April 29, 2022

A founder's guide to non dilutive funding

Non dilutive funding is a good alternative funding option for startup founders and small business owners. Read on to learn more about the different types of non dilutive funding on the market.

What is non dilutive funding?

Non-dilutive funding is 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 funding, 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 - 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, (even if that means that they give up some ownership and control in their business and that VCs will have a say in company decisions). While this is an important route you'll want to go down in the future for bigger expansion, there are increasingly more options for you to consider since non-dilutive funding can be incredibly useful at different stages of growth, especially earlier stages.

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 VC and equity funding for now.

What are the considerations for non dilutive funding?

Here are some of the main considerations for non dilutive funding: 

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 selling equity 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 funding 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?

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. 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 those who have 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 offers 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. This makes them 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 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. People will pitch into your business based on the narrative you tell about your product and how much that resonates with the audience. 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.

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. 

 

Growth financing - recurring revenue lending

Companies with annual recurring revenue (ARR) might be good candidates for lending sources based on their 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.

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 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.

Finding out how much efficient working capital you can access through Capchase using our runway calculator.