Funding can be a pressing problem for most fledgling businesses, with investors unlikely to take risks, especially on unproven entrepreneurs.
In this article, Stenn explains what non-dilutive funding is, its unique benefits and drawbacks and the different types available to businesses.
Non-dilutive funding refers to the ways businesses can access liquid capital without sacrificing shares. There are a range of non-dilutive funding options available.
In most types of funding (for example, equity finance or venture capital investment), a company offers up a percentage equity stake in return for a loan-free injection of capital. Non-dilutive funding offers an alternative to these services as it doesn’t require companies to relinquish shares of equity or ownership.
Imagine there was a small healthy food vendor called ‘Fresh Start’. Due to the specialist nature of the business (which takes a nutritionist’s angle to healthy meal planning), it decides it doesn’t want to offer shares to investors who may want a say in how it is run. It decides that non-dilutive funding is the right course of action – allowing the stakeholders to retain full control.
This type of funding is essential for startups who want to minimise dilution – when existing company owners reduce the percentage stake they hold in a business – on the road to profit, while gaining access to external capital.
Stenn provides dilution-free funding for businesses based on their unpaid invoices.
Before we can understand the benefits of non-dilutive funding, we first need to discuss how it differs from dilutive funding.
The major difference between dilutive and non-dilutive funding is that, in dilutive funding – as its name suggests – a company dilutes its shares by relinquishing them to investors in return for capital.
Non-dilutive funding, on the other hand, is a means by which a company receives funding that doesn’t affect stakeholders’ shares or ownership percentages.
The main benefit of non-dilutive funding is that a company’s original stakeholders maintain total control over the company. This makes it perfect for startups that don’t require business support from investors and will have no problem paying back loans or covering business expenses within the first few years of operation.
Businesses may have to provide proof of a positive credit history or a solid business plan to convince investors to offer non-dilutive funding – as they stand to incur a greater risk of repayment compared with owning an equity stake.
For those able to qualify for an agreement, there are a range of advantages and disadvantages to non-dilutive funding:
Advantages of Non-Dilutive Funding
Full Control: With non-dilutive funding, a business retains full control without diluting shares to investors. This means that businesses funded this way don’t need to answer to investors and have creative control and autonomy over key decisions.
Future Profit Stays Within the Company: When there are no outside investors diluting shares, most of the profit stays within the company and can be directed toward actions that can grow the business.
Less Business Strain: Interest payments are tax-deductible which helps offset some of the financial strain put on a business during its initial period. This also takes stress off business owners, allowing them room to financially maneuver and grow the business.
Disadvantages of Non-Dilutive Finance
Debt: Despite not diluting a business share, the company isn’t completely devoid of obligation. Many non-dilutive funding lenders can hold businesses accountable through regular interest payments on loans. It’s important to understand the extent of any debt that needs to be paid so that a company doesn’t end up behind on interest rates that may result in expensive repercussions.
Long Application Process: Another disadvantage of non-dilutive funding is the lengthy application process, which also may require endorsement from a third party to be considered. If part of the paper trail seems out of place, this could also set a company back months. This is why it’s always important to prepare any documentation in advance.
Lenders: While non-dilutive funding prevents outside investors from gaining a percentage stake in a business, that doesn’t mean that a business is completely unanswerable to lenders. Those who invest in a business through non-dilutive means will have expectations in exchange for their funding, and loans will still need to be repaid.
Situational: Different businesses benefit from unique finding solutions. And while non-dilutive funding might work for a business with the ability to pay back interest loans, other businesses may struggle to access the initial industry connections and capital projections needed to secure funding.
Non-dilutive finance covers a range of financial solutions that offer access to capital without requiring the business to relinquish shares.
Here, we look at some of the most common types of non-dilutive funding and how they work.
Venture debt is a form of debt financing that is only available to venture-backed startups – those that have received funding from venture capitalists.
This type of non-dilutive funding is often reserved for companies that are small and can’t offer a percentage in company shares or receive funding from bank loans.
Despite its name, venture debt funding isn’t issued through venture capital firms themselves, but by a specialized debt lender, such as banks, private equity firms, hedge funds or business development companies. These lenders use the initial backing of the venture capital firm as a sign of trustworthiness that the business is viable and can repay its debts.
Small Business Loans
The idea of taking a small personal loan is a familiar concept to most entrepreneurs. However, small business loans present some unique differences.
The lender will still check a business owner’s credit score, however, what’s more, important is the balance sheet and income statements of the company. Lenders will want to know whether a business even can pay a loan back and interest rates may vary wildly depending on what they find.
Usually, these loans have a longer period in which to be paid back – roughly three to five years. Because small business loans are generally considered long-term debt, they can be recorded as liabilities on an income statement before calculating any tax liability.
