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June 11, 2024
8 min read

Alternative financing: Instruments companies should know

All you need to know about alternative financing for companies.

Leasing, factoring, crowdfunding, convertible loans, or venture debt: companies can choose between numerous alternative financing options. These alternative finance instruments complement traditional approaches, contributing to a diverse capital structure. What essentials do businesses need to understand?

Securing capital is crucial for any company to fuel investment and operational needs. To meet their financial requirements, businesses often employ internal and external financing methods. Companies can access debt or equity with the help of internal and external capital sources, such as bank loans or venture capital.

Beyond these conventional routes, there are various alternative financing methods that are reshaping the financial landscape. The following guide provides you with the most important information about alternative financing.

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Quick overview of what you need to know about alternative financing.

Forms of alternative financing

The modern financing landscape offers a diverse array of instruments for raising capital. Alternative finance instruments are available to companies of all sizes and in all industries. The choice allows for financing customized to the company's capital needs. 

Below, we introduce distinct forms of alternative financing that companies can access.

Factoring

With factoring, a company sells its outstanding customer invoices to a factoring institution. In return, the company receives a part of the invoice amount instantly as capital. It is immediately liquid – and does not have to wait several weeks or months for the customers' money. This procedure is particularly beneficial with long-payment terms.

The factoring institute buys the outstanding receivables and approaches the customer to collect the entire invoice settled. It retains the difference as a fee.

Factoring has several benefits for companies:

  • They receive capital directly instead of waiting for the payment of their receivables.
  • The company's liquidity increases immediately. 
  • Companies are protected against payment defaults, as the factoring institute takes over the receivables management, including dunning and collection procedures.

Trade, healthcare, or manufacturing: Factoring is used in various industries today. In particular, it has established itself as an alternative form of financing for SMEs. In 2022, the revenue in the German factoring industry amounted to €372.9 billion. This corresponds to a growth of around 137% compared to 2012.

When does factoring come in handy?

When a company is growing, factoring comes in handy. Growing sales also mean that the total number of open customer invoices increases. In theory, companies that rely 100% on factoring have no outstanding receivables.

Convertible loans

With a convertible loan, companies receive a loan from investors. They can convert this loan into company shares at the next financing round. In addition, the company pays interest to the investors.

The convertible loan is unsecured and subordinated. It means that there is no security for the investors. They are treated as subordinates and must step back to all other investors. 

Convertible loans for startups

Although convertible loans do not legally count as equity, banks classify them as equity-like, similar to a silent partnership. This handling increases the creditworthiness of companies. From an accounting perspective, a convertible loan is a hybrid of equity and debt. It classifies as a mezzanine capital. 

Convertible loans are particularly interesting for startups with existing investors. The procedure is faster because the existing investors are already familiar with the business model. In addition, the administrative effort is low: a convertible loan does not require notarization. 

Convertible loans are relevant between two funding rounds. The startup quickly receives debt capital (for example, because it has to bridge a critical phase), which converts into equity in the following official round. 

For companies, a convertible loan has further advantages:

  • Because the company valuation is not the focus, startups receive capital quickly and bridge the gap until their next funding round.
  • A convertible loan is less expensive than a direct investment in the company.
  • The lenders only receive information rights but no co-determination rights.
  • Banks give companies a higher credit rating, as they treat convertible loans as equity.

Venture debt

Venture debt is a risk loan to primarily finance growth. It is comparable to a conventional bank loan and is issued by private and government providers. The risk loan ensures startups can invest in further growth and remain liquid between equity rounds. 

Characteristics of venture debt:

  • It provides debt capital for startups
  • Venture Debt always follows venture capital: It is usually raised shortly after or during an equity financing round.
  • Companies use it to finance growth, for M&A, for marketing or sales activities, or to hire new employees. 
  • Venture lenders receive high-interest rates (8% to more than 20%) on the capital they provide, plus warrants, covenants, and other collateral. 
  • The company must repay the money in monthly installments over a specified time.
  • Venture debt is suitable for startups that have already completed the seed phase. One prerequisite is, for example, sales, an established product, and a focus on growth.

Leasing

Besides factoring, leasing is one of the most widespread alternative finance options. 

