-dilutive capital is a good alternative funding option for startup founders and small-to-medium-sized business owners seeking financing that does not require them to give away equity or ownership in their company.
The common perception of many founders is that their only funding option (especially for Software as a Service (also known as ‘SaaS’) startups) is to raise VC money.
Businesses that lack access to traditional capital markets may have no other choice but to seek out VC. VC requires a company to give up some ownership and control in their business and allow the venture capitalists or investors to have a say in company decisions.
While there can be mutual upside to dilutive funding and it is an important route to pursue in the future for bigger expansion, there are increasingly more funding options for companies to consider that do not require surrendering complete control. This autonomy can be especially important and useful for startups in different stages of growth.
When to pursue non-dilutive funding versus equity financing?
Non-dilutive funding: scaling your early-stage startup
Whether you are looking to increase your company's valuation or reduce financial risk while scaling your startup, non-dilutive financing can be extremely valuable, especially in the earlier stages of growth.
Early-stage startups often struggle with low valuations, especially before they have been able to prove their business model or achieve significant revenue. Non-dilutive funding allows these startups to secure financial resources without impacting their valuation or negotiating equity terms.
Unlike equity financing, which requires startups to generate returns to shareholders, non-dilutive funding typically involves grants, loans, or subsidies that do not require immediate repayment or profit-sharing. This takes some of the financial pressure off and reduces risk for the startup.
Equity financing: funding your pre-revenue startup
However, an important factor to note is that non-dilutive funding sources typically require upfront guarantees that a company can pay back the borrowed amount, usually in the form of some type of recurring revenue source or other significant revenue sources.
If you're pre-revenue, the more applicable funding option may be dilutive funding such as VC and equity funding for now.
What are the considerations for non-dilutive funding?
While there are many benefits of non-dilutive funding, it is important to be mindful about whether or not it is the right fit for your specific business in its current position. Here are some of the main aspects to consider:
Pros
- You don't have to sell your stake in your business to get funded.
- You can obtain funding without putting up personal collateral or proving credit-worthiness.
- You can leverage your current or predictable revenue and obtain funding that's realistic for you to pay back based on your expected revenue.
- You can obtain more flexible terms for repayment.
- Your funding will be “cheaper” since the cost of equity funding can be quite high compared to borrowing.
- Funding may be more accessible to many different types of founders and business models.
- Private companies cannot borrow money to raise cash, so non-dilutive financing can serve as a bridge to the next round.
Cons
- You may secure a lower amount of funding, at least initially.
- It may be harder to qualify for funding that is non-dilutive, since lenders will try to mitigate their risk.
- You may need to seek more than one funding source (especially if the initial amount of funding is low).
- Since the funding is more like a loan, it will need to be repaid within agreed-upon terms.
- Some of the lenders might provide very harsh terms (including personal liability) since there is less regulation around some of these non-dilutive funding sources.
- Some lenders may include warrants/covenants in their terms, which could give them the option to access your equity even if that's not what you want.
What are the types of non-dilutive funding?
There are several non-dilutive funding options out there but not every avenue will be the right fit for every business. Today, we’ll dive into what the most common non-dilutive funding options are, and how they work to cover crucial operational costs, product development and marketing expenses, and power scalable growth.
Loans
Loans can be offered by banks, credit unions, online lenders, and non-bank financial institutions. Small businesses may have their own set of loans available exclusively to them from banking or government entities.
Short-term loans are built to offer immediate funding and often necessitate faster repayment. Typically, they provide a lower amount of funds and higher interest rates than long-term loans. Online lenders, however, have made it easier for entrepreneurs to get approved for short-term loans, especially SaaS entrepreneurs.
The payback period is shorter but the quick application turnaround time makes it a worthy option for many.
Getting approved for long-term loans is more difficult. Traditional banks have strict requirements and a history of turning away new, small businesses, especially SaaS businesses which they still cannot properly underwrite. For this reason, seeking non-dilutive funding through bank loans can be challenging.
Companies that usually qualify are on average two years or older and already have a strong revenue stream. This is not a good option for companies with a weaker credit history or no collateral to put forward.
Lines of credit
A business line of credit (LOC) is a short-term business loan, but better. You can borrow against the amount you're approved for and the repayment terms range from a few months to a couple of years.
The amazing thing about this type of funding is that you only pay interest on the amount you use, and your credit replenishes as you pay it back. In order to qualify for this, you'll need a strong credit score and credit history.
