The Ultimate Guide to Non-Equity Capital Funding

Non Equity Capital Funding

 

Bridgeup Funding >> Non-Equity Capital Funding
  More autonomy, better cash flow, sustainable scaling of your business – the trifecta of every start-up founder’s dream.

Funding can easily be termed as the lifeblood of any start-up that is looking to grow. However, most funding models are equity-based and require the founders to part with precious stocks of the company.

Alternatively, non-equity capital funding is a funding model which involves an asset other than stocks as collateral security upon which the funding is provided to start-ups. In simple terms, it means raising funds without parting from any part of your company, be it in terms of shares or relinquishing control over the day-to-day functioning of the business.

In the long run, non-equity financing helps reduce a lot of issues that come with equity-based financing.

 It is essential to understand how non-equity capital funding can prove to be a game changer for your start-up, in contrast to equity-based financing. Without further ado, let’s dive right in!

Problems with Equity-Based Funding

Let us understand some of the primary problems that may emerge when opting for equity-based funding –

  • Erosion of Control

Since equity funding involves trading your shares in exchange for funds, it eventually leads to the dilution of the founders’ stock. Primarily investors or venture capitalists are in the game looking to maximize their profits, so they are unlikely to provide the necessary funding without trading it for maximum equity.

Since stocks are usually a direct representation of the voting rights of the shareholders and the ownership of the company, the dilution of stocks eventually leads to reduced control of the founders over their own start-ups.

  • Profit Sharing

Every investor investing in the start-up will expect a share in the profits that it earns. Since profit is distributed in accordance with the portion of shares owned, the investors are likely to earn a part of the profits irrespective of how much they contribute to the growth of the company.

In case your company grows, the stocks usually offer the most valuable economic returns in the long run. However, if the founder trades off the stocks for a low value to raise equity funding in its early stages, it is the investor who would reap the monetary benefits of the stocks and not the founder who has put in all the hard work over the years.

  • Potential Conflicts

Equity funding involves trading stock which is basically the share of ownership of the company. So, if the investor also gains a say in the functioning of the company, he might unduly and excessively interfere with the day-to-day affairs therein.

This is especially problematic when the goals of the founder and the investor do not align. This may lead to conflict between all the participating authorities and work to the detriment of the company in the long run. One of the recent instances of such conflict leading to an ugly spat was between the founders and the investors of BharatPe.

What is Non-Equity Capital Funding

Non-equity funding is essentially a funding model which involves raising the required funding for your start-up without trading its equity stocks. This allows start-up founders to keep control of company stock while raising the necessary funds.

Some non-equity funding examples include stock indexes, physical commodities, futures contracts, real estate, and fixed-income securities.

Although non-equity fails to garner the attention of most start-ups due to a misconception that it is not a very smart way to raise the required fund, in reality, this is not true. Non-equity funding is a concept that has been gaining increasing acceptance as a smarter alternative to equity funding in recent years.

Equity Funding vs. Non-Equity Funding

Both equity and non-equity funding have a distinct set of features that set them apart from each other. To make a smart choice, it is important for every founder to understand the differences between the two.  Here are the five main differences between equity and non-equity funding –

  • Equity

One of the most distinct differences between equity and non-equity funding is obviously in terms of equity. While in the former, capital is raised in exchange for equity, the latter doesn’t involve trading equity for the capital raised.

  • Retention of Control

While equity funding allows the investor to take control of the shares of the company, the same is not true for non-equity funding. Thus, the dilution of shares leads to reduced control of the founders in equity financing, but in the case of non-equity financing, the founder gets to keep his shares and the overall control of the company.

  • Requirement of Security

The most popular form of non-equity funding is debt funding, which involves taking a loan in exchange for collateral security. Thus, any start-up looking to raise funds through debt funding needs to have valuable security that it can use as collateral.

In contrast, equity funding requires no such security since the investors invest in exchange for the shares of the start-up itself. However, there are other alternatives such as ARR lending, bootstrapping, etc. wherein such security is not required.

  • Increased Risk for Founders

In the case of non-equity funding, it is common for founders to often opt for loans for the start-up, which puts them under immense pressure and the risk of repaying them in the time specified.

However, in equity funding, founders face no such risk as the investors bear the risk of their own money. Although there are other alternatives to non-equity funding that doesn’t involve taking a loan, they are usually harder for start-ups to obtain.

  • Duration & Amount

While equity funding is offered for longer periods, non-equity finance usually has a shorter term for repayment. Moreover, the amount granted for non-equity funding is usually lower than equity funding due to the reduced returns for the investors. This makes it harder for start-ups to sustain solely on non-equity funding options in the long run.