With leasing, a company rents machines, vehicles, office equipment, or hardware from a leasing company or directly from the manufacturer for a certain period. A regular fee is payable, for example, monthly or quarterly. At the end of the leasing contract, the company can either buy the leasing object or return it. 

In practice, there are various types of leasing:

Finance leasing with full amortization

The lease payment covers the acquisition costs, financing costs, and the profit of the leasing company.

Finance leasing with partial amortization

The leasing rate only partially covers the costs of the leasing company. At the end of the contract, the contract is either renewed or the company buys the leased objects.

Operate leasing

The company leases an object only for a short time to work with it. This operational leasing occurs, for example, during seasonal fluctuations in business. 

Sales-and-lease-back

The company already owns the leasing asset. It then sells it to a leasing company. Afterwards, it can lease it back again. In this way, it can directly access the funds and remains liquid.

All-in leasing

Asset costs, maintenance, repair, and other expenses are covered.

Leasing has several advantages for companies:

  • Leasing is balance sheet neutral and does not affect the equity ratio. 
  • The leasing rate remains constant over the entire period. That makes planning easy.
  • The leasing rate is treated as an operating expense for tax purposes. This treatment reduces profits, which leads to lower taxes in the year of acquisition.
  • The company secures liquidity as the leasing company finances the leasing asset.

Production, hardware, software, cars, and cloud applications drive the leasing business. In 2022, their volume was around €66 billion in Germany. They thus accounted for more than 90% of leased objects.

Crowdfunding

In crowdfunding, many individuals participate with small amounts in financing a company's project. In return, they receive a "Thank you", for example, in the form of the product produced. This product can be an item of clothing or a commodity.

An online platform collects the capital. This platform acts as an intermediary between the company and the donor.

A popular form of crowdfunding is equity-based crowdfunding. Here, the company receives mezzanine capital from investors, which stands between debt and equity and has characteristics of both. The investors contribute small to medium amounts, usually starting at 100 euros. In return, they receive their investment, including interest rates over a specific period.

In equity-based crowdfunding, companies use three financing instruments, depending on the contract: 

  • Participation certificate
  • Silent Partnership
  • Participatory loans

Alternative debt financing

In recent years, several alternative financing models have been established. They describe non-dilutive, alternative debt funding for companies. In other words, companies do not sell their shares in return for equity funding, but finance themselves with debt and retain the company shares. 

As described, fintechs are technology-driven and use data-driven approaches. They focus their risk analysis on specific metrics regarding financial ratios, recurring revenues, and unit economics. This way, capital requirements precisely align with the company's business plan. 

What alternative debt financing instruments have in common is that they do not dilute the shares of existing shareholders or reduce their influence on the company. This type of alternative finance is also offered by re:cap. 

The use cases of alternative debt funding are individual. Among other things, companies can use it to:

Build a bridge to profitability with alternative financing instruments.

  • create a cash buffer to postpone the next equity round to a more convenient time

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Postpone your VC round with alternative financing instruments.

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Refinance large one-time expenses like M&A with alternative financing instruments.

The goal is to service the capital needs at an ideal time for the company. This precision – possible on a monthly or even daily basis – avoids overfunding, which impacts the cost of capital and capital efficiency. 

Alternative debt financing offers several advantages: 

  • Companies secure the liquidity they need that fits their business plan
  • No dilution of company shares
  • Companies can agree on flexible repayment terms
  • Financing does not include warrants

Revenue-based financing

Recurring revenue financing (RRF) and revenue-based financing (RBF) are instruments related to alternative debt funding. These instruments have been popular in the USA and Great Britain as alternatives to conventional financing for quite some time. However, more and more early-stage companies from the software and SaaS environment are also using this type of financing in Europe.

Revenue-based financing

With RBF, companies receive debt capital and guarantee investors a fixed percentage of their revenue over a certain period. If the revenue increases, the costs increase. 

Recurring revenue financing

In RRF, companies also receive debt capital. The amount financed and the interest are based on the amount of recurring revenue and remain the same over the entire period. Thus, capital is provided to the company only up to a specific financing limit, which depends on the annual recurring revenues. 

In both alternatives, the investors assess the company in advance. They review its financial performance. They analyze metrics and deduce how the business might develop in the future. Based on this, investors decide the funding amount and the interest rate.

