What are the pitfalls of non-dilutive capital for startups and their founding entrepreneurs?
There are many ways to fund a startup. Two of the main categories of funding are dilutive and dilutive capital. Each has its benefits and potential detractors.
So, how do these capital sources differ? What falls under their umbrella? What are the perks and pitfalls of each? How do you get the money?
Let’s find out…
The Ultimate Guide To Pitch Decks
Here is the content that we will cover in this post. Let’s get started.
- 1. What Is Dilutive Capital In Startups?
- 2. What Is Non-Dilutive Capital?
- 3. Types Of Non-Dilutive Capital
- 4. Grants
- 5. Prize Money & Awards
- 6. Convertible Notes (A Hybrid Solution)
- 7. Debt Financing
- 8. Tax Credits
- 9. Licensing, Royalties & Spinoffs
- 10. Pre-Sales
- 11. Donation Based Crowdfunding
- 12. Asset Based Financing
- 13. Collaborations
- 14. Dilutive Vs. Non-Dilutive Capital: The Pros & Cons
- 15. Control
- 16. Speed & Size
- 17. Your Slice Of The Pie
- 18. Creating A Smart Capital Stack
- 19. Summary
What Is Dilutive Capital In Startups?
Put simply; dilutive capital refers to any money brought in that requires the company to give up equity ownership.
Types of dilutive capital often include:
- Partnerships with friends and family
- Angel investments
- Funding from angel groups
- Startup accelerators and incubators
- Venture capital
- Private Equity
- Strategic corporate capital
Going public and an IPO also means giving up ownership.
Note that there can be exceptions and hybrid solutions available from these types of investors as well.
Keep in mind that in fundraising, storytelling is everything. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
What Is Non-Dilutive Capital?
Non-dilutive capital is most notably different from dilutive capital in that it does not require giving up equity and ownership, and all that comes with that.
There are actually many types of financing that fall under this umbrella. The more entrepreneurs and their teams of advisors, board members, and executives understand, the more options they have. Which can prove to not only be advantageous at many stages of the startup journey but absolutely vital for survival and staying competitive.
Types Of Non-Dilutive Capital
Let’s take a quick look at the best options for non-dilutive capital for startups.
- What is it? – Grants are typically free money that does not have to be repaid. Though this can be subject to certain rules and achievements. Especially if you want more grant money to follow it up in the future. Grants can come from both public and private money. Such as education institutions, big corporations, and local, state, and government grants.
- The benefits – This money does not require giving up ownership, nor require repayment.
- How to get it – Grants typically have to be applied for. There are many grant directories, as well as agencies, that proclaim that they can help with your applications.
Prize Money & Awards
- What is it? – There are many competitions and awards that can be applied to aspiring entrepreneurs and early-stage startups. Many come with financial rewards. In addition to credibility and visibility. These may range from business plan competitions run by schools to those run by publications and corporations or government agencies, and hackathons.
- The benefits – This non-dilutive capital can help your startup gain a lot of awareness, and can be a great form of validation in your pitch deck for future rounds of fundraising.
- How to get it – Keep your eye out for these competitions at schools, in the local press, or create Google alerts to be notified of them.
Convertible Notes (A Hybrid Solution)
- What is it? – Convertible notes are more frequently being offered by investors that have traditionally provided dilutive capital, as well as startup accelerators. This is different in that this money starts out as debt (loans), and then can be converted to equity ownership by choice, or automatically if triggered by a certain event or milestone.
- The benefits – This can be easier to obtain than just debt or equity at the start of a venture. It provides more security for investors. Then more upside for them if things work out. These sources that provide this form of funding also often offer a lot of additional advice and resources for entrepreneurs to gain early traction, before introducing them to other investors.
- How to get it – Some investors will offer this option to early-stage startups. You will also find it common if you apply to startup accelerators like Y Combinator.
- What is it? – Debt financing means loans, and are a great option for non-dilutive capital for startups. Loans require repayment and can be collected if borrowers default. There are actually many types of debt financing in this space, including:
- Business loans
- SBA loans
- Lines of credit
- Business credit cards
- Working capital loans
- Factoring loans
- Merchant cash advances
- The benefits – While this type of funding can require operating and credit history, applying, and a fair amount of paperwork and waiting in some cases, it has become streamlined. Some sources will provide next-day capital, with a fast online application, and no personal guarantee or credit check for the founders.
- How to get it – Mid-stage startups with revenues will have more options for borrowing. Today this includes local banks, startup-specific lending institutions, and online business loan lenders.
- What is it? – While not your typical type of capital, or necessarily a cash injection, tax breaks and credits can be highly valuable. They are often given to lure businesses into cities, with the hopes of job creation, or revitalizing areas. These deals may also be found in tandem with cash incentives, such as for your employees to buy homes in the area.
- The benefits – Tax perks like this can at least save your company thousands and even tens of millions of dollars. They may go a long way towards paying for new facilities and expanding into new areas.
