What is non-dilutive funding?

Non-dilutive funding is a form of financing in which a company does not finance itself by selling its shares. This approach preserves the existing ownership structure and safeguards against share dilution.

In contrast, equity financing from venture capital firms or angels investors entails the sale of shares in exchange for equity, ultimately leading to dilution. In non-dilutive funding, startups opt for debt capital rather than parting with equity financing, offering a distinct alternative to traditional venture capital fundings.

Non-dilutive funding types for startups

Startups have a range of avenues to secure non-dilutive capital, many of which originate in the realm of alternative financing and have gained prominence as financial instruments in recent years. Here are nine sources of non-dilutive funding:

Venture Debt

Venture debt is a risk loan that startups raise shortly after or at the same time as equity funding from venture capital firms. It serves as a crucial tool for funding growth while maintaining the company's liquidity between two equity funding rounds.

Venture debt empowers startups to access substantial sums of debt capital, sometimes reaching up to €50 million, without the immediate sacrifice of equity shares. 

However, it's vital to note that the non-dilutive nature of such loans may not always be guaranteed. In certain cases, these loans may include warrants that allow venture debt lenders to convert them into shares at a later stage, resulting in dilution for the company.

Alternative Debt Funding

Recently, new funding instruments have emerged, reshaping the financial landscape. There has been a growing number of providers offering a variety of alternative debt funding designed to the precise needs of startups and growth companies.

Those providers strongly focus on technology and utilize data-driven approaches. Their risk assessment focuses on financial metrics, recurring revenue streams, and unit economics. Capital needs are designed particularly to the business needs of startups.

There are also several advantages of alternative debt funding:

• companies can get the cash balance they want,
• it is non-dilutive,
• it offers flexible terms,
• it allows for adaptable usage, and
• does not involve warrants or covenants.

Central with this type of debt funding is the focus on the actual capital needs of a company.

Revenue-based Financing (RBF)

With revenue-based financing, investors receive a predefined monthly percentage of the company's future revenues in return for their investment. This type of financing is non-dilutive. No new shareholders are taken on board. Revenue-based financing is especially interesting for startups with recurring revenues. 

Recurring Revenue Financing (RRF)

Recurring Revenue Financing is another form of revenue-based financing and takes into account future revenues. The amount financed and the cost are based on the company's risk profile and the amount the company wants to raise. The use cases of RRF and RBF are identical – only repayments and cost profiles differ.

Bank and business loans 

Bank loans or business loans are probably the most classic form of non-dilutive funding. However, it is not an option for most startups and growth companies. They do not yet generate fixed and predictable revenues and can hardly offer relevant collateral to banks. For many financial institutions, business with young companies is too risky. 

Term loan

Similar to a bank loan, a term loan is a non-dilutive financing instrument. It must be repaid over a certain period (up to ten years). Startups receive debt capital in the form of a one-time payment. Funds or fintechs act as lenders. The repayments and interest are fixed in advance and remain the same throughout the entire term. 

On the one hand, this increases planning security for the startup but leads to higher capital costs, since companies are tied to the repayments and conditions of a term loan for many years (lock-in effect). In addition, a term loan must be repaid even if the startup does not grow or generate profits as planned.

Government grants 

There are also a variety of non-dilutive financing options from the government sector. Actors like the European Investment Bank or German KfW provide development loans to startups at discounted rates. These are also called grants. 

Especially projects in the field of R&D are financed. The capital allocation is tied to strict conditions for the usage of the money. Startups with a close connection to science are particularly eligible for government funding. These include, for example, biotech, health tech, or climate tech. 

Friends and Family 

A business loan from Family & Friends is a viable non-dilutive option for startups, especially in the founding phase. Young companies receive funding as well as favorable conditions and flexible repayment terms. 

Bootstrapping

Bootstrapping, equity, or internal financing is probably the most independent form of business financing. Founders grow from the funds they generate themselves or come out of their own pockets. They do not bring external investors on board and retain control.

Pros of non-dilutive funding

Startups can benefit from non-dilutive funding in several ways:

• Preservation of control: non-dilutive funding allows startups to maintain a higher degree of control over their company. They don't have to cede significant decision-making authority to external parties.
• Enhanced capital planning: with non-dilutive funding, startups can better anticipate and structure their capital costs.
• Attractiveness for future investment: by retaining a larger share of their equity, startups remain an appealing prospect for subsequent investments from other investors.

Less dilution of shares, sustained control

When a company's shares are sold, it's a typical occurrence for new shareholders to gain certain rights. While this might seem routine, these changes significantly affect the company and its strategic direction.