The difference between alternative and traditional financing

Traditional corporate finance relies on well-known instruments like loans, credit, and subsidies, typically provided by established financial entities such as banks, equity and debt funds, or other financial institutions.

In contrast, there are alternative forms of finance, often provided by digital financial service providers (Fintechs) that revolutionize traditional offerings using technology and data. With their offer, those providers stand apart from the conventional financial world.

Fintechs provide alternative finance

This approach enables fintechs to have a streamlined process when providing capital, usually without lengthy negotiations, bureaucracy, and administrative work. Particularly startups seeking to raise financing benefit from it, as traditional options often fall short. Why? 

  • Startups lack of tangible assets (machines, real estate, vehicle fleet), 
  • a (still) lacking orientation towards break-even, and 
  • a business model that might deviate from the conventional underwriting models of banks.

Nevertheless, under specific circumstances, early-stage companies remain viable candidates for business financing. By focusing on data and digitization, alternative finance providers can assess risk profiles and the future growth of startups. Usually, the underwriting models of banks are not able to do that. The business model of early-stage tech companies operates outside their frame. 

A high degree of individualization helps fintechs to make financing decisions. In this way, they can determine a startup's capital needs precisely. However, alternative financing methods are not exclusive to startups; mid-sized companies also tap into its potential to support their operations. 

Alternative business finance doesn't intend to replace its classic counterpart. It acts as a supplement to bank loans, venture capital, or other traditional financing instruments. The sweet spot lies in combining classic and alternative funding options. 

In doing so, companies can diversify their capital stack and finance investments matching their needs. After all, not every type of financing is suitable for every investment need.

Companies should combine different financing options

Whether traditional or alternative financing, or a combination of both: companies today have a variety of instruments at their disposal.

The choice of financing method should align with a company's unique investment and business model, allowing for a tailored approach to capital acquisition. Ideally, companies combine classic and alternative financing options. 

With finance options available no matter size or stage, each business can select the most suitable financial instruments to meet their specific needs.

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How do SaaS companies work?

SaaS stands for Software-as-a-Service and refers to a licensing and distribution model by which companies offer software solutions online as a service.

What growth stages do SaaS companies go through?

After the preparatory early-stage phase, the product goes live, becomes better known, and establishes itself in the market, before the customer base ideally expands significantly and finally either a company sale, a merger, or further growth takes place.

Why is revenue financing ideal for SaaS companies?

In the important second growth phase, when SaaS companies are already on the market and generating recurring revenue, revenue financing provides flexible SaaS funding based on the ARR without dilution or loss of control.

What is ARR?

ARR refers to annual recurring revenue. Specifically, in the subscription economy, ARR refers to the annual value of regular revenue generated through subscriptions.

What does ACV mean?

ACV stands for Annual Contract Value and in a SaaS business, it refers to the average annual value of a subscription - i.e., the holistic contract value excluding one-time fees divided by the contract term in years.

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What is a corporate loan?

As a counterpart to the personal loan, the corporate loan serves entrepreneurial purposes - as a short-term cash injection for liquidity needs or as an investment for long-term growth. Entrepreneurs use the borrowed capital, for example, for new personnel, a larger office, marketing, better hardware, or the company's establishment.

What kind of business loans are there?

A short-term business loan runs for a few months or years, while a long-term loan runs for several years. If a company needs capital quickly, an overdraft is an excellent short-term loan financing option - there are not many conditions to be met for this, as the principle is similar to an overdraft.

What are the providers of business loans?

There are many providers of business loans. Three overriding types come into focus:
- via the principal bank
- state-subsidized
- digital solutions
The first way is via the branch banks. The options are diverse, whether long-term or short-term credit, investment or working capital credit, just like the linked conditions. Subsidized corporate loans are also run through the house bank, but regional or nationwide development banks (such as KfW) are involved here.
Modern solutions come from FinTechs that specialize in smart financing. Whether credit or alternative, this is where startups and large companies meet technology-savvy innovators of the digital age.

What is the advantage of corporate loans?

A corporate loan is usually available quickly. In addition, because it is debt financing, founders do not have to give up control as well as company shares and do not have to share profits with lenders.

What is the disadvantage of business loans?

Business loans come with interest and are often tied to a specific purpose, so entrepreneurs are limited in how they can use the capital. It is also usually a restrictive concept with strict repayment terms, warrants, and very little flexibility - which is why many companies are looking for a suitable loan alternative.