Top 7 Reasons Non-Equity Funding Can be the Best Option for You

So, here are the top 7 reasons why opting for non-equity funding can be the best option for you –

  1. Ownership Retention – The primary reason most start-up founders opt for non-equity-based funding is the fact that it doesn’t involve trading the precious shares of the company. So, it ensures that others do not unduly benefit from the hard work that you’ve put into your company, ensuring you get to remain the sole owner of your  start-up.
  2. Control – Since shares are directly linked with voting rights and ownership, trading them also means allowing the investor to have a say in the company. This could lead to excessive interference by the investor looking for higher returns, who may not necessarily understand the personal goals you have set for your start-up. Thus, non-equity funding is the best option if you (like most founders) wish to keep the control of the company to yourself.
  3. Conflicts – You would know what the best decision is for your company. However, an investor may have his own set of plans and goals for your start-up, which are completely different from yours. This could lead to unnecessary conflicts which may work to the detriment of the best interests of your company. However, such problems are unlikely in the case of non-equity funding.
  4. Flexibility – Most non-equity funding options offer increased flexibility like no repayment date, low or zero interest, friendly loan terms, etc. which can go a long way in allowing founders to provide the necessary space and time to nurture the start-up in the best possible way.
  5. Specified Period of Time – Unlike equity funding where the investor can retain the shares for an indefinite period of time at his own discretion, non-equity financing offers the option of stipulating a specific period of time within which the start-up can pay off the sum borrowed and free itself from any obligation or duties towards the investors.
  6. Informal Fundraising – Unlike equity financing, which happens during specified periods and rounds, non-equity funding can be obtained at the discretion of the founder. This allows the start-up to raise the required amount whenever the need arises without having to wait for any formal rounds.
  7. Increased Profitability – Since most non-equity funds are provided at a fixed rate of interest, it allows the start-up to maximize its benefits as its profits rise. However, in the case of equity funding, a share of the profits is always payable to the investors.

Best Ways to Get Non-Equity Capital Funding

 Now that we have understood what non-equity funding actually is, let us understand the various ways a start-up can obtain such investment for itself –

  • Investor Debt Financing

In layman’s terms, it refers to borrowing money from investors as loans. In the case of investor debt financing, a legally binding loan agreement lays down the terms of repayment over a specified period of time.

Such loans can be obtained from angel investors, government initiatives, banks, and sometimes even corporate social initiatives. However, it is important to ensure that the investor debt financing loans opted for have  zero or no interest and consist of friendly terms such as an option of writing off the loans for it to be beneficial for the start-up.

  • Revenue Sharing with Investors

Revenue sharing is another model which involves the start-up agreeing to share a certain part of their revenue (not profit, mind it!) for a specified period of time.

In such a case, the investor only makes money when you do and hence ensures that the functioning of the start-up can be optimized to be beneficial for both the investor and the founder.

  • ARR Lending

ARR lending, which essentially stands for annual recurring revenue lending is a powerful option of non-equity funding which was pioneered by Venture Capitalist Arthur Fox in the 90s. Over time, the popularity of this model has only grown, especially due to the fact that most start-ups want to avoid the excessive pressure for immediate growth and loss of equity due to equity-based funding raised from Venture Capitalists.

In ARR lending, the parties agree upon a principal amount that does not have a fixed date of repayment. In contrast, the loan repayment is based on the percentage of annual or monthly revenue that is generated by the start-ups.

The fact that it allows start-ups the flexibility to stay cash flow positive and repay the loan without a date of repayment makes it a very powerful alternative to other models of capital funding.

  • Bootstrapping

Bootstrapping basically refers to a self-funding strategy that excludes investors or loan money altogether. It uses revenue generated from paying users to fund the growth and operation of the start-up. Some of the most popular options for bootstrapping are -

  1. Lifetime Deals - One of the first options of bootstrapping that is usually popular in software start-ups is to provide lifetime subscriptions at discounted rates to encourage users to opt for early sign-ups. This enables each user to become a micro-investor thus supporting the start-up in its early years and enabling it to grow.
  2. Crowd Funding - The second alternative is to opt for crowdfunding, which is a strategy that is mostly popular for start-ups that sell physical goods. The start-up collects the payments from customers beforehand by offering early bird discounts and then uses the funding to manufacture/design products for the customers.

Taking a Balanced View in Funding Your Start-up

Although initially regarded as an unconventional method of raising funds, non-equity funding has consistently garnered mainstream attention over time and is today viewed as a powerful financing option that start-ups can explore as an alternative to equity financing.  One prime reason is the fact that it allows founders to retain a greater degree of autonomy in their business and its related operations.

That said, both equity and non-equity capital funding models have their respective pros and cons.  Ultimately, each start-up has its own financial need, requirements, goals, and vision.  It is therefore imperative for founders to understand the funding options they can opt from and choose the one that best caters to their start-ups. The norm is – mostly, the nature, type of business, and the industry the start-up operates in – are what stand out as the guiding factors in helping founders seek a particular kind of financing.

Why BridgeUp?

BridgeUp is a platform that provides comprehensive financing solutions for businesses looking to skip the traditional fundraising methods or bear the debt or dilution that they bring. With BridgeUp, you can scale your business fast, while still being grounded in the security that upfront capital offers.

 Looking to get funding quickly and seamlessly so you can amp up the growth of your business? Call us at +91 -9819660287 or drop us a query on the contact form here.

Related Resources

Zeus Dhanbhura

Zeus Dhanbhura

CEO at BridgeUp