While equity funding is a popular choice, it is not always the right model for every company. There are times in your startup’s growth trajectory when you must preserve ownership for you and your existing shareholders.
This is where non-dilutive funding or alternative financing (Alt-Fi) comes into play. Alt-Fi offers an attractive alternative for entrepreneurs and business owners, giving them the option to raise funding without the need to give up equity, ownership, or control of their company. This article will delve into the nuances of this funding mechanism to provide strategic direction to startup leaders.
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What is non-dilutive funding?
Non-dilutive funding is a type of capital funding where the business owner does not have to give up a share of their equity in return for the funding.
Non-dilutive funding models like cash flow-based financing allow founders to secure timely financing without relinquishing any portion of their businesses. It does not dilute the existing shareholders’ percentage of ownership, voting rights, or earnings per share. It has become a powerful weapon in the growth arsenals of both venture-backed and bootstrapped startups.
This go-to choice of funding for most startup founders comes in different forms.
Here’s a look at some of the most common types of non-dilutive funding:
| Venture debt | For venture-backed startups. VC firms collaborate with banks, private equity, or hedge funds to offer this type of debt financing. Venture debt is complementary to equity funding. It enables startups to continue their growth trajectory without having to raise more equity capital. |
| RBF | Revenue-based financing is where a business secures capital in return for a percentage of its future revenue. RBF is a favorite for ecommerce as reimbursements match the seasonality of the business. |
| Loans | There are different types of small business loans offered by banks, credit unions, non-banking financial companies, and online lenders. It is the most common way of injecting non-dilutive working capital into your startup business. Loans have longer repayment terms and come at competitive interest rates. |
| Grants & Subsidies | While grants are the most sought-after, they are among the most difficult types of non-dilutive funding to secure. Unlike loans and debt, grants or subsidies do not have to be paid back. They warrant extensive reporting and come with stringent guidelines for what the funds can be used for. |
| Tax credits | By utilizing tax credits, businesses can lower the amount of tax that they owe. While they do not add cash to the businesses, they reduce their tax liabilities and increase their retained earnings. |
| Crowdfunding | This type of non-dilutive funding allows startup founders to pre-sell the product to a large number of individuals, typically via online platforms like Indiegogo or Kickstarter. It should not be confused with Equity crowdfunding, a dilutive type funding where retail investors buy shares of the company. |
Who is eligible for non-dilutive funding?
Apart from grants, non-dilutive funding needs to be repaid.
Therefore, it is important to ensure that you are in a position to generate revenue from your business and repay the loan. In this case, if you’re a startup founder toying with a business idea and haven’t yet stepped into the market, non-dilutive funding is probably not the best option for you.
Non-dilutive funding is ideal for startup founders who have survived the founding phase and have started generating revenue.
Established businesses with some form of traction or proof of concept are best suited for non-dilutive funding. Some forms of non-dilutive funding, like government grants, are available only to certain types of businesses. This may be a business with a certain revenue level or from a particular industry or region. Prior to opting for non-dilutive funding, it is important to have a clear understanding of your business model and market conditions.
What is the cost of dilutive funding?
When you depend on equity financing to fund your business, the Return on Equity (ROE) for your existing shareholders, including you, will go down.
ROE measures the profitability of the startup in relation to its shareholders’ equity. In other words, the ROE indicates how well the startup is using its equity to generate profits.
Here’s how you can calculate the ROE:
ROE = (Net Income/Shareholders’ Equity) * 100
Let’s understand this better with an example:
For instance, ACME Ltd. is a startup with a net income of $750,000 and shareholders' equity of $5,000,000. ROE for ACME = (750,000 / 5,000,000) * 100 = 15%
Knowing your ROE will help you answer the following important questions about funding:
- What is the current number of outstanding shares?
- Can shareholders be expected to approve of this decision?
- How will the issuance of new shares affect the ROE?
What is the cost of non-dilutive funding?
When determining the costs associated with non-dilutive funding, it's important to consider interest rates or fees. In non-dilutive funding options like revenue-based financing, some of the new-age players forgo interest fees, providing a flat fee model recovered incrementally based on the monthly revenue of the business.
You also need to take into consideration the cost implications of the funding. Balancing the funding amount with the associated costs ensures that the company effectively manages its financial resources while minimizing the impact on its profitability and long-term sustainability.