How do credit and loans differ?

Some refer to short-term financial assistance and a smaller amount as a loan and to longer terms and higher capital as a loan. However, the terms are usually used interchangeably.

What are the interest rates on corporate loans?

They can be less than 1% or in the double digits. The credit rating determines this: the higher the risk class, the higher the interest rates. The amount of capital, term and any collateral also determine the interest rate. Therefore, it is always a good idea to compare different corporate loans.

Who grants corporate loans?

Companies can obtain the traditional loan from their principal bank - a government subsidy via federal or regional development banks is also possible. Modern variants come from FinTechs, which use technology-driven solutions for smart financing.

What are the alternatives to corporate loans?

Various financing solutions work with equity and debt. With equity financing such as venture capital, founders lose valuable company shares and often have to give a say. A particularly smart alternative to corporate loans and equity financing is non-dilutive, non-restrictive and very flexible turnover financing.

What is the best credit alternative?

There is no all-comprising answer to this question, as financing is always an individual solution. However, recurring revenue financing is increasingly establishing itself as a particularly attractive and popular alternative to loans and equity financing.

What makes re:cap stand out as an alternative to loans?

With re:cap, SaaS companies can obtain growth capital very easily and quickly - up to 50% of ARR. The innovative funding works with planned revenues and also flexibly aligns repayments accordingly. In addition to on-demand financing, re:cap offers valuable insights and benchmarks on request.

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What does debt financing mean?

In debt financing, companies receive a certain amount of money from an external investor. The company holds the debt capital for a limited period and must be repaid - usually with interest and within a fixed time duration.

What does debt capital include?

Debt capital includes typical liabilities of a company, such as loans, bonds, and provisions, as well as unique forms like deferred income.

What are examples of debt financing?

There are various types of debt financing, which can basically be divided into short-term and long-term debt. Unique and mixed forms are also possible - examples:
- Short-term: overdraft, trade credit, acceptance credit
- Long-term: promissory note loans, bonds, long-term bank loans
- Special form: leasing, factoring, asset-backed securities
- Mixed form: mezzanine as a mix of equity and debt financing

What is short-term debt capital?

Short-term debt capital is provided to companies for a short period of time - repayment usually takes place within a few months. Such capital is primarily used to meet short-term liquidity needs.

What is long-term debt?

Long-term debt capital is provided to companies for a longer period of time - repayment usually occurs within several years. The capital is used for investments.

What is the difference between equity and debt financing?

From the perspective of the capital providers, it is primarily a question of liability because, in the case of equity financing, capital providers are liable for entrepreneurial activities. In return, they usually receive a share and benefit directly from the profits. Because founders relinquish shares and entrepreneurial control, this is referred to as a dilutive type of financing. This is not the case with debt financing, which involves interest and is generally more restrictive.

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How can I finance my startup?

From bank loans to private savings to equity financing: There are many ways to finance a startup - through external providers and your own capital. As a novel and popular solution, so-called revenue financing is also becoming more and more established in Germany.

Which companies fund startups?

In addition to investment companies from the venture capital segment, there are innovative FinTech companies such as re:cap. They innovate to create modern funding solutions. re:cap enables companies in the subscription economy to trade future revenues for on-demand, non-dilutive capital. Fast, transparent and easy.

Who is startup funding with re:cap suitable for?

The funding solution from re:cap is specifically aimed at subscription companies that reach a growing customer base with their already launched product and generate predictable, recurring revenues. In addition, the legal entity must be at least partially located in the EU.

How quickly can I get startup funding?

As long as you are within your financing limit, you can access new funds as often as you like. The financing limit will be increased based on the growth of your business and the track record on the re:cap platform.
The funding will typically arrive in your bank accounts within two business days once it gets approved.

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What is working capital?

Working capital is also called operating working capital. It is the difference between current assets and current liabilities and, as a balance sheet ratio, provides information on companies' capital stock and financial strength.

What does working capital tell us?

The working capital figure shows which funds are tied up in regular company operations - it can also be used to determine whether working capital financing is necessary.

Is high working capital good or bad?

A positive value shows that current assets can cover current liabilities - this is important in terms of the golden rule of the balance sheet. A negative value conveys a risk, because affected companies are considered to be illiquid. This can lead to financial bottlenecks.

