4 Startup Fundraising Alternatives That Help You Avoid Dilution
Entrepreneurs struggle with term sheets when raising startup funding
The most common term entrepreneurs use when negotiating an investment term sheet is dilution (or the anti-dilution clause).
It’s the clause that dictates how much ownership an entrepreneur retains as he sells off pieces of his startup’s equity.
I remember talking to a startup founder who raised money from someone who called himself “a billionaire.” No one really knew if this guy was an actual billionaire.
But when the founder said the billionaire requested a 51% stake in the company for a small influx of cash, I couldn’t believe it.
I prefer to believe the guy wasn’t a successful investor over the idea that he’d be a vulture.
Almost every ultra-high net worth individual I’ve met knows that investing in a startup means you don’t screw over the founders.
But let’s say you found a good investor. There’s still a solid argument for raising capital that doesn’t dilute you as a founder.
It’s very hard to bring on people who believe in your vision and let you lead the company toward that vision.
So here are 4 ways to raise funding for your startup or small business without the headache that dilution gives you.
1 — Bootstrap
This is always the facetious answer: “just do it yourself.”
And your response is,
“I wouldn’t be seeking funding if I could do this myself…without the funding.”
So, let me just start with “bootstrap” to get it out of the way (but also because it really is the most important).
So many times I run into entrepreneurs who have a choice to spend the next 3 months between finding investors and generating revenue. Meaning, these guys already have a finished product, service, and users (or customers but just haven’t reached break-even).
And so often, it’s a matter of establishing the right sales strategy. Often, the entrepreneur can replace pitching an investor with activities that generate revenue or profitability.
By the time the 3 months are up, you may have generated enough revenue to substantiate a higher valuation when raising capital.
By the time you finish growing revenue after 3 months, you may not even need the investment.
2 — Loans
I consider the topic of loans as twofold: direct and indirect. Direct is pretty much taking a loan out for business purposes.
There are helpful business loans that the Small Business Administration (SBA) can help with. Keep in mind that loans really only work for businesses that have generated revenue for about 2 years.
Actually, most banks will require 2 years of financial traction. Lenders will also require other things such as collateral — what kind of assets do you or your business own.
Your local SBA will have a funding program that simplifies the application process and actually matches the right lenders with you.
What I consider “indirect” is based on a strategy from the big guys.
There are little tricks to the loan game, and a really important one is used by private equity firms a lot. It’s called a leverage buy-out (or LBO). The firm basically takes out a large loan to roll-up a series of acquisitions into one.
You can employ this strategy to consolidate your small loans into one with favorable interest. Loans are an indirect way to alleviate the pain of raising capital, but remember that they eventually have to be paid back.
In fact, lenders are the first creditors to get paid when the time is up.
3 — Grants (Government)
Look at SAM.gov and you’ll see the United States spent almost a trillion dollars on contracts with private companies here at home.
These include both grants that the government gives for free to companies that support the American economy and commercial contracts for services, making the government your customer.
Imagine that: the United States of America is your customer.
The local SBAs can help you develop the right strategies to make this vision come true. If I were to give you the quick and dirty: browse SAM.gov for contracts that request your business’ product or services (or similar), then build a relationship with the government buyers (procurement agents).
For the sake of transparency, these buyers move positions a lot but they tend to stay within industries they’ve become experts in.
If they hopped industries, they wouldn’t be effective at their jobs because they wouldn’t understand the nuances.
Once you have a relationship, you can learn of ways to tap into government budgets, create custom needs for your product or service, and
4 — Grants (Foundations)
You can learn a lot from non-profits. There are great family funds, charitable foundations, and institutional investment groups that allot a portion of their money toward businesses that have a social mission.
If you don’t have a social mission, you can still get funding from them. I truly believe that every business, especially new startups, can find a way to help the community while making a profit.
Show how your company makes a difference in the community to a foundation with a similar vision or cause, and you can increase your chances of getting non-dilutive funding from it.
Dilution strikes fear in the hearts of founders who know anything about it because they normally associate it with “vulture capitalists.”
These are the kinds of venture capitalists who create and perpetuate a bad reputation for investors because they take advantage of startup investment deals.
The above strategies will help you avoid this issue until you’ve met the investors who genuinely care for your business.