Alternative funding in an uncertain market

One thing that VC Twitter (and the broader news cycle) hasn’t been dancing around is the need for founders to conserve cash in an uncertain market. Unfortunately, many of the earlier stage businesses I’ve chatted with have grown accustomed to the easy money approach VCs took in 2021. What does a founder do when faced with a need for more money at a time when they aren’t ready for a traditional priced equity raise?

One possible answer is looking for different sources of funding that are often put on the back burner during periods of fast cash. Although these sources will likely be smaller in nominal dollar amount than raising a traditional venture capital round, they come with two key, overarching benefits; 1) they are often non-dilutive or minimally dilutive and 2) require a smaller (or more concentrated) commitment of time from founders to close when compared to traditional equity financing. While definitely not an exhaustive list, some of the most common sources on non-dilutive funding we discuss with founders include:

1. Pitch competitions — events like these (XPrize, TechCrunch Disrupt, etc.) are often filtered depending on your company’s current revenue, geographic location, or funding stage. Pitch competitions provide founders with multiple benefits including non-dilutive funding, feedback on the company pitch and business model from assembled guests/advisors, and an opportunity to gain exposure that could potentially attract new customers or investors. While payouts are admittedly not likely to get near the value of a venture fundraise, winning these competitions can put cash in the bank and provide valuable feedback and exposure opportunities for your business.
2. Government grants — depending on where your business is located and your target market, many local and state governments have a portion of their annual budget dedicated to facilitating and growing a startup ecosystem in their region. Grants will also create additional legitimacy for your business that could attract additional investors at your next, larger scale fundraise.
3. Crowdfunding — this avenue is particularly useful for CPG or other tangible product launches and can be a great way to inspire your “100 true fans” to evangelize your company. Crowdfunding can result in early indicators of potential product market fit and lower CAC while proving to investors and future retail partners that you can create demand and successfully move product. Many crowdfunding platforms already exist that simplify this process for you, but it’s of critical importance to assess each platform to ensure the fine print sets your business up for the best possible outcome. Some platforms like Republic offer equity investment opportunities for backers while others like Kickstarter do not have an equity component but won’t pay out any of the raised funds if a company’s specified goal is not hit. Getting the right mix of these provisions that best supports your business is critical. Finally (and probably most importantly), reliance on crowdfunding alone to raise money can signal to future, institutional investors that you have struggled to raise traditional venture dollars. Given this view (fair or unfair), it’s important to control the strategy and narrative on why crowdfunding makes sense for your business and isn’t a “last-ditch” effort to gather money.
4. Revenue based financing — (“RBF”) another option for businesses with a more stable revenue base that provides a way to manage cash flow without selling equity. Some key benefits of RBF include 1) none of the personal guarantees that accompany bank loans, 2) RBF can be significantly cheaper than selling equity and 3) payments are based on a percentage of monthly revenue so if your sales are choppy, your payments will reflect that. However, this is a double-edged sword because if your business beats revenue expectations, you’ll be paying a larger amount than planned. Founders should be wary when considering and negotiating RBF given it requires repayment in the very asset you don’t have when initially entering the contract…cash. Unlike equity financing, which does not require cash repayment, RBF does indeed require payments and could result in a higher cost of capital than initially expected given a company’s growth rate and payback dynamics. This example from Pollen VC is a great overview that works through the calculus in detail.
5. Venture debt — this is an option if you’ve recently raised capital given venture debt’s role as a complimentary funding vehicle to the traditional equity raise. The key rule to venture debt that Silicon Valley Bank outlines well here is that this vehicle is a “complement to your traditional equity raise, not a replacement”. Because early stage businesses will likely not have the financial metrics that support a traditional loan, SVB and other lenders use venture money raised as a proxy for financial health and underwrite a loan amount that represents a percentage of equity financing raised. Venture debt varies on a case-by-case basis, but usually includes a facility fee, traditional interest rate, and tiered borrowing structure that unlocks as your company grows (e.g., $1.5m of a $2.0m loan available initially, $500k available after hitting an ARR target). Additionally, you should also expect a minimally dilutive equity component attached to the loan. A common construction is common stock warrants at the company’s most recent 409a valuation that equate to 0.25% — 1% of the fully diluted capitalization.
6. Equipment financing — for hard tech startups, it can often be daunting to gather the funding necessary to build manufacturing capabilities and inventory. One option for startups is to look for equipment financing to help fund the cost of new equipment and inventory. Equipment financing specifics are built on a case-by-case basis, but you’ll likely have more flexibility to get a loan at an earlier stage given the assets you purchase are usually held as collateral against the loan. Also, it’s important to keep in mind that loan values in asset financing arrangements are tied to the salvage value of a product at the end of its useful life. This means equipment financing can be harder for cutting edge products where the market and residual value have not been repeatedly proven (e.g., LIDAR for self-driving cars, etc.).

It’s our hope that some of these methods may help fuel your business in a time of market uncertainty. While there are certainly many other avenues that we didn’t cover above, understanding different sources of capital outside of traditional venture gives you options, one of the most important things in our current economic climate.