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Q&A: VC cash crunch has startups turning to non-dilutive financing

Q&A: More startups are turning to non-dilutive financing with VC funding in short supply.

Miguel Fernandez.jpg

Miguel Fernandez, co-founder and CEO of Capchase, at Web Summit 2022 in Lisbon, Portugal.

Piaras Ó Mídheach/Getty Images

The lack of venture capital funding over the past two years has led more startups to look for alternative ways to finance their businesses.

New data from New York-based fintech platform Capchase found that non-dilutive funding for European startups increased nearly 50% in 2023 when compared to 2022.

We spoke to Capchase CEO Miguel Fernandez about how the VC downturn has impacted the non-dilutive financing market and what lies ahead for 2024. This interview was edited for length and clarity.

PitchBook: What is non-dilutive financing?

Fernandez: Most of the time, startups have three options when it comes to funding. They can use customer payments or bootstrapping and invest back into the business, VC funding or non-dilutive financing. Non-dilutive financing is basically any type of debt that doesn’t have an equity component. Venture debt isn’t included because of the warrants that allow lenders to buy equity later on.

Typically, there are two options. (One is) revenue-based financing, so you raise capital and repay investors with a percentage of your revenue. The good news there is that the faster you grow, the faster you pay back and if sales slow down, you pay less.

The second is a term loan, which is much more predictable. From the beginning, you know how much you’re getting, when you have to pay it, and how much you have to pay. This is more geared toward SaaS companies than revenue-based financing.

How has the downturn in the VC market impacted demand for non-dilutive financing?

Most startups prefer external capital instead of bootstrapping because they need to grow fast to stay competitive.

What we’ve seen in the past couple of years is that equity dollars chasing startups have been more expensive as a result of high interest rates. There has been much less VC capital in the market for startups to raise. The same goes for venture debt because it is given based on the probability that a company is going to raise another round. That’s not as helpful in an environment like this.

So a lot of startups have been looking at other sources like non-dilutive financing as an alternative. We’ve also seen more startups raising smaller rounds of VC funding because of the downturn and supplementing it with non-dilutive financing.

Has the risk for non-dilutive financing providers increased alongside demand?

The downturn has also been challenging for many providers. Capital is more expensive to loan and fewer companies are a good fit due to the increased risk.

It’s always easy to give people money; the hard thing is getting it back. Non-dilutive financing providers who prioritized loaning to hypergrowth businesses are now paying for it. It’s the same story for us as it is for VCs: you invest on the assumption that the good times are going to last forever, and when the market shifts, that assumption can kill you. And that has been the case for some providers who have had to shut down or lay off employees.

I think if the market does pick up, we’ll see more players trying to get into the non-dilutive financing space given the demand that we’re seeing.

With VC dealmaking expected to pick up this year, how will this market be affected?

Each has its purpose and companies are getting much savvier when building their capital structure. Equity should be and is used by companies to finance non-predictable activities because you don’t have to pay that money back in the form of cash flow. For things like launching new products or entering new markets where you don’t have a known outcome, equity works really well.

Other things are totally predictable, and they scale in line with the company’s revenue. Examples are customer acquisition costs or sales and marketing expenses. You know how they work and can project into the future. It’s not worth giving up ownership for things like this so non-dilutive financing fits well. We particularly see it with second-time founders, those are the companies that are using both tools much more effectively.

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