- How to get it – Look for programs in cities you are considering expanding to. Create Google alerts for news on other companies receiving such breaks, and contact the authorities in those areas. Or, like Amazon, run a competition, and get cities to compete for you to choose them.
Licensing, Royalties & Spinoffs
- What is it? – While technically a type of sale, new startups often create a lot of IP that can be financially leveraged very early. In many cases, pivots mean that this IP, software, or other patents and technology is not going to be used as part of the main line of business. If this can be licensed, or spun off and sold, it can bring in cash quickly, or even be a source of monthly income to fuel other efforts and operations. And, that makes them a great source of non-dilutive capital for startups.
- The benefits – Aside from the potential cash and cash flow, it means deriving returns and monetary value from the many detours you take in the early days of your startup.
- How to get it – Assess what IP and other assets you have that you could cash in on, and look for others who are trying to build something similar to it.
- What is it? – One of the best ways to get out of the gate, make money, and establish a profitable business is to run pre-orders and pre-sales. That brings in cash, without having to give up any equity, or take on the burden of debt.
- The benefits – In addition to the above, this strategy proves the demand for your product or service, right from the start. Which de-risks your venture for future investors or creditors. Meaning you can negotiate much better terms on other money, and give up less equity for more capital.
- How to get it – Get up a landing page, and begin early marketing tests to secure these sales, and create a self-sustaining startup.
Donation Based Crowdfunding
- What is it? – Donation-based crowdfunding is the original form of crowdfunding before the JOBS Act came into law. This can be pure donations to help you get an impactful startup off the ground. Or you can offer gifts and perks, including your product and brand wear, in exchange for donations.
- The benefits – In addition to the money, this offers easy early proof of concept and helps you polish your product. While gaining engagement, a following, and building credibility.
- How to get it – Find the right platform for your specific startup, create a budget, and secure early participants before going live with your campaign.
Asset Based Financing
- What is it? – In addition to debt financing for general operations and working capital, startups can also take advantage of asset-based financing for specific needs. This may include real estate loans and equipment leasing that work as excellent options for non-dilutive capital for startups.
- The benefits – This funding can be easier to get as there are hard assets to provide collateral for lenders and investors. This is especially important for early-stage startups with little to no operating record or revenues. The terms of this financing can also be better thanks to less risk for lenders.
- How to get it – Research asset-based lenders for the specific assets your business needs. Including office space, commercial facilities, machinery, devices, and more.
- What is it? – There are many creative ways to bootstrap your startup. This includes creative collaborations which leverage the capital and other resources others have. For example, collaborating on marketing campaigns or sharing office space.
- The benefits – This can help eliminate overhead and early expenses while testing partnerships, which can grow into other types of funding or acquisitions later on.
- How to get it – Reach out to those in your industry and supply chain. Find out their needs, and how you can help them while leveraging their capital and assets.
Even as you’re reading up about how non-dilutive capital works, you’ll need in-depth information about how to raise startup capital for your business. Check out this video I have created explaining the different sources you can tap.
Dilutive Vs. Non-Dilutive Capital: The Pros & Cons
There are advantages of both dilutive and non-dilutive capital for startups. Each also has its own potential downfalls. Though exactly how it will play out for your venture will ultimately rest on the specific investors and funding partners you choose to do business with.
Among the top factors involved that differentiate these two types of funding are the following.
Giving away equity and ownership in your company does mean giving up control. Both in the form of shareholder voting rights, and board seats.
However, with the right investors on board, this capital can enable your company to gain more credibility, avoid major pitfalls, and see many more opportunities opened up.
This is in contrast to many non-dilutive capital sources in which creditors are not very invested in your success.
Speed & Size
Non-dilutive capital generally means moving more slowly and limiting the size of your company. You just don’t have the amount of capital needed to develop, hire, and scoop up market share fast enough. You can’t afford to go big. Your valuation will be limited. It may take you 10 years to build a $10M company, instead of two years to build a $10B company.
Your Slice Of The Pie
Non-dilutive capital can mean that the original cofounders retain nearly all the shares and ownership. It means you will get the bulk of the proceeds should you ever sell your company. Yet, that pie may be a fraction of the new slice you may earn if you bring in equity investors and create a much larger pie.
Creating A Smart Capital Stack
Both types of funding have their perks and pitfalls. Yet, this doesn’t have to be an either-or question. In fact, savvy entrepreneurs often stack many of these forms of funding together on their journey. Especially equity from VCs and large credit facilities. You can use them all, and use each to strategically improve the terms of the next money you bring in.
Both dilutive and non-dilutive capital for startups is available. Each can have its role in your capital stack.
While many do not want the dilution of equity fundraising, non-dilutive financing can mean you move slower, and are limited in capacity. In some cases, this can cost you the market.
Inform yourself of all available money sources and options, and create a smart stack that optimizes growth, dilution, and your end game.
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