An unfortunate set of dominos began to fall in early 2020. Lockdowns, and ensuing unemployment, compelled central banks to flood the markets with liquidity. As economists predicted to a T, this unprecedented quantitative easing led to 9% inflation. To fulfill the other side of its mandate, The Fed had to reverse course and raise interest rates. The resulting market turmoil caused both public and private valuations to decline sharply.
While private markets have remained fairly resilient, with Q2 2022 seeing VC totals higher than before the pandemic, many founders are looking for alternative, less dilutive forms of funding.
According to the LTSE 2022 Future of Equity Report, over a third of founders are now looking for non-dilutive funding, such as government grants or revenue-based financing. Non-dilutive funding simply refers to capital that doesn’t require owners to give up equity or ownership in their company.
What’s Driving This Shift?
Securing capital becomes more challenging in a downturn, with VCs advising founders to “plan for the worst” and “avoid the death spiral.”
In today’s market, as valuations are coming down, founders and business owners are more interested in flexible capital that doesn’t require them to give up control. Falling valuations also mean that for any given level of funding, founders will have to give up more equity than they would have just a year ago.
Market volatility has forced many startups to reevaluate their burn rates and runway. With the future more uncertain than ever, founders are understandably reluctant to give up any equity or control over their companies.
One Entrepreneur article discusses a founder from Cleveland who used non-dilutive funding to raise $3.2 million for 29.3 percent of the company. Had the founder employed a mix of dilutive and non-dilutive funding, he would have raised just $2.3 million for 42.2 percent of the business.
Of course, dilutive and non-dilutive funding aren’t mutually exclusive. In many cases, combining the two will be the best way to finance a company’s growth. As a CB Insights report explores, a track record of non-dilutive capital “indicates that a company has hit milestones linked to product development and financial performance,” which can make it easier to raise dilutive capital down the line.
Non-Dilutive Funding Options
Government grants are one popular form of non-dilutive funding. The Small Business Administration (SBA) provides several federal grants: research and development (R&D), management and technical assistance, COVID-19 relief options, community organization grants, and more.
For example, the Paycheck Protection Program (PPP) was a type of small business loan created in response to the COVID-19 pandemic. Businesses could apply for these loans, which were forgiven if they used them for qualifying expenses, like payroll or rent.
Another popular non-dilutive funding option is revenue-based financing (RBF). With RBF, investors provide capital in exchange for a percentage of future revenue. SaaS companies often use this financing type, as it’s easy to predict and track recurring revenue.
Further, venture debt is another form of non-dilutive funding that has been gaining popularity in recent years. Venture debt is a loan backed by a startup’s equity. This type of financing can be helpful for companies that need to make large one-time purchases, like equipment or real estate.
The Takeaway
As recent surveys indicate, non-dilutive funding is rising as founders seek to preserve equity and control in their companies. While dilutive funding will still play a role in many startups’ growth plans, non-dilutive options are becoming increasingly popular.
Government grants, revenue-based financing, and venture debt are all popular non-dilutive funding options. As the market continues to evolve, we expect to see more companies take advantage of these financing options.