What is non-dilutive funding?
Non-dilutive funding refers to capital that doesn't require you to give up equity in your company to receive funding. It contrasts with venture capital (VC) investment, where you typically sell a portion of your equity in return for working capital.
With non-dilutive funding, you can secure funds based on other business factors. This type of funding is a valuable alternative for startup founders and small-to-medium-sized business owners who seek financing without giving away equity or ownership in their company.
Many founders commonly perceive 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 feel compelled to seek out VC. However, VC funding requires companies to give up ownership and control, allowing venture capitalists or investors a say in company decisions.
While there can be mutual benefits to dilutive funding, and it is an important route to consider for larger expansion, there are increasingly more funding options that do not require surrendering complete control. This autonomy is particularly valuable for startups at various growth stages.
When to pursue non-dilutive funding versus equity financing?
Non-dilutive funding: Scaling your early-stage startup
Whether you aim to increase your company's valuation or reduce financial risk while scaling, non-dilutive funding can be extremely valuable, especially in the early stages of growth.
Early-stage startups often struggle with low valuations, particularly before they have proven their business model or achieved significant revenue. Non-dilutive funding allows these startups to secure financial resources without affecting their valuation or negotiating equity terms.
Unlike equity financing, which requires startups to generate returns for shareholders, non-dilutive funding typically involves grants, loans, or subsidies that do not require immediate repayment or profit-sharing. This reduces financial pressure and risk for the startup.
Equity financing: Funding your pre-revenue startup
However, it's important to note that non-dilutive funding sources often require upfront guarantees that a company can repay the borrowed amount, usually in the form of a recurring revenue stream or other significant revenue sources.
If you're pre-revenue, dilutive funding options such as VC and equity funding might be more applicable.
What are the considerations for non-dilutive funding?
While non-dilutive funding has many benefits, it's crucial to consider whether it is the right fit for your specific business at its current stage. Here are some key aspects to consider:
Pros
- You don't have to sell a stake in your business to secure funding.
- You can obtain funding without personal collateral or proving creditworthiness.
- You can leverage predictable revenue and secure funding that's realistic to repay based on expected income.
- You may obtain more flexible repayment terms.
- The cost of funding is generally lower compared to equity financing, which can be expensive.
- Funding may be more accessible to various founders and business models.
- For private companies, non-dilutive funding can serve as a bridge to the next round, especially when they cannot raise cash through traditional means.
Cons
- You may secure a lower amount of funding initially.
- It may be harder to qualify for non-dilutive funding as lenders seek to mitigate their risks.
- You may need to seek multiple funding sources if the initial amount is insufficient.
- Repayment is required within agreed-upon terms, as the funding is typically structured like a loan.
- Some lenders may impose harsh terms, including personal liability, due to less regulation in non-dilutive funding sources.
- Certain lenders may include warrants or covenants, giving them the option to access your equity even if you prefer not to.
What are the types of non-dilutive funding?
There are several non-dilutive funding options available, but not every avenue will suit every business. Below, we'll explore the most common types and how they can cover crucial operational costs, product development, marketing expenses, and support scalable growth.
Loans
Loans can be offered by banks, credit unions, online lenders, and non-bank financial institutions. Some loans are available exclusively to small businesses from banking or government entities.
Short-term loans offer immediate funding with faster repayment terms, typically providing lower funds and higher interest rates than long-term loans. However, online lenders have made it easier for entrepreneurs, especially in SaaS, to get approved for short-term loans.
While getting approved for long-term loans can be challenging due to strict requirements from traditional banks, online lenders offer quicker approvals with less stringent criteria. However, these loans often come with higher interest rates.
Companies that qualify for long-term loans are usually over two years old with a strong revenue stream. This option is less suitable for companies with weaker credit histories or no collateral.
Lines of credit
A business line of credit (LOC) is a short-term business loan with added flexibility. You can borrow against your approved amount, and the repayment terms range from a few months to a couple of years.
