May 17, 2022

Non dilutive capital: what it is & how to choose it

As a founder, you know that access to capital is mission-critical. So how can you access the cash you need while holding on to your equity? Check out these practical tips.

For growth-stage businesses, access to capital is mission-critical. With fast-moving revenues and expenses, there are risks with not having enough cash on-hand. At the same time, companies cannot risk duling their equity — especially at the early stages. In these situations, non-dilutive capital can be a solid, debt-based option for solving cash crunches. Let’s start with a story to illustrate why.

The Importance of Working Capital

Resolving cash flow problems

Consider the experience of Lawtrades, a Capchase customer that operates a marketplace for legal services. On a tactical level, Lawtrades connects clients seeking legal services with freelance lawyers, paralegals, and compliance professionals using custom software. At an $80M valuation as of early 2022, the company is a success. But that hasn’t always been the case. 

In 2019, the company was at its seed stage, burning through its financial reserves, and struggling to raise its Series A round. As with any marketplace business model, the company was walking a financial tightrope walk of balancing the supply and demand side equation. The profit margins selling to their customer base of startups were razor-thin — and the company was on the verge of bankruptcy due to cash management issues.

After COVID, the company stumbled into a previously unseen market opportunity with bigger businesses. All of a sudden, customers were spending hundreds of thousands of dollars per month. But higher growth actually made cash flow challenges worse. The issue was simple. Customers were taking a long time paying their bills. Lawtrades needed to pay their talent network faster than they were getting paid.

Finding solutions  

At this stage of the business, some founders may consider raising a round of venture capital. However, raising VC isn’t always the best option. For one, when founders give away equity too early, there’s a risk of dilution. When entrepreneurs give too much of their business away, they end up getting less back for their hard work. In addition, when founders dilute their ownership at the earliest company stages, it can be more difficult to raise venture capital in future financing rounds.

Non-dilutive capital was the best option for Lawtrades at the time. But finding a solution was not straightforward. It took time to identify and partner with the right lender.

First, Lawtrades approached several banks but could not find the right lending product due to underwriting challenges around the business model. A marketplace model was not a type of business that a bank could underwrite.

After realizing that banks weren’t the right option, Lawtrades found their way to the alternative financing ecosystem and eventually to Capchase’s dynamic financing solution. Since September 2020, Lawtrades has been taking out monthly draws from Capchase, borrowing flexibly when needed.

Capchase is one of many non-dilutive options for alternative financing and revenue based financing. So how do you choose the right non-dilutive capital option for your business?

Choosing non-dilutive capital 101

Keeping your options open 

As a founder, executive, or finance leader the last situation you want is to need capital in a crunch. For this reason, it’s important to keep your eyes open to lending solutions. There’s a saying among entrepreneurs to always be “shopping around” for funds. The key is not to be seeking financing but to generally remain aware of solutions that exist in the market. Here’s how to self-educate:

  • Talk to your VCs about trends that they observe in their portfolio companies
  • Maintain open lines of communication with fellow entrepreneurs
  • Ask for recommendations from other lending institutions
  • Read publications like TechCrunch or BetaKit to see what journalists are writing about

You’ll find that the market for financial services is vast and diverse. So it’s important to narrow down your preferences to solutions that are an exact fit with your business model and goals. For instance, Lawtrades chose Capchase for being fast, flexible, and a good fit for the core marketplace business model.

Examples of non-dilutive capital

Non-dilutive capital isn’t limited to companies like Capchase. There are many different options from which you can choose. Here are a few examples.

Loans. You can borrow funds to pay back with interest. Loans are available from banks, in addition to alternative financing lenders. When applying for a loan, you should expect to commit time to an application process. Typically, lenders will require a collateral, credit check, or guarantors. Every financial institution is unique with its own terms and conditions.