Credit cards
A business credit card extends your purchasing power by offering you access to revolving credit. Using the card can help improve your credit history and periodically, you can even ask your card provider to reassess your credit limit to increase your spending power.
One major drawback can be the high interest rates on your balance for the months where you cannot pay back what you owe in full. Another major downfall of some cards is that they require a guarantee.
When you sign a personal guarantee, you put your own personal assets at risk in the unlucky case that your business can't make its payments, which is obviously not a good set up. Ideally, if you do decide to go the credit card route, you find one that doesn't include this liability.
Merchant cash advances (MCA)
A merchant cash advance (MCA) gives you the option to borrow against your future predicted credit card revenue. It has the highest approval rate of all types of small business funding, mostly because it's also one of the riskiest and most onerous options.
Many MCAs require a minimum in sales each month for you to qualify, as well as having involved paperwork requirements. They also have some of the shortest payment terms, sometimes as low as 3 months with the heaviest interest rates and penalties incurred if this is not followed. MCAs should be considered only if you truly don't have other options.
Grants
There are few and far-in-between small business grants available which makes them a highly sought-after and limited resource (since it's money that does not need to be paid back). Grants also come with some of the most stringent red tape for what the funds can be used for and what they cannot, along with extensive reporting requirements.
While there are limitations to the funds, for startups that want to focus on improving their product or technology, a grant aimed at supporting innovation, research, and development (R&D) can give them the freedom to do so without immediate commercial pressures.
Additionally, securing non-dilutive funding from a reputable industry grant can also enhance the startup's credibility and status because external experts or entities have given their "stamp of approval" to the business idea or technology.
This makes grants an ideal funding source only with very specific and approved use cases in mind as well as proper understanding and resourcing to keep up with the paperwork (especially if the grants are coming from government sources).
Crowdfunding
Peer-to-peer lending as a means to raise capital has become very popular especially after platforms like Kickstarter took off. Crowdfunding involves appealing to a large number of individuals (mostly through online channels), asking them to fund your venture and business goals.
People will pitch into your business and offer their financial support based on the narrative you tell about your product and how much that resonates with the audience. Many companies choose to offer “perks,” or rewards associated with different donation tiers, as an incentive to donate. When creating a crowdfunding campaign, it’s important to consider the upfront cost of fulfilling these rewards, from production costs to postage costs.
Crowdfunding websites also take a percentage of your total raised funds as their fee. Crowdfunding can be a powerful tool but requires a lot of effort and the payoff might not match the effort required. Although it can be one option a company uses, it should not be the only option.
Venture debt
Only available to venture-backed startups, venture debt is another form of non-dilutive financing. With this option, small companies can take on debt rather than giving up shares of their company. This allows companies to secure funding without relinquishing control to a venture firm that may already have a significant share of ownership and/or control.
Venture capital firms will partner with banks, hedge funds, or private equity firms to provide financing to the startup. The loans can usually be paid within 3-5 years and allows a company to comfortably carry a balance while also investing in growth today.
Venture debt is considered a great complement to equity funding, especially for those companies that want to extend their runway between funding rounds. Plus, a longer runway is an essential part of becoming more attractive for future VC funding if you anticipate seeking out more funding down the road.
Growth financing: recurring revenue lending
Companies with annual recurring revenue (ARR) can be good candidates for lending sources that award funds based on a detailed analysis of the company’s recurring revenue.
This is especially a good option for SaaS companies that have subscription-based revenue which is predictable, and may have trouble getting funded through other non-dilutive funding sources simply because traditional sources have trouble understanding and underwriting SaaS business models.
Additionally, successfully securing recurring revenue lending can also enhance investor confidence and credibility. It demonstrates that the startup has a viable revenue model, market traction, and potential for sustainable growth, which can strengthen the startup's position when seeking additional funding or partnerships in the future.
ARR growth financing is similar to venture debt in that it allows subscription-based companies to maximize their returns without losing company ownership.
At Capchase, we offer this revenue-based financing service through our Grow product and find that companies tend to leverage this funding to build out their headcount, enhance their product, and extend their runway.
Whatever your company's business goals are, you need liquidity to make it happen. We allow you to access your future revenue up front and still retain complete control so you can put cash towards achieving your company's vision.
Curious to know if Capchase Grow might be the right fit for your company? Reach out to us to discuss your options with a SaaS growth expert here.
