How to fund companies and preserve equity
Clients, grants, debt, barter,...so many choices, so little time
Funding is always a tricky topic and, probably for the same reason, a topic of great interest among the community.
As an investor, entrepreneur, or advisor, it is important for you to understand the different sources of capital available to businesses, above and beyond equity. Once companies face a liquidity event, this funding choice will greatly impact your financial returns.
Depending on the stage of the organization, the industry in which it operates, its geography, its founding team, and other factors, there might be some slight variations to the below.
Equity is usually where all thoughts turn when referring to funding. Despite being myself an equity investor in multiple companies, I always recommend entrepreneurs, early investors and advisors to think hard before giving up equity. After all, if you believe in the business, wouldn’t you want to preserve your equity from dilution? Raising equity obviously has its place in many scenarios (and I will write a future article focusing on equity), however it is important to know that non-dilutive alternative sources of capital exist.
The first and best source of capital that we too often ignore is simply clients. By selling its products and services - assuming positive unit economics - a company generates cash flow. It happens frequently that time, energy and efforts are allocated to find alternative sources of capital (such as equity or debt), …while putting the same inputs in selling and delivering would yield equivalent or better results (without dilution, interests and with an increased valuation). Bootstrapped companies usually don’t receive much press, unless they go public, as there are no glitzy announcements to make on mega rounds. However, this strategy can be extremely profitable for the founders - just ask Ben Chestnut of Mailchimp 😉
Bootstrapping is not always possible, especially when CAPEX requirements are high or when it is important for a company to win market shares as fast as possible.
In that context, grants can come very handy. And let’s be honest grants usually come very handy in almost every situations. As long as the opportunity cost of spending resources on the application is lower than winning new business, this is a great funding avenue. And in most cases, it goes straight to the bottom line. Grants are not to be paid back and are allocated by governments, foundations and other organisms supporting companies based on specific criteria. It is always worthwhile to spend a bit of time to check if some grants could be applicable to your business.
Bartering is probably the oldest type of commercial exchange out there, and thanks to technology (and Covid 🙄) it is having a huge resurgence in popularity. The concept is very simple, businesses trade their spare capacity and resources with other businesses. Online platforms, such as BizX or BarterPay, make the entire process user-friendly. This is an amazing way to boost cash flow and bottom line, while winning new clients. Whether your company sells products or services, bartering is applicable. Most of the platforms also enable charitable giving.
Having questions or comments on this topic? Interested in seeing specific topics addressed in future editions? Share your thoughts in the “comments” section.
Debt is another avenue to access funding while preserving equity. Obviously it comes at a cost, but in the grand scheme of things, this cost is likely to be less than the cost of equity dilution (assuming a growing company and that interest rates don’t go to the roof😉). In my travels, I found that debt is usually a lesser known mean of funding. Probably because most financial institutions are still not very well-versed in financing early-stage companies, especially in non-traditional industries (meaning with no hard assets to lend against). Accordingly, they don’t tend to offer such products to their clients.
Multiple types of debt are accessible; the first is venture debt. To access venture debt, a company must be backed by VC investors. The financial institution will leverage the information and due diligence put together during the equity raise to underwrite the loan. Venture debt follows equity and allows investors to optimize the dilution by balancing equity with debt. It tends to be less onerous than regular business loans.
The second type of debt, working capital line, is more traditional and appropriate for companies with positive working capital. This type of financing is usually more useful for businesses that are later stage or/and with low capex, as the company’s financials need to be solid enough to bear the costs of the financing.
Another type of financing is user-acquisition funding. This growth capital focuses solely on marketing budgets. Revenue-based lending companies, such as Clearco, Product Vessel, Juice, provide capital to turbocharge their clients’ top line. In most cases, they also provide assistance regarding digital marketing expertise which comes very handy. Businesses that can benefit from their services are mainly in the ecommerce space, with some options for subscriptions and gaming businesses too. This funding method can turn out to be quite expensive, however it can still be a very smart option for businesses that have the potential to see their valuations jump significantly thank to these services.
Last but not least is the well-known, if not yet widespread, corporate credit card. It has not always been easy for entrepreneurs to access corporate credit cards. Fintechs such as Brex, and CAARY (I am an investor), have now been stepping in to fill in the gap left by traditional financial institutions. Bypassing credit check and founder liability, while offering spend management platforms, they help entrepreneurs manage short-term liquidity. Credit cards are absolutely not a replacement for structural, long-term financing. However, they are another tool in the funding toolkit that are very useful.
Depending on a company’s specific financial situation, one or a combination of the funding options mentioned above, will allow to preserve equity while fueling day-to-day operations and growth.
The first reason businesses fail is lack of funding, even before inadequate management. It is then primordial that investors, entrepreneurs and advisors understand the options available to them and select them very carefully.
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Will Tang, Chief Revenue Officer, at FrontFundr and I will host a session on Linkedin live on Thursday, March 10th, at 2pm ET to answer questions on equity crowdfunding investing. Please share any questions you might have. We are looking forward to our exchange!