Non-Dilutive Funding: Take the Free Money

(Hey, it’s me, Evan. You should star this email so you can always come back to it - trust me, you will. And make sure it’s in your Primary inbox)

One VC told me a horror story recently about founders who sold 28% of the company before their Seed round.

“We won’t even look at those deals, because the founding group is already so diluted that at a certain point either they’re going to mentally check-out or we would have to force a recap.”

If you shoot yourself in the foot today, it might never heal.

So today we’re covering…

Non-dilutive capital: the closest thing to free money you’ll get.

Some of them can be very expensive, and you need to watch your wallet.

But you've got to know that there’s a few main types of non-dilutive capital…

• Grants: Basically “free” money from governments / organizations for research they want you to do
• Customers
• Loans (and Venture Debt)
• Asset-Backed Lenders: Revenue-based financing, Inventory financing & lease capital

I made a list of the main providers, link is down below 👇

But first, a reminder of What’s Equity

Equity represents a proportional share of two basic things:

• The business’s profit (or loss)
• Control / voting power

It’s important not to give equity away too cheaply, because:

1. You could be selling yourself short - maybe your valuation’s currently outta whack but you should be getting at least equal value for what that share of the business is worth,
2. Future investors will look at your capital structure (who owns what, how much they invested to get that percentage, and when the deal happened) as a guideline for the deal you’re offering today, and
3. Recapturing equity can be extremely difficult.

A single bad deal can last a lifetime - and can mean you’ll never raise again.

Although selling equity remains one of the most common ways of raising capital for a business, it’s not the only way.

Grants are basically free money

Grants can be wonderful non-dilutive options for small businesses.

In the US, medtech and drug development companies commonly access NIH grants as a source of non-dilutive funding.

Small Business Innovation Research (SBIR) grants are generally more available for businesses beyond the healthcare field.

SBIR grants are given in three phases

• Phase I - Feasibility / commercial viability study. $50-$250K for 6 months.
• Phase II - Generally $750K for 2 years, but can go up to $2 million without SBA approval
• Phase III - Commercialization (No funding - generally this will be a contract with the government)

Corporates such as Visa, Fedex and Patagonia all offer corporate grants as well.

Founders’ most important practical concern with grants:

You can take the money, but your company still owns the IP you generate as a result.

Customers - because you’d be shocked at the checks they’re willing to write

If you have an outstanding product, then customers can be a surprising source of capital

Give customer a solid deal, and you might be able to raise a substantial portion of your round.

Example: In a super-protective industry, one founder I know was able to get a few dozen large customers to buy from him directly and pay him upfront (8-figure annual sales in Year 1).

Instead of going the traditional route of spending $10M and 5 years running pilot programs, his customers bankrolled him.

If they say no, so what?

But if they’re open to it, maybe they’re a strategic partner.

SBA loans & Venture debt*

When done properly, these can either be the cheapest financing you’ll get (apart from “free” options), or can make up a substantial portion of a larger package including equity.

Which, by the way, you got at a better valuation because you came to the table with SBA financing in your back pocket, and that equity investor’s money is no longer “first capital in.”

Beware, SBA loans almost always involve a Personal Guarantee.

I have to mention venture debt here. Technically it’s non-dilutive but in almost all cases there’s an equity kicker.

Asset-backed Lenders: Revenue, Inventory & Lease finance

This group of non-dilutive funders may be perfect for the right business, but it can be expensive.

Revenue-based financing is becoming extremely big. We’re talking Lighter Capital, Stripe Capital, Paypal Loans & Clear (huge for Ecommerce businesses).

But be careful with revenue-based financing.

Stripe Capital may be great but it can be 31% APR.

That’s more expensive than most credit cards.

If you’re an asset-heavy business, you need to take some of the capex burden off your equity shareholders.

Lease finance helps stretch a round. It’s a must for any manufacturing business, for example - rather than purchase your production machines outright, a financing company essentially buys them and leases them to you.

Lessors include:

• Farnam Street Financial (one founder I know has a multi-million line with them, she really recommends)
• Trinity Capital
• SBG Funding

Inventory finance (or A/R factoring, receivables finance and others) is also good for later-stage businesses.

There’s about 50 different permutations of inventory finance, but basically you’re trading pretty-certain future cash flows (i.e. money from a sale) for money today.

How to know inventory finance could be for you:

Do you sell to Fortune 500s or large corporates? Is it profitable, but carries 60/90/180-day terms?

If so, you basically have a green light for inventory finance since lenders can obtain credit insurance on pretty much any publicly-listed company, which massively reduces the lender’s risk exposure.

It’s similar to revenue-based financing, so watch your wallet & shop around - there’s sharks out there.

Summary

Think of these like different tools in your toolkit.

All of them can be used to stretch a round, or used in combination to get to your financing goal.

Here’s a list of Non-Dilutive Capital Providers I keep - maybe you’ll find it helpful.

Check it out - and I’ll see you next week.