Non-Dilutive Funding: What Is It and How Does It Work?
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Non-dilutive funding is a type of business funding that allows you to finance your business without giving up any percentage of your ownership. Although it can be used during any stage of a business’s growth, non-dilutive funding is usually discussed concerning early-stage startup capital as an alternative to dilutive funding or equity financing.
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How does non-dilutive funding work?
Non-dilutive funding can come in various forms, including small-business loans and startup grants. Each type works slightly differently, but they allow you to retain complete control over your business and avoid the pressure of reporting to investors.
Depending on which type of financing you choose, there are costs associated with non-dilutive funding, both monetary and not. With loans and lines of credit, for example, you will run into interest and fees, whereas grants can be challenging to find and may not offer as much money as you need to get your company off the ground.
Types of non-dilutive funding
Small-business loans
Small-business term loans are offered through various financial institutions, including banks, credit unions and non-depository or alternative lenders. Depending on several factors, term loans can be a relatively inexpensive way to get funding. A regular loan may be ideal if you have strong personal credit and assets and your business is already generating revenue. However, getting a traditional loan can be more difficult if your business is in the pre-revenue stage.
Grants
Small-business grants are a free source of funding for businesses in various stages of growth. They are usually provided through federal or local government sources, private companies, nonprofits, small business development centers, or incubator programs targeted toward specific industries and niches. For example, the U.S. Department of Agriculture offers Rural Business Development Grants to support the growth of small businesses in rural areas. Similarly, the Coalition to Back Black Businesses is a grant program providing money to Black-owned small businesses in economically distressed regions of the United States.
Revenue-based financing
Revenue-based financing can function similarly to equity financing, but instead of giving up equity, you agree to exchange a percentage of your future revenue for upfront capital. Revenue-based loans can be a good option for early-stage startups with low monthly expenses because payments fluctuate with the month-to-month success of your business.
Venture debt
Venture debt financing is financing for businesses already backed by a venture capitalist. It is most commonly available in conjunction with equity financing and works well as an option to avoid further dilution of your company’s shares. It can be a good strategy for businesses in the growth stages after initial investments have been made.
Similar to typical small-business loans, terms for venture financing are usually four to five years, with interest rates ranging from 7% to 12%. Venture debt lenders may also require debt warrants, which allow them to purchase stock at a future date for a price determined at the time the loan is made.
Pros and cons of non-dilutive funding
Pros
You don’t have to sacrifice equity in your company. It may seem like a cost-effective option initially, but giving up equity can harm you in the long run. With a loan or a grant, you still own 100% of your company, meaning any long-term value you build will be yours.
It can offer you more flexibility. Equity financing runs the risk of raising too much capital, giving out too many shares or raising too little and not having enough to meet business goals. There may be more wiggle room when projecting loan amounts because they are not tied to equity. Loans also come with a set repayment schedule, so you know exactly what your obligations are each month and your total cost of financing in the long run.
You can build business credit. Loans or lines of credit can help build your personal and business credit, and winning grants can also build your resume as a reputable company, which may provide exposure to new markets and clients.
Cons
It can be harder to qualify. Qualifying for a business loan can be difficult, especially if you are a pre-revenue startup. You may be required to have a certain minimum credit score, collateral or a designated amount in personal assets to show lenders that you can repay the loan. Grants can also be competitive and challenging to find and may be targeted toward specific industries, such as tech or healthcare.
You may not get enough capital. Because grants don't have to repaid, they're difficult to find in high-dollar amounts. Loans can be limited by the value of your collateral or your projected business revenue and may not be suited for high-growth startups.
You may have to bring in personal financials. Loans from a bank or non-depository institution may require a personal guarantee, which means your personal assets can be at stake if your business fails.
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