Crowdfunding is a way of raising money for a business by collecting money from many people, typically through online platforms. Crowdfunding is often used by startup companies that are looking for a solid cash injection to get their business up and running – with these companies often providing a product or service.
Crowdfunding isn’t always viable as it relies heavily on public interest. Therefore, it’s better for companies that are selling a product the public may be interested in, like a new board game, a quality-of-life invention or a useful piece of software.
Crowdfunded businesses are often at the mercy of their large backer base, and when a company doesn’t deliver on its promises it could damage its reputation and harm any further profit made from the business.
Invoice factoring is non-dilutive as businesses effectively ‘sell’ their unpaid invoices to factoring providers – meaning they do not relinquish any shares in exchange for liquid capital.
In an invoice factoring agreement, businesses working with delayed payment terms upload their unpaid invoices and access up to 90% of the value in liquid capital immediately. The factoring company then ‘owns’ the invoice and receives the full client payment upon expiry of the delayed payment terms.
Invoice factoring is a popular choice as businesses only access funds that they are already owed, so there are no long-term repayment obligations like those required in traditional loan agreements.
Merchant Cash Advance (MCA)
A Merchant Cash Advance is a funding option in which a business accesses liquid capital in exchange for a percentage of future debit and credit card sales as repayments. The exact terms of the advance can vary, and criteria are usually dependent on how much a company borrows and how well its products sell.
Because of this, a company must have a proven track record in historic sales before it can apply for an MCA. This type of funding is beneficial for companies that have a high volume of sales, as it means lenders will receive those sales percentages faster.
Short payment terms are the main selling point of an MCA, allowing a company to pay back a loan with each day of sales instead of longer term. This type of funding is usually better for securing smaller loans.
Grants are the most sought-after form of non-dilutive funding but also the most challenging to secure. Grants don’t require repayment and they’re most common in the non-profit sector. It’s not unheard of for a small business to receive a grant, however, especially if they are based on an innovative new idea.
A business can apply for a grant through certain commerce organisations depending on the country the business is based in.
This type of money lending was especially prevalent during the post-covid era when small businesses were trying to get back on their feet. Unfortunately, this has also created a drought in grants being offered to companies in recent months.
Revenue Based Financing
Revenue-based financing is a solution in which a company pledges a percentage of its future revenue - rather than shares - in exchange for capital investment.
This form of financing can be useful for companies with a high volume of profit from sales, as a percentage of that profit is less likely to impact the overall performance of the business, and the injection of up-front capital can be essential for long-term business growth.
There is a range of alternatives to non-dilutive funding – essentially any funding option that is exchanged for an equity share in the business.
Equity financing is a common alternative financing option and refers to the process of offering percentage shares in a company in return for an injection of capital that could be used to help grow a business.
This type of financing is good for companies that are unable to generate enough initial capital to pay off loans but also results in a slight loss of company control (depending on the percentage sold) which may conflict with the business aims of the original stakeholders.
This alternate style of funding is popular among businesses with existing consumer interest or initial capital, but also companies that seek the input of an investor with industry experience and knowledge.
To summarise, a company should consider non-dilutive financing if they’re either in the position to apply for a grant or are generating enough capital to pay back loan agreements.
Here, Stenn provides its key takeaways to consider around non-dilutive funding:
Non-dilutive funding is a form of business finance that doesn’t result in the diluting of shares to outside investors.
Non-dilutive funding is great for businesses that can repay loans.
Businesses will still be subjected to repayments in most cases (unless they receive a grant).
There are different types of non-dilutive funding, including crowdfunding, small business loans and MCAs.
Non-dilutive funding isn’t perfect for every business, and others may benefit from alternatives like equity financing.
Q: Does Dilution Hurt Shareholders?
A: When a company has its shares diluted, it gives up a percentage of ownership and equity to external stakeholders. This reduces the overall control the original shareholders have over the business and the potential profits available when they come to cash in or sell up.
Q: Is Venture Capital Non-Dilutive?
A: Venture capital can be non-dilutive, offering a company a fixed-interest loan instead of taking a percentage of shares in that company. While it’s non-dilutive that doesn’t mean a business is free of all obligations to that venture capital firm. They still reserve the right to force a business into bankruptcy to regain their loan if that company cannot pay back the loan.
Businesses engaged in international trade may be eligible for an instant liquid capital boost with Stenn.
Stenn finances invoices for hundreds of small and medium-sized organisations with manageable payment terms.
Apply for financing with Stenn today or find out about the other financing options available to your business in our Resource Hub.
About the Authors
Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.
Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.
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Disclaimer: The above article has been prepared on the basis of Stenn’s understanding of the subject. It is for information only and doesn’t constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.