The advantage of this funding type is that you only pay interest on the amount used, and your credit replenishes as you repay it. However, qualifying for this requires a strong credit score and history.
Credit cards
A business credit card extends your purchasing power by offering access to revolving credit. Using the card can help improve your credit history, and you can periodically request your card provider to reassess your credit limit to increase your spending power.
One major drawback is the high-interest rates on balances carried over months when you cannot pay back what you owe in full. Another concern is that some cards require a personal guarantee, putting your assets at risk if your business cannot make payments.
Ideally, you should find a credit card without this liability if you choose this funding route.
Merchant cash advances (MCA)
A merchant cash advance (MCA) allows you to borrow against future credit card revenue. It has the highest approval rate among small business funding options, but it's also one of the riskiest and most onerous.
MCAs often require a minimum monthly sales threshold for qualification and involve extensive paperwork. They also come with short payment terms, sometimes as low as three months, with heavy interest rates and penalties for non-compliance. MCAs should be considered only when other options are exhausted.
Grants
There are few and far-between small business grants available, making 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 requirements for what the funds can be used for, along with extensive reporting requirements.
For startups focusing on product or technology improvements, a grant aimed at supporting innovation, research, and development (R&D) can provide the freedom to do so without immediate commercial pressures.
Additionally, securing non-dilutive funding from a reputable industry grant can 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, along with proper understanding and resources to manage the paperwork (especially if the grants come from government sources).
Crowdfunding
Crowdfunding is a method of raising capital through collective contributions from a large number of individuals, usually via online platforms. Platforms like Kickstarter have made this approach popular, especially for startups and creative projects. Crowdfunding allows you to present your business idea or product to a broad audience, who can contribute funds in exchange for perks, equity, or simply to support your venture.
While crowdfunding can provide access to non-dilutive funding, it requires significant effort to create a compelling campaign that resonates with potential backers. It's important to consider the costs associated with fulfilling rewards and the percentage of funds that crowdfunding platforms typically take as a fee.
Crowdfunding is a viable option for startups looking to raise funds without giving up equity, but it should be part of a diversified funding strategy rather than the sole source of capital.
Venture debt
Venture debt is a form of non-dilutive funding available exclusively to venture-backed startups. This option allows small companies to take on debt rather than giving up shares of their company. By securing funding without relinquishing control to a venture firm, startups can maintain more ownership while accessing the capital needed for growth.
Venture debt is typically offered in partnership with banks, hedge funds, or private equity firms and is often used to complement equity financing, extending a startup's runway between funding rounds. The loans are usually structured with a repayment period of 3-5 years, providing flexibility to invest in growth without immediate pressure to raise additional equity funding.
This financing option is particularly attractive for companies that want to maximize their returns and maintain control while preparing for future funding rounds.
Growth financing: Recurring revenue lending
Growth financing, particularly through recurring revenue lending, is a non-dilutive funding option suited for companies with predictable income streams, such as SaaS businesses with subscription-based revenue. This type of financing is based on a detailed analysis of the company's recurring revenue, allowing them to access capital without giving up equity.
This approach is particularly beneficial for SaaS companies, which may find it challenging to secure funding through traditional sources due to the unique nature of their business models. By leveraging their predictable revenue, these companies can secure funding to fuel growth, enhance their product, or extend their runway without diluting ownership.
Recurring revenue lending not only provides immediate capital but also enhances investor confidence and credibility, demonstrating that the startup has a viable revenue model and market traction. This can strengthen the startup's position when seeking additional funding or partnerships in the future.
At Capchase, we offer this type of non-dilutive funding through our Grow product, helping companies leverage their future revenue to build out their teams, develop their products, and extend their runway without giving up control.
Whatever your company's goals are, having the right amount of liquidity is essential. With non-dilutive funding options like recurring revenue lending, you can achieve your vision while retaining full control over your business.
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.
