Non-Dilutive Funding: A Simple Guide for Startups

ne of the greatest challenges in the startup community is obtaining the capital vital to launching without prematurely surrendering equity that would allow the founders to benefit if/when the company is successful. Many startups have been successful without founders experiencing any of the financial benefits relative to their sweat equity.

This is why non-dilutive funding—capital that finances the growth and development of the startup without sacrificing equity is so important. The less equity surrendered early in the launch of the enterprise, the greater the chances of the founders reaping substantial financial gain from their hard work. 

If equity is given away, it’s better to do it later when it can be surrendered for strategic reasons rather than merely to survive. Aside from financial considerations, there are also issues of control. When equity is surrendered to outside parties, those entities may not have interests that are simpatico to the founders. 

To appease their investors, the outside stakeholders may wish to grow the firm much faster than the founders desire, and like baking a cake with too much heat, this can derail the company. Non-dilutive funding can be a powerful tool to avoid these problems which is why it is so important in entrepreneurial finance.

The two most important stages in a startup’s development are the pre-seed and seed funding stages. The pre-seed funding stage is when there is a new idea whose viability must be explored through market research; an examination of potential product-market fit; and a hard-headed assessment of the realistic costs and benefits of conducting the project. 

The core questions are simply: Is it worth it? If it is worth it, what is the best business model to commercialize the proposed venture? What resources will we need to make it happen? It usually costs money to accurately obtain this information. Many a startup has floundered because it did not invest appropriate resources in understanding the market it was attempting to compete in.  

After this stage, if the data shows the idea is promising, entrepreneurs can progress to the seed funding stage. The purpose of the seed funding stage is to prove whether or not their product/service can work in the market that they have researched. This is when product development begins and it requires even more funding as the resources associated with a real company must be obtained: hiring employees; renting an office; product marketing and technology development. Costs can quickly escalate so entrepreneurs are often tempted to sacrifice equity to the first person willing to write a check.

The Strategic Value of Non-Dilutive Funding

The strategic value of non-dilutive funding goes well beyond control and preservation of equity. Non-dilutive funding can provide stability in the valuation of the enterprise as unlike equity its value is independent of the impact of market fluctuations. 

This means that it can act as a financial stabilizer that is not hostage to valuation-driven dynamics. This role as a risk mitigation tool is underestimated. Generally, venture capitalists are in the business of facilitating and encouraging risk to maximize the value of the few home-run firms in their portfolio that drive success. 

But this can undermine the long-term viability of the firm so access to a source of capital that can constrain this is essential. In addition, by giving more control to founders, it can free them to be more creative and more flexible to pursue long-term ambitious projects that those outside parties who hold equity in the enterprise may be opposed to. 

Another advantage is that obtaining non-dilutive funding is generally easier and quicker. Startups can meet with dozens of venture capitalists over months as they solicit equity funding and only a small percentage of them will ever receive it. 

During this time the market dynamics may well have changed to the detriment of the enterprise. In contrast, the application process for non-dilutive funding is generally quicker, less complex and less dependent on networks and connections that many entrepreneurs lack. Finally, diversification is a core strategy throughout finance so having access to many different types of entrepreneurial finance tools is always an intelligent and sound business practice.

Types of Non-Dilutive Funding

There are many different types of non-dilutive funding. One of the types that is growing in popularity is the entrepreneurship competition. As universities have increasingly become epicenters for startup development, they have begun to organize business plan competitions to spotlight the entrepreneurial ventures of the students at their universities. These competitions allow students to learn how to write a strong business plan, network to build a team and be mentored by local venture capitalists who often use these events as deal-sourcing venues. 

Students also learn the “art of the pitch” and the types of data points that are of most interest to financial decision-makers: problem-solution fit, feasibility, execution, scalability, team quality and team complementarity as well as business model validation. The feedback from experienced professionals is priceless. 

The prizes offered can also be substantial and of great help during the pre-seed and seed stages of enterprise development. For example, the Rice University Business Plan Competition offers $150,000, $100,000, and $50,000 to the first, second and third place winners respectively. There are dozens of these competitions across the country. 

In general, they are part of an effort on the part of many universities to brand themselves as an “entrepreneurial university” which is a special category of university that is renowned for having an ecosystem—both scientific and financial—that supports the development of new business ventures. 

This can have positive downstream impacts for the university as the successful entrepreneurs are likely to become alumni donors and entrepreneurial universities attract the financial support of venture capitalists and angel investors in their area since doing so is deemed to be beneficial to their own businesses and economic interests.

At a national level, another type of entrepreneurship competition that can be a significant source of non-dilutive funding is the X Prize. Founded in 1994 and organized by the non-profit X Prize Foundation, the X Prize Competition designs and hosts public competitions that are intended to encourage technological development. Its mission is to enable radical breakthroughs for the benefit of humanity through incentivized competition. To realize that mission, it makes monetary awards as large as $10 million with three goals:

• Attract investments from outside the sector that take new approaches to difficult problems.
• Create significant results that are real and meaningful. Competitions have measurable goals, and are created to promote the adoption of innovation.
• Cross national and disciplinary boundaries to encourage teams around the world to invest the intellectual and financial capital required to solve difficult challenges.

Past winners include Team NimbRo at the University of Bonn which won $5,000,000 and Valencia IA4COVID19 which won $500,000 for their AI-driven pandemic response system. The funding can be quite large because it is often supported by corporate donors interested in a particular subject. In the past, these supporters/donors have included Qualcomm, Cognizant, and Tata Group.

US Government as a Source of Non-Dilutive Funding

The United States government is also a major source of non-dilutive funding. For example, in the energy space, through the US Department of Energy (DOE) and the National Renewable Energy Lab (NREL), the American-Made Solar Prize is a million-dollar competition that encourages teams of creative individuals and entrepreneurs by awarding non-dilutive prize funding and in-kind resources to support the field with solar solutions that have potential commercial applications. 

Biotech firms which are always starved for capital can also benefit. For example, the Biomedical Advanced Research and Development Authority (BARDA) provides several different grant funding opportunities for startups working on solutions to address health security threats in the United States. 

BARDA funds companies that develop medical countermeasures (MCM) that address public health and the medical consequences of pandemic influenza and emerging infectious diseases (like SARS-CoV-2 and COVID-19) as well as chemical, biological, radiologic and nuclear accidents, incidents and attacks. BARDA grants cover a broad range of capabilities from medtech to biopharma, drugs, vaccines and digital health diagnostics. 

The amount of funding can be substantial starting at $750,000 for six months, extending to $2 million to $10 million and proceeding to up to $20 million in follow on funding. Another funding source from BARDA, in collaboration with the National Institute of Allergy and Infectious Diseases, is Project NextGen. This initiative coordinates with the government and private sectors to advance new, innovative vaccines and therapeutics to undertake laboratory R&D, clinical trials, and potential FDA authorization, to achieve commercial availability. The key questions of concern during the funding proposal process are:

• Do you have the R&D resources on your team to participate fully in the R&D grants, cooperative agreements or contracts? 
• Are you prepared to collect and compile information (e.g., a one-page summary or brief tech deck) to share with BARDA personnel during calls or meetings?
• Do you know any companies that have participated in the solicitation mechanism you are interested in? Read press releases and reach out to them to ask about the required processes.
• Do you know personnel within the federal entities you could contact to familiarize them with your technology? 

In addition, Congressionally Directed Medical Research Program (CDMRP) provides biomedical R&D funding for Gulf War illness, respiratory prostate cancer, psychological health, traumatic brain injury and more.

The National Institutes of Health’s Small Business Education and Entrepreneurial Development (SEED) program is an increasingly important source of non-dilutive funding for biotech firms. SEED is a comprehensive suite of resources that are designed to help life science and healthcare startups overcome the challenges intrinsic to developing and commercializing their innovations. 

Only about of a quarter of first-time applicants are successful but for those that do qualify, the benefits are immense. In 2023, SEED provided $1.3 billion in financing to biotech startups. However, the advantages of the program go well beyond the financial as it also offers:

• Resources and education: The program has a range of educational resources, workshops and training opportunities. These resources are designed to help entrepreneurs understand the regulatory landscape, commercialization strategies and other critical aspects of starting and scaling a life science and healthcare startup.
• Networking opportunities: SEED seeks to connect founders with a network of entrepreneurs, mentors and potential collaborators. This network can be invaluable for gaining insights, forging partnerships and accessing additional resources.
• Market access and commercialization support: The program can help companies navigate the complex process of bringing a healthcare product to market, including assistance with regulatory compliance, clinical trials and market analysis.
• Technical assistance: SEED can offer technical assistance to help resolve specific business, regulatory or technical challenges. This can include access to NIH’s vast research infrastructure and expertise.
• Guidance on intellectual property: SEED provides guidance on IP issues, which can help companies to secure their innovations.
• Credibility and visibility: Being associated with the NIH and SEED program can enhance a startup’s credibility in the eyes of investors, partners and customers. 

SEED is an example of how access to non-dilutive funding can also provide access to the additional resources and knowledge essential to the long-term viability of a startup.

These are more recent examples of the success that the US government has had across its history in supporting entrepreneurship. However, the most successful of these programs is the Small Business Innovation Research (SBIR) and Small Business Technology Transfer Programs. Established in 1977, “America’s Seed Fund” or SBIR and STTR programs, which are overseen by the National Science Foundation and housed within the Directorate for Technology, Innovation and Partnerships, provide up to $2 million in seed funding but take no equity in startups. 

Their sole mission is to support American innovation so as to facilitate economic development in the country. The key criteria are technological innovation, the size and character of the market opportunity and the quality of the team. Hundreds of millions of non-dilutive funding have been channeled to American entrepreneurs through these programs.

Debt Financing

Debt financing is another source of non-dilutive funding but historically it has been difficult to obtain for startups due to the high-risk nature of their businesses, particularly in the technology sector where there is typically a 90% failure rate. One way for a startup to position itself to give up less equity in the future is to use a form of debt financing known as venture debt. Venture debt is a specialized category of debt financing for startups that have already raised funds from venture capital investors but are looking to raise more money while sacrificing less equity. Using venture debt, short-term capital advances are made against liquid assets including accounts receivable and inventory until they convert to cash. 

The ability to have already raised capital from venture capital serves as an important credibility signal to venture debt lenders because they are focused on the borrower’s ability to raise additional capital to fund growth and repay the debt. This form of debt is very important strategically because it is available to early-stage startups and growth companies that do not have positive cash flows or significant assets to offer up as collateral. 

It can be secured against a startup’s intellectual property and future revenues so it is a more accessible financing option for startups that may not have currently valuable assets or steady cash flow. Venture debt loans are typically in excess of $1 million and are usually structured as follows:

• 3-year monthly amortizing (can include an interest-only period in the beginning) senior secured term loan, with a fixed interest rate
• Likely would include negative covenants and sometimes also financial covenants
• A warrant agreement, giving the debt provider the right to acquire a small portion of shares at the current valuation, exercisable at a liquidity event (a sale of the business or an IPO). 
• Upfront and back-end fees

Prominent venture debt lenders include Viola Credit, Triple Point Capital, Flashpoint, Columbia Lake Partners and Kreos Capital.

Revenue Based Financing

An increasingly prominent form of non-dilutive funding is revenue-based financing. Through revenue-based financing, instead of sacrificing equity, the startup agrees to exchange a percentage of future revenues at a discount for upfront capital. For example, the investors receive a percentage of the startup’s monthly revenue rather than interest payments until the original investment is repaid. 

Because a percentage of future revenues is being repaid rather than a set figure every month, there is greater flexibility as payments can fluctuate with the month-to-month success of the business. This is tailor-made for Software-As-A-Service companies that are often able to generate revenue more rapidly than most startups and the repayment structure is more flexible than that of traditional loans. These funds can then be used to enhance the revenue-generating capacity of the firm by paying for business expenses, product development, marketing campaigns, inventory and employee salaries. It can thereby initiate a self-reinforcing positive feedback loop of paying for the core elements that will produce the revenues required to repay investors.

An advantage of revenue-based financing is that the application process is surprisingly quick and simple—funds can be approved in days or a few weeks. This process consists of the following:

• Onboarding: Register for an account, and enter the basics: company information, traction and capital needs/plans.
• Data Connection: Securely connect bank accounts, accounting systems, and billing/subscriptions platform.
• Offer Selection: Receive a financing offer, sign off on the terms, select a deposit location and receive access to your capital.
• Begin Repayment: The repayments are automatically pulled from the original deposit account each month. The repayment amount can be fixed or variable based on monthly revenue.

The speed of the process has to do with the lower size of the financing. Revenue-based financing is typically between $10,000 to $1 million but some lenders will make larger deals of up to $5 million. The lender typically advances a loan sized as a multiple of monthly recurring revenue (e.g. 4x) and gets repaid every month as a pre-agreed percentage of the borrower's revenue (which will fluctuate over time). Instead of an interest rate, a fixed fee (and/or) a cap on the borrowed amount is agreed upon, which represents the cost of borrowing. The total cash cost of debt will likely be higher than that of venture debt.

There are essentially two types of revenue-based financing: true revenue-based financing—loans with fixed monthly repayments or repayments as a percentage of receipts and receivables financing. In receivables financing, there are two categories: receivables factoring and merchant cash advances. Receivables factoring entails the sale of individual invoices to an entity or investor. In this category, if a specific contract falls through, it will need to be replaced with another. The startup receives an offer, pays an initiation fee and then pays back the amount plus interest over 6 to 12 months. In contrast, using merchant cash advances, the entire business including its fundamentals are evaluated. If approved, the startup receives a discounted cash advance and agrees to pay it back via equal installments over 6 to 18 months but there is no interest.

While revenue-based financing is especially suitable for SAAS startups, it is more generally suitable for companies that anticipate having a highly predictable or recurring revenue stream such as that which is available through monthly subscriptions. Other good candidates include firms with:

• A customer acquisition cost payback period of less than 1 year
• High Return on Investment from ad spend and other customer acquisition cost channels
• Opportunity to accelerate growth by hiring sales personnel
• High accounts receivable and low liquidity
• High working capital and low liquidity
• More than 6 months of remaining runway 

The key is that the funds to be allocated should be capable of acting as a catalyst to unlock the full revenue-generating capacity of the firm. This highlights the downside of revenue-based financing as a form of non-dilutive funding: revenue is required. It is simply not a good financial solution for pre-revenue startups in need of capital. In addition, the funds allocated are smaller than for other options such as venture debt or even some grants. 

It is important to note that there are risks intrinsic to revenue-based financing. Firstly, it is relatively new so there is likely not enough history of using it to fully understand all the many things that could go wrong. In addition, from an investor point of view, the return on investment depends on the business being able to generate enough revenue to repay the loan which could be problematic in the event of an economic downturn. 

In contrast, if the company is unable to make payments, it could face reputational damage with creditors that could inhibit its ability to raise funds in the future. Revenue-based financing is also subject to market risk as the value of investments can fluctuate based upon changes in the overall economy and financial markets. This can generate volatility for investors who may be looking to use revenue-based financing to diversify their portfolio with an alternative form of lending. In addition, revenue-based financing is not a liquid asset investment which can enhance its risk despite the lesser levels of capital invested.

Prominent Non-Dilutive Funding Platforms

There are a number of platforms that have emerged to provide non-dilutive funding. These include: 

• CapChase: A New York-based FinTech company that offers ARR financing to SaaS businesses. Its underwriting process typically takes 48 to 72 hours, and once approved, the initial funding is deposited into your bank within three business days. The minimum amount a business can draw from CapChase is $25,000. The maximum depends on revenues but is usually $1,100,000.

• Clear Co: Clear Co provides lending options to US-based eCommerce businesses. The platform delivers upfront cash to meet various operational needs, such as stock purchases, vendor payments, marketing, and logistics. A company can receive up to $20 million from Clear Co. Almost 7,000 customers are currently using its services to grow their startups. A firm that generates a minimum of $10k per month can apply for the funding. 

• Pipe: Pipe acts as a trading platform, providing a firm with a secure, fast, and non-dilutive alternative to venture capital. Instead of directly specifying the initial funding, it lets the firm sell customer recurring contracts to available investors. Subscription contracts are treated as assets. The moment the deal is finalized, Pipe automatically deposits the agreed-upon funds into a business account. To be eligible, a firm must have a minimum of $100K ARR and be US and UK based, or at least have a subsidiary in those countries.

• Founderpath: Founderpath was established in 2019 to help founders bootstrap their SaaS businesses. Since then, it has grown into a successful venture, raising $60 million to support over 130 companies. The platform attracts startups earning $1M to $5M in annual revenues and offers them 30% to 50% of their ARR in upfront capital. The signup process on Founderpath can take 24 hours to nine days, but after approval, the money is deposited in 24 hours.

• LighterCapital: Based in Seattle and founded in 2010, Lighter Capital supports tech startups in the US, Canada, and Australia. If a firm 15k in monthly revenues, it can opt for three of its non-dilutive financing products; Revenue-based, term loans, and contract-based loans. (The contract product delivers upfront cash against 12-month short contracts or a large receivable.) For repayment, Lighter Capital allows up to three years of relaxation. The firm can fix monthly installments or tie the repayment schedule to your future sales. Firms can receive a $1M to $4M loan but in addition to funding, Lighter Capital also provides access to its community network and offers other perks like software discounts.

As the venture capital community adapts to a new era of higher interest rates and structural changes due to new technologies that are transforming the operation of the industry, it is becoming harder and harder for startups to obtain equity financing. It was always difficult but it is now incredibly difficult. Startups are increasingly looking to non-dilutive financing such as grants, government funding, entrepreneurship competitions, venture debt and revenue-based financing as an alternative. 

This alternative can have enormous upside by offering founders more control and a greater financial stake in the enterprises particularly during the early phases when one does not really know the value of what one is building. Moreover, as is evident with the growth of venture debt and revenue-based financing, there is a substantial amount of creativity embedded in these financial products. Even a firm does not seek to rely upon non-dilutive funding exclusively, the ability to diversify financing can be a powerful financial tool in helping to build a successful business.