For new investors, this means:

• They receive co-determination rights in important strategic decisions of the company. 
• They obtain a seat on the company's board of directors.
• They receive control rights in the form of information and disclosure rights. 

For founders, this dynamic results in:

• They have less control over their company. 
• They have to consult with third parties on crucial strategic decisions.
• They retain fewer shares in the company. It increases dilution.
• Depending on the distribution of company shares, the startup may be less attractive for future investors. The more shareholders are on board, the more diluted the cap table becomes.

Less cost of capital

One aspect that often eludes founders is the potential high capital costs associated with venture capitalists, which tend to surface much later in the entrepreneurial journey.

Equity financing from venture capital firms or angel investors incurs indirect cost of capital. On the one hand, these implicit costs include the loss of control. On the other hand, the founders profit less from the long-term increase in value of their company in the event of an exit or IPO. These costs typically materialize years down the road and may not loom large at the time of funding.

The cost of capital becomes a reality when major parts of the proceeds from the sale of the company do not go to the founders (or employees) but to the investors. 

With non-dilutive funding, it's a different story. The startup does not give up any shares and retains control. Although capital costs also incur here, these are known in advance and can be structured more efficiently.

Cons of non-dilutive funding

While non-dilutive funding is advantageous in many ways, it also has its drawbacks:

• Limited funding amounts: non-dilutive funding sources such as grants or loans often come with capped amounts. This can limit the financial resources available to a company compared to VC funding, which typically has higher potential for raising larger sums of money, especially for high-growth startups.
• Repayment obligations: While non-dilutive funding may not dilutes ownership, it often comes with repayment obligations. This can create financial strain, especially for startups or small businesses that may not have steady revenue streams to meet repayment schedules.
  

When is non-dilutive funding an option for startups?

When a startup considers its next funding, it should evaluate the available non-dilutive options. After all, non-dilutive means that I don't have to give up any shares in exchange for equity funding and thus retain more control over my business.

Since investors usually issue debt capital in the case of non-dilutive financing, this form of financing is more likely to be available to startups that have survived the founding phase and are generating their first revenues.

Depending on the business case, debt capital can be structured flexibly. It allows young companies to sell fewer shares and retain more control. Many startups no longer categorically exclude debt but actively include it in their financial planning. 

After all, there is the right financial instrument for every investment. All-in-one solutions have become rarer. A company's capital stack is becoming more diverse as founders begin to recognize the advantages of different sources of capital. 

To best benefit from developments such as non-dilutive funding, three questions are relevant: 

• What do I need the capital for, and which funding option is best for my investment?
• What does the investor's business model look like, and how does it impact my company?
• How much risk do I want to take for the capital I receive?

Examples of startups using non-dilutive funding

Non-dilutive funding helps achieve various objectives. 

What does this look like in practice? 

• The Dutch web hosting provider Cloud86 maintains its independence and uses non-dilutive funding for growth measures.
• TabTool uses non-dilutive funding to secure flexible access to more liquidity.
• Exporto uses non-dilutive funding to drive its internationalization while less diluting its capital shares. 

Non-dilutive funding preparation for startups

Since non-dilutive funding is usually debt financing, different terms, and conditions apply than with investments from venture capital firms or angel investors. Startups should: 

• Evaluate in advance which non-dilutive funding method is right for them.
• Be clear about how much capital they need at what time and for what type of investment.
• Have all relevant financial metrics and data at hand.
• Be aware that debt is usually non-dilutive but must be repaid, including interest. It affects future cash flow. 

However, it is also clear that non-dilutive funding can be a "seal of approval" for startups. Those able to raise capital and repay it with interest show a certain financial maturity. 

A company's business model is usually intensively evaluated and validated during the debt funding process. It provides venture capitalists with initial indications of whether an investment in such a company is worthwhile.

Is non-dilutive funding right for my business?

Despite the current situation, venture capital firms play a major role in startup financing. And the role of equity funding will not change significantly in the future. After all, venture capitalists are the ones who can provide young, unproven business models with the necessary funding sums. 

However, equity financing is not the best solution for all investments. Startups are increasingly looking for alternatives, which is why "take it or leave it" situations have become rarer. 

The number of alternative financing instruments has increased massively in recent years. Debt capital, in particular, is experiencing an upturn – especially for startups that have successfully managed their first few years of business. 

Every financing is individual, and so should the financial instrument. So founders can evaluate the fitting type of funding, the right amount, and the right time. They already have the selection of financing instruments in place for this purpose.