Grants. Grants may be available from research institutions, nonprofit foundations, or government sources, depending on where you live and your specific business model. While grants are available for all types of business, the most valuable ones are competitive. With grants, your organization will need to agree to specific terms and conditions; however, there is typically no need to pay back the funds. One drawback to grants is that the application process can take a long time.

Tax Credits. Depending on your business model, your organization may be eligible for tax credits. Certified public accountants (CPAs) or companies like Main Street Financial can help you find credits for which your business is eligible.

Crowdfunding. Depending on your specific project, your customers and supporters may simply want to offer support. Platforms like Indiegogo and Kickstarter can help you raise funds that you can use as working capital. The biggest challenge with crowdfunding is that there are no guarantees. Until your campaign is over, you won’t know if you’ve raised the funding you need to execute on your business goals. On the flip side of the equation, there are plenty of problems that may arise before your product reaches your backers.

Revenue based financing. As internet-based business models expand, new types of alternative financing are becoming available outside of major banks. Revenue based financing is one example. Revenue-based financing provides cash to companies, upfront and on demand. It is a type of financing that provides capital upfront against monthly or annual recurring revenue (MRR or ARR).

Maintain independence and raise money your way

Get financed

How to choose the right option 

Most businesses have access to multiple financing options. For this reason, you can think about your non-dilutive capital as being part of the bigger picture of your financial technology stack. Long-term, it’s important to choose solutions that can evolve with your business. Here are some considerations when evaluating non-dilutive capital partners:

  • Partnership strength. A company’s financial picture will inevitably evolve over time. During these moments, it’s critical that your lenders be trustworthy and adaptable. The last thing you want is to get locked into a stifling financial relationship.
  • Growth potential. Can your non-dilutive capital partner scale with your business? It’s important to avoid getting locked into financing that does not scale with your business. In the case of Lawtrades, for instance, Capchase has raised the company’s credit cap each month to support scaling ARR.

Lawtrades credit cap

    • Trust. When you’re borrowing money, it’s important to make sure that you’re working with a reputable lender. Just as you’re being evaluated as a borrower, it’s important to do your due diligence. Is your prospective lender willing to share customer testimonials? Have you read up on third-party reviews and media interviews? Make sure that you’re working with a company that you can trust to have your back.
    • Cost of capital. It costs money to borrow money. So before you choose to work with a lender, it’s important to make sure that you’re receiving a competitive, cost-effective offer in terms of interest rates and fees. Over time, interest rates and fees can add up. It’s important to ensure that the numbers make sense for your business.
    • Terms and conditions. Every financing solution has its own agreements with borrowers. One of the most important considerations is the payback terms. With revenue based financing, for instance, it’s possible to borrow funds as needed or upfront and stage regular payments month over month. This approach is different from term loans that require paybacks at fixed monthly intervals or credit lines that require minimum monthly payments. 
    • Technology. Finance is critical to every aspect of a business’s operations. When choosing non-dilutive capital, it’s important to make sure that your lender’s technology infrastructure integrates seamlessly with your company’s. Can you sync your bank accounts with your lender to enable transparency and faster underwriting? How easy is it to access your data? Is there helpful technology available?
    • Customer support. With any business relationship, it’s common for questions, concerns, or challenges to come up. Will your non-dilutive capital partner be able to answer your questions as they come up? Before agreeing to work with a lender, you’ll want to make sure that your bases will be covered if you need support.

    When considering non-dilutive capital, your financing partner needs to work for your business’s unique growth goals. The best lenders care about their customers and establish protocols for positive relationships and successful outcomes.

    Remember that a range of options are available to meet your business’s needs. If one solution doesn’t seem to be fit, don’t be discouraged — keep looking, and be selective in your search. Pay careful attention to positives and negatives to ensure that you’re making the right tradeoffs.

    Are you interested in learning more about revenue financing?

    It’s important to do your research and make the decision that’s best for your business. Here are 3 immediate steps you can take: 

    Disclosure

    This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal, or tax advice.