Can working capital be too high?

The question of working capital levels is answered differently depending on the company or business model - especially across industries. However, working capital levels that are too high often indicate that working capital is being used less wisely and that too much cash is being tied up.

What are examples of working capital?

In business management, working capital is usually indirect and long-term goods that companies need for their products and services. A distinction is made between tangible resources, such as warehouse and office space, and intangible ones, such as licenses.

How does working capital financing work?

Working capital financing allows companies to increase their working capital and generate positive value. It provides them with short-term cash to pay liabilities or make investments.

What are the different working capital options?

Working capital financing is multifaceted. Depending on the industry and business model, various types may therefore be considered, such as drawing on the credit line, receivables credit, factoring, and inventory lending. Increasingly popular are alternative solutions such as non-dilutive and non-restrictive sales-based financing.

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What is a convertible loan?

The definition of a convertible loan is simple: it is a normal loan in which the company does not repay the borrowed amount after the expiration of the term, but converts it into company shares. It is therefore technically a combination of both equity and debt.

How does a convertible loan work?

The following scenario is a typical example of a convertible loan: A company receives capital with a predefined interest rate. The parties agree on a term and also a discount on the company's shares, which acts as a risk compensation. At the end of the term, the investor receives the shares in the amount of the convertible loan plus interest - so-called qualified capital for the company.

How high are convertible loans?

Usually, convertible loans are around 100,000€ - but they can also be up to 400,000€ and more. To collect as much capital as possible, start-ups often arrange several convertible loans with different investors.

What should a convertible loan agreement regulate?

In principle, there is freedom of contract here - a convertible loan agreement is therefore not subject to any legal rules. The following components are the basis: the amount of the loan, the interest rate and discount, and the term. In addition, some parties agree on a cap (maximum valuation) or a floor (minimum valuation). Subordination is also included in many convertible loan agreements.

What is an alternative to the convertible loan?

Founders can obtain convertible loans quickly and easily and use them flexibly. These advantages also characterize re:cap's convertible financing. However, convertible financing involves giving away shares. This is not the case with re:cap's solution, which is non-dilutive funding for sustainable growth. Therefore, it is an ideal alternative to the convertible loan.

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Is crowdfunding free of charge?

No. In case of success - i.e. if your project reaches its target budget - you pay platform and transaction fees between 4 and 12 percent to the crowdfunding platform. The exact amount depends on the platform. If your campaign fails, you pay nothing.

Why is crowdfunding so popular?

Crowdfunding brings many advantages. The fact that the legal form and creditworthiness of the project do not play a role in crowdfunding certainly plays a major role in its popularity. Thus, especially creative people and artists of all kinds, as well as non-profit initiatives, can collect money for their projects. The positive marketing effects, as well as customer proximity and loyalty, also ensure the good reputation of crowdfunding.

Who is crowdfunding suitable for?

Crowdfunding originates in the artistic sector for financing various creative projects in the fields of music, film, theater, and art. Today, however, it is also used by private individuals, non-profit organizations, and companies of all kinds - whether in the startup phase or as a boost in ongoing operations.

What are the different variants of crowdfunding?

There are four types of crowdfunding, which differ primarily in the consideration:
1) In equity based crowdfunding, investors receive returns on their investments.
2) In reward based crowdfunding, the initiators provide non-cash or intangible compensation for the investment.
3) In donation based crowdfunding, investors donate their contribution.
4) In lending based crowdfunding, the investors grant private loans with a fixed interest rate to the initiators.

How do I receive crowdfunding?

Whether you are a startup or a medium-sized company: crowdfunding can theoretically be 'applied for' by anyone. However, success depends on how many investors are convinced by the project. Anyone who wants to try their hand at crowdfunding must first create a campaign on one of the common crowdfunding platforms and advertise it on their own channels.

Does crowdfunding make sense?

Crowdfunding offers particularly many advantages for private, non-profit, and creative projects - or as a supplement to public funding. In addition, crowdfunding can be particularly worthwhile for early-stage startups that have largely completed their product development and now need fresh capital for growth. Young companies that want to test their business model or product can also benefit from the communication and participation of a crowdfunding campaign - providing an indicator for other forms of financing.

Is crowdfunding proprietary or debt financing?

Crowdfunding is financing based on debt capital. The capital provided comes from a large number of investors, mostly private individuals and companies - the so-called crowd or swarm. Hence the term 'crowd financing'.

What are the alternatives to crowdfunding?

Crowdfunding is considered an alternative financing option, which is opposed by several common alternatives (or supplements). Among them are public funding, corporate credits, venture capital, or even founder competitions. Newer forms of financing, such as re:cap's recurring revenue financing, offer another alternative to crowdfunding.

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What is factoring?

The definition of factoring is simple: to quickly receive the money from open invoices and generate liquidity, companies hire a factor who settles the outstanding payments as an advance and takes over the accounts receivable management. It is therefore a sale of receivables.

How does the selling receivables work?

The factor checks the verity of the invoice and the creditworthiness and default risk of the debtor. Then the factor pays the majority of the outstanding invoice amount to the contracting company, usually within 48 hours. After the factor has collected the receivable from the debtor, the company receives the remaining gross amount that the factor has retained as security.

What types of factoring are there?

Anyone interested in factoring should take a closer look at their options because there are differences. In recourse factoring, the factor bears the full risk of default. Less secure - from the point of view of the selling company - is non-recourse, in which there is no protection against bad debts. If companies do not want their customers to know about factoring, they can choose the silent option.

What are the risks involved in factoring?

Since there is a large number of factoring companies, companies can quickly end up with a provider whose credit rating itself is weak. However, the performance of a factor is not always directly apparent. In the worst case, the assigned factor goes insolvent and the company loses a lot of money. In addition, some customers see it as a sign of mistrust if it is not the company providing the service that demands payment but a third party unknown to them - this could be circumvented by silent factoring.

What are the costs of factoring?

There is no single answer to this question because the fees are very opaque - based on various key business figures. In addition, the total costs are not only made up of a clearly defined factoring fee but of several items. Interest often accrues as well.

What are the most popular alternatives to factoring?

TexSince factoring is revenue-based financing, other revenue financing options are also great alternatives to factoring. This is also true for re:cap's solution - it is tailor-made for companies with a subscription business model that generate predictable, recurring revenue.t

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What are venture capital alternatives?

Venture capital is not suitable at all times - and not for every type of company. Common alternatives are:
- Venture debt (hybrid debt financing),
- Founder competitions,
- Government subsidies
- or alternative forms of financing,such as crowdfunding.
Companies with subscription business models can also exchange their future revenues for immediately available capital - with re:cap financing.

When is venture capital worthwhile?

Generally for founders and entrepreneurs in the growth phase. But not every startup is attractive to investors. Venture capital funding is worthwhile when the business idea is innovative, the sales argument is clearly recognizable, and the founding team is convincing. In addition, the market must promise growth.

How do I get venture capital?

Private venture capitalists, also known as business angels, and so-called venture capital companies provide equity capital. But not just like that. If you want to go into fundraising, you have to be convincing. Prerequisites are a watertight pitch, a realistic understanding of the current company valuation, the amount of capital needed and the time frame in which the capital is needed.

How does venture capital work?

Venture capital is a form of private equity financing in which venture capital companies provide capital to promising unlisted companies in exchange for a stake in the company. Those who want to grow their company with venture capital must first contact investors and convince them of the company's merits.

How long does venture capital take?

Often several months pass between the start of fundraising and the receipt of venture capital. The pitch only follows after the founding team has identified potential investors. Afterward, the company is preliminarily reviewed by the potential investors. If this goes well, a term sheet is signed, followed by due diligence. The capital will flow only when the investment documentation has been completed.
If you can't or don't want to wait that long, you can look for alternative forms of financing like the one offered by re:cap. With re:cap you can bridge the time to the next round and thus, optimize the upcoming financing round. At the same time, this increases your options when looking for investors.

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What is alternative financing?

These are forms of financing that companies can use as an alternative to established models such as loans - they are often modern solutions that are quickly and easily available digitally.

What are the different types of alternative financing?

The market for alternative financing options is growing, so companies can already choose a model that suits them individually. The better-known ones include convertible loans, factoring, crowdfunding, and venture debt. Alternative debt instruments, including recurring revenue financing or revenue-based financing, which have been successfully established in the U.S., are still rather new in Germany but becoming increasingly well-known and popular.