Venture capital isn't the only option for startups. While raising capital in the early stages of business development is crucial, there are alternative financing options for startups. As the founder, fundraising is one of your primary responsibilities, so you should explore all possibilities.
Generally, there are two startup financing solutions available for founders to raise money for their business: dilutive and non-dilutive.
Dilutive funding is business financing that gives away a portion of your equity in exchange for the operating capital your business needs. As a result, you no longer have complete control of your company. Also, your profit share decreases, and you're now under constant pressure from the investors to deliver significant returns.
Conversely, non-dilutive funding is any form of business financing without losing equity. This type of financial support is ideal for startups, as you can start and scale your company without giving up total control.
Read on as we explore several common alternative financing methods for startups, giving you the essential knowledge you need to make the best choice for your new business.
What Alternative Financing Options are Available for Startups?
While there are many significant advantages to embracing open innovation and input from external partners, you don't have to give up equity. By retaining complete ownership over your business, you will have full control over its direction and no pressure from investors looking for an exit pay-off.
There are several alternatives to traditional equity fundraising that don't lead to dilution, including:
- Revenue-based funding
- Venture debt
- Equity-based crowdfunding
Let’s take a look at each of these options.
What is Revenue-Based Financing?
The boradest, more traditional definition of Revenue-based financing (RBF) is the following:
A fundraising model where investors get a portion of the ongoing gross revenues in exchange for providing capital. As with any business financing, investors will consider parameters such as operating margins, cash flows, revenues, growth potential, and scalability before lending money.
Once convinced of the potential borrower’s prospects, the investor lends the money needed by the startup at a mutually agreed interest rate. The pre-agreed amount is a multiple of the principal investment and is usually three to five times the original amount invested.
While this is similar to how venture capitalists or angel investors operate, the revenue-based financing plan differs because the repayment amount depends on the revenue the borrower generates. This arrangement means repayments fluctuate with the borrower's performance, increasing when the business generates more revenue and decreasing when it's lower.
Advantages of Revenue-Based Financing
Choosing RBF to get your startup off the ground presents several advantages for startup owners:
- You don’t need a high credit score to qualify for funding – You can get financing with a FICO® credit score as low as 550, making RBF an excellent alternative financing option for founders with a poor credit history.
- No personal collateral required – Revenue-based funding doesn’t require a personal guarantee as collateral against the loan. While the interest is relatively higher than bank loans, business owners don’t risk their personal assets.
- Simple to apply and get approved – The approval process of RBF is more flexible than traditional bank loans. Investors can release funding as soon as they’re satisfied with your company’s monthly recurring revenue. You only need to provide your business’s income statement for the last three months.
- Quick capital – Speaking of the approval process, it takes 7 to 10 days to get the money once you submit your application, making RBF a convenient and quick alternative financing option for startups and small businesses.
- No large payments – The fact that RBF repayment amounts depend on your business’s revenue means that you don’t have to carry the burden of large, unaffordable repayments if you experience a bad month business-wise.
However! There have been siginificant evolutions of RBF ove the past several years, and new organizations are forming to support the model differently. One such organization is RevUp Capital. Below, RevUp Capital Managing Partner Melissa Withers talks through developing features, and also red flags, that entrepreneurs should consider with RBF.
What is Venture Debt?
Venture debt is a form of debt financing offered to venture-backed businesses. Also known as venture lending, this type of funding complements venture capital to fuel growth in early-stage companies while minimizing equity dilution during new fundraising rounds.
Institutions that offer venture lending include dedicated venture debt funds and technology banks. The target market for this type of alternative financing is any business or startup that is generating revenue but doesn’t have the trading history required to obtain traditional bank loans.
Companies generally apply for venture loans alongside an equity financing round. Venture debt allows founders and existing shareholders to raise funds to accelerate growth, prepare a safety net for the unexpected, and achieve higher valuations without giving up additional equity.
When underwriting a venture debt, lenders consider the company’s current cash burn rate, capital strategy, size of equity round, and each investor’s reserve capital for follow-on rounds.
Advantages of Venture Debt
Venture lending offers several benefits to startup founders, including:
- Improved liquidity – Startups that are yet to break into profit can leverage venture debt to enhance cash flow and strengthen their balance sheet.
- Propels growth – Venture lending is an excellent small business startup financing option to speed up expansion and respond quickly to new opportunities. Once secured, stakeholders can draw down the funds over time, making venture debt ideal for acquisition growth strategies.
- Extend cash runway – Funding acquired from venture lenders can provide headroom for a loss-making business as it closes in on profitability.
- Easy to get funding – Since venture debt lenders focus on the applicant’s business model and enterprise value, companies don’t need to be profitable to qualify for this type of funding. However, the applicant must be generating some revenue.
- Capital expenditure support – Venture debt can come in handy for startups that want to buy expensive equipment or fund other investments to secure further growth.
What is Equity-Based Crowdfunding?
Equity-based crowdfunding, also known as crowd-investing, is a financing strategy where a startup turns to institutional and individual investors for capital in exchange for a slice of equity. Each investor owns a stake in the business proportional to their investment.
Unlike other crowdfunding methods, this option is a more convenient alternative financing strategy that offers investors financial securities, like corporate stocks or bonds. Investments vary wildly, and investors can put in as little as a few hundred dollars.
The idea behind equity crowdfunding is to offer small businesses and startups an opportunity to raise more money and give investors a chance to invest in a founder’s passion project.
Crowdfunding takes place on specialized online platforms such as StartEngine and Wefunder. The digital nature of crowd-investing nurtures a more liberal and hassle-free small business startup financing.
Advantages of Equity-Based Crowdfunding
Here are some of the perks of using equity-based crowdfunding to finance your company.
- Investors can be your business’s advocates – People who invest in your business will want it to succeed. As a result, they'll help spread the word about your company, increasing brand awareness and attracting more investment to accelerate growth.
- Quick access to investors – Crowd-investing typically happens online, allowing founders to reach many potential investors quickly.
- More control – Equity-based crowdfunding puts company valuation and share pricing in the hands of the founder. Also, since there are no major shareholders, owners retain most of the decision-making power.
- Free market research – Because the investors have a stake in your business, they may give you helpful feedback on how to improve your company’s offering and messaging, thereby increasing your chances of success.
- Validation of your business idea – When you raise funding through crowdfunding, you effectively get approval that you have a viable concept, which lays a solid foundation for attracting even more funding in the future.
Where Can Startups Find Alternative Financing?
The best place to get this type of financial support is applying to one of the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs.
Here is a brief overview of these programs and what to expect.
SBIR and STTR Programs
These highly competitive programs encourage small businesses in the U.S. to engage in Federal Research or else Research and Development (R/R&D) with the potential for commercialization in the future.
The eligibility criteria for SBIR/ STTR programs are as follows:
- The applicant should be a firm with 500 or fewer employees.
- The company must be for-profit, which means nonprofit entities cannot apply.
- The startup must be primarily U.S.-owned, with at least 51 % of ownership held by U.S. citizens.
Commercial Alternative Financing Options
While there are many providers of alternative financing for small businesses, four companies stand out. You can learn about them below:
Endeavor Capital Partners
Endeavor provides ABL financing and A/R contract finances to defense, national security, and space entrepreneurs.
Founded by a team of engineers and scientists, the company funds innovative ideas that would ordinarily struggle to get financing from traditional lenders with no financial history.
"Endeavour is a Balance Sheet as a Service (BSaaS) firm supporting US Federal Government contractors. As an official Department of Defense Trusted Capital Provider, Endeavour offers non-dilutive cash funding for unpaid invoices, Small Business Innovation Research (SBIR), and Small Business Technology Transfer (STTR) programs up to $10,000,000, and can help companies improve their working capital position in order to finance growth strategies and manage operating expenses.
At our core, we are scientists and engineers, and love working with people who are solving complex problems with highly technical solutions. MassChallenge alumni have access to a custom Accounts Receivable Funding facility deemed “Escape Velocity”, which is designed for innovative early-stage and growing technology companies. Escape Velocity ensures that the MassChallenge ecosystem enjoys ‘most favored nations’ pricing and terms with Endeavour, throughout their business lifetime.
Additionally, providing exceptional service is simply not enough. Endeavour contributes 50% of net profits to Mission Oriented causes that supports Veterans, their families, and their Communities. Learn more about ENDEAVOUR at www.endeavourar.com."
- Christopher Lay, Co-Founder and CEO of Endeavor
VendorTerm works with founders to provide non-dilutive capital for business growth. The company offers financing against invoices issued by the applicant to his or her customers.
The client pays VendorTerm while the startup benefits from immediate liquidity on post-dated invoices.
"In one word, our approach to alternative financing is - flexible. We believe capital products should be available on an as-needed basis for founders. Startups should not be locked into any long-term contracts or commitments. That is why our model is transactional, think about it as an a la carte option that fits in your capital stack. Versatility is core to VendorTerm, which is why we work with both commercial startups and government-focused startups;
Most government contracts and grants are milestone-based. Some milestones will not need an outlay of capital to start. Other milestones may require upfront investment by the startup. That is when VendorTerm’s flexibility, speed, and ease of use are most valuable. In these instances, VendorTerm will provide upfront capital for the related milestone and then wait for the (usually) 60-day term to be paid back.
This approach is the same for our commercial offering. Any B2b product or service company with an invoice can work with VendorTerm. Startups can choose to finance their entire accounts receivable, or one invoice at a time."
- Patrick Woloveck, COO of VendorTerm
Pipe is a subscription financing platform that allows SaaS companies to finance their business without dilution or debt. That way, software businesses can get their revenue upfront by partnering with a vetted group of financial institutions.
Clearco (formerly Clearbanc)
Clearco offers financing to SaaS founders, mobile app developers, and e-commerce businesses with a 6 to 12.5 percent payback fee. The company funds businesses in the United States and all ten Canadian provinces.
Bootstrapping a startup isn’t easy. If you want to get your new business off the ground without sacrificing equity, you should use alternative financing.
MassChallenge has a platform and a ready-made network of innovation partners to help connect startups with companies, partners, and talent.
Join the MassChallenge platform today to find alternative financing through a mutually beneficial partnership that helps your startup grow.