Determining the cost of non-dilutive funding involves the following steps:
- Consider your business stage and funding purpose
- Calculate your financial needs and explore different non-dilutive funding options to find the best-suited financing solution
- Understand interest rates, fees, and repayment terms
- Conduct a cost-benefit analysis for financial sustainability
- Explore a balanced mix of non-dilutive funding and equity
Keeping X as the principal amount, a as the flat fee, Y is the total amount that needs to be repaid:
X + a% of X = Y
Here is an example for better understanding:
For instance the principal amount is $300,000. Now, the flat fee is usually between 6-12%; in this case the flat fee is, say, 5%, and the agreement is for 36 months. So, that means 5% of monthly revenue will be repaid every month until the total amount of $450,000 is collected.
Maintaining ownership is crucial for startup sustainability. If the company is too diluted, it would be hard to raise the next round. Non-dilutive funding helps maintain the 50%+1 after the Series A rule, where founders and shareholders retain 50% ownership plus one additional share of the company after each funding round.
By strategically using non-dilutive funding alongside equity financing, founders can maintain greater control over their company’s ownership structure and drive key decisions independently, safeguarding their long-term business vision. Moreover, when it comes to making important decisions on future funding strategies or exits for the startup, founders can proceed with greater control and enjoy the freedom to pursue the best path for their business.
Also, non-dilutive funding, particularly through increasingly popular cash flow-based financing options like Recurring Revenue Financing/ Revenue-Based Financing, Invoice Financing, and Supply Chain Financing, is easily accessible as it does not require collateral.
When does it make sense to use non-dilutive funding?
If your business generates revenue from day one, non-dilutive financing can be an attractive option early on. This approach allows you to secure funds without giving up equity, preserving ownership and control. However, it's also worth considering dilutive financing in the initial stages. By bringing in investors early, you can build your brand and leverage their expertise and networks. This can be particularly beneficial when it comes time for equity dilution, as a more established brand with strong investor backing can offer the founder greater influence and negotiating power.
While VC funding is a perfect choice for new businesses and rapid expansion projects, as a company matures and its equity becomes more valuable, it will typically shift focus to non-dilutive forms of funding to preserve equity value. Even with VC support, non-dilutive funding can be a strategic choice to extend the runway between equity funding rounds. Non-dilutive funding can be used for various purposes beyond just operational needs and marketing campaigns. It can finance large orders, maintain smoother production cycles, and ensure uninterrupted business growth. This type of funding supports different stages of a business's growth journey and is particularly ideal for startups working on innovative or disruptive products or services.
Here are a few reasons why:
- Longer runway for innovation: This funding provides capital without immediate pressure for returns, supporting longer development cycles and market validation efforts crucial for innovative startups.
- Flexibility in growth strategy: Startups can adapt and experiment freely, making strategic adjustments based on market feedback without predefined growth metrics imposed by equity investors.
- Alignment with mission-driven goals: Non-dilutive funding often aligns with specific mission-driven objectives related to societal impact, sustainability, or technological advancement, offering more than just capital.
- Risk mitigation and sustainable growth: Diversified funding sources reduce dependency on traditional equity investors, mitigating financial risks associated with market fluctuations and economic downturns.
A CFO, even a part-time CFO, can help with deciding about the mix between equity and debt.
Is non-dilutive funding right for you?
In the aftermath of recent turbulent years, startups are pivoting from rapid expansion towards sustainable business practices to navigate uncertain times effectively.
Startup founders once fixated on rapid growth at any cost, are now embracing a more nuanced approach towards unit economics. This shift signals a fundamental transformation in the startup ethos — a move towards resilience and longevity.
Imagine a future where startups no longer measure success solely by funding rounds and valuation spikes. Instead, they focus on building robust, self-sustaining enterprises that weather economic storms and thrive in uncertainty. Non-dilutive funding emerges as a cornerstone of this new paradigm.
As we embrace this transformative era, let us redefine success beyond funding metrics and valuations. Let us forge a path towards sustainable growth, where non-dilutive funding becomes the catalyst for innovation, enabling founders to execute their vision without compromising ownership or succumbing to short-term pressures.
About the author
Bhavik Vasa is the Founder of GetVantage. Bhavik is a 2x Founder, BusinessWorld 40u40 Achiever, FintechAsia200 fellow, Explorer, and a Dad on Duty! He has over 17+ years of global experience across FinTech, Digital Financing, Digital & Startups. Bhavik is the Founder of GetVantage, India's first Capital Gateway, an Embedded finance and growth capital platform for emerging small businesses. He is deeply passionate about building for and empowering founders. He founded GetVantage as a purpose-driven company built by founders for founders. He is also an Angel Investor with 30+ portfolio brands and a mentor/advisor to many startups. Previously, Bhavik was Chief Growth Officer at ItzCash, instrumental for its scale as India's leading Fintech, and its exit to a Nasdaq-listed group. Bhavik has a Bachelor's degree with honors in International Business from Northwood University, Florida, and executive training in Entrepreneurship from Stanford University.
