Why Delaying Your Next Capital Raise Could Pay Off Big
Posted: Tue Dec 10, 2024 8:29 am
If your business is growing, chances are you're looking for additional funding to fuel that growth.
In our experience, business owners looking for growth capital first think of reaching out to venture capitalists, private equity investors, angel investors, or even the public markets. After all, many of the world’s largest companies have grown this way, so why wouldn’t you ?
There are some drawbacks to equity investments, however. By selling off part of your business now, you are giving up a portion of your business and its future profits, and you may lose control over the direction and governance of your business.
By delaying raising equity for a while and opting for non-dilutive financing, you can get much more from your investors and thus maintain better control over your business.
What is non-dilutive financing?
Non-dilutive financing refers to debt that does not require you to give up any ownership of your business. BDC offers traditional debt financing and flexible financing – through its BDC Capital division – in the form of:
cash flow loan , which is a term loan that does not require business assets or personal property to be pledged as collateral. In the case of a cash flow loan, banks typically provide the loan based on past and projected cash flows. The principal is typically repaid through scheduled monthly payments and monthly interest;
mezzanine financing , which is often structured as lump sum payments and cash flow sweeps (based on a percentage of available excess funds);
quasi-equity financing , which has customized repayment terms and a term of two to eight years. This type of loan is often structured so that the majority of the principal repayment is made at the end.
All three types of loans can be structured as subordinated loans, which will be repaid after the secured creditors and lenders if the company were to restructure or liquidate. By structuring the financing in this manner, the company will have access to additional funds to support its growth. In terms of pricing, the cost will typically be lower than equity, but higher than loans secured by hard assets such as equipment or real estate, because the bank is taking on additional risk.
Three Examples of Deferred Equity Investments Using Non-Dilutive Debt Financing
There are many examples of situations where a company rich people database may want to delay raising equity capital by using debt financing. Here are three examples of companies we have worked with over the past year.
1. Financing sudden growth
We recently worked with a company that developed technology to help the long-term care market implement more efficient workflows and content delivery mechanisms. Due to the COVID -19 pandemic , demand for their product doubled in a matter of months.
The company turned to BