Are you seeking funding to accelerate your business and take it to the next level? You’re likely considering raising capital. It’s no surprise, as it’s the most publicized financing method, often associated with incredible success stories in entrepreneurship.
But are you sure that raising capital is the best financing option for your situation? Do you know the different options available to you? What are the advantages and disadvantages of dilutive and non-dilutive funding models? Which financing model is best suited to your startup or scale-up, depending on its development phase? Iter Advisors is here to help you figure it out.
What is dilution?
In chemistry, dilution is a process that results in a solution with a lower concentration than the original. In corporate finance, the concept is quite similar, as dilution refers to a decrease in a company’s earnings per share due to capital expansion. Simply put: dilution corresponds to a reduction in the portion of the “pie” held by each founder or shareholder as new shareholders are brought in.
Capital dilution differs from a transfer of shares:
In a share transfer, part of the shares changes hands, but the total number of shares remains the same. The shareholder transferring the shares sees their ownership percentage decrease, but the percentage held by other shareholders is unaffected.
In dilution, new shares are issued to new shareholders, increasing the total number of shares while the founders’ shares remain the same. As a result, the ownership percentage of all initial shareholders decreases.
With dilution comes the integration of new stakeholders, to whom founders must grant voting rights and dividend rights. Initial shareholders thus relinquish some control in exchange for capital. Non-dilutive financing, on the other hand, has no impact on ownership.
Let’s take a closer look at the ins and outs of these two fundraising models.
The non-dilutive model
Non-dilutive financing allows access to refundable or non-refundable capital, typically involving the following scenarios:
- Credits: Short or medium-term cash advances.
- Bank loans: Debt contracted with a bank, with pre-determined terms, interest rates, and repayment conditions.
- Honor loans: Interest-free, unsecured loans, often intended for business creation, takeovers, or personal projects. They are granted by organizations promoting entrepreneurship.
- Tax benefits: Programs that reduce tax liabilities, such as the R&D tax credit, innovation tax credit, or Young Innovative Company status.
- Grants: Conditional funding programs that help entrepreneurs, such as public or private scholarships, regional aid, or competition awards.
- Crowdlending, crowdinvesting & crowdgiving: Forms of participatory financing, often via platforms, allowing individuals to contribute, with or without compensation.
Advantages of non-dilutive financing
Non-dilutive financing allows founders to keep ownership intact, avoiding the need to distribute control among a larger group of decision-makers. This means founders or shareholders retain full control of their company.
Disadvantages of non-dilutive financing
Non-dilutive financing often involves paying interest in the case of credits or loans. Additionally, grants, tax benefits, and participatory financing generally provide less substantial funding compared to some dilutive options.
The dilutive model
Dilutive financing involves the entry of a third party into the company’s capital, typically in the form of:
- Business angels: Private investors who individually invest significant sums in exchange for equity.
- Venture capital: Investment funds that acquire equity with the aim of profit. Depending on the company’s stage, this may involve seed capital, venture capital, or growth capital.
- Corporate venture: Investment funds created by large companies, often within the same sector, to invest in startups and benefit from synergies.
- Crowd equity: A form of participatory financing via equity, where individuals invest their savings or funds in exchange for shares.
- Love money: Funds provided by family and friends, which can be dilutive or non-dilutive, depending on the context.
Advantages of dilutive financing
Bringing in new shareholders provides significant and structuring capital for a startup or scale-up. These new shareholders often contribute valuable expertise and contacts. Furthermore, the additional equity from the operation can lead to financial savings, such as reduced costs or a decrease in company debt.
Disadvantages of dilutive financing
Dilutive financing reduces earnings per share, as there are now more shares to compensate. It also leads to a relative loss of control for founders or shareholders, which can be concerning for some entrepreneurs, though the portion of capital given to new investors may be small.
Dilutive or non-dilutive: which financing model is right for your startup or scale-up?
Now that you know the ins and outs of these financing models and their respective pros and cons, the question is: which model should you choose to fund your business? It depends primarily on:
- Your ambitions
- The financial maturity or development stage of your startup or scale-up
Choosing the right financing model based on your ambitions
If you aim to build a stable and profitable family business, your financing strategy will differ from someone looking to create the next unicorn. The bigger your ambitions, the more you’ll benefit from dilutive financing. However, it’s important to note that raising capital is always a one-way street — there’s no turning back, and your equity story will be impacted.
The equity story refers to the narrative surrounding changes in company shares, particularly in light of new investors and the capitalization table. A savvy entrepreneur avoids overvaluing their company and “leaves room” for future rounds. Having a clear vision for your startup’s future is crucial when deciding whether to raise funds.
Choosing the right financing model based on your company’s maturity
- Seed or pre-seed, early stage: Founders often turn to non-dilutive financing at the inception of their startup. Crowdfunding or grants allow them to test their model, convince early adopters, and make their first sales. The typical strategy is to raise as much non-dilutive public funding as possible and use it as collateral for a bank loan. The only dilutive financing used at this stage is love money.
- Series A: Once market traction is confirmed, founders generally lean toward dilutive financing, such as business angels or venture capital, to unlock funds during the seed stage and accelerate growth.
- Series B, Series C, scale-up: At more advanced stages of development, entrepreneurs often turn to venture capital or corporate venture for significant amounts of funding to help their business take off.
Non-dilutive financing is generally favored at the beginning of the entrepreneurial journey, while dilutive financing is preferred once the company reaches a certain level of maturity.
Conclusion: Dilutive vs. non-dilutive
There are many options available to fund the growth of your startup or scale-up. Choosing between dilutive or non-dilutive financing is a highly strategic decision.
It is highly recommended to seek professional guidance for fundraising and to access the right capital at the right time. For more assistance, feel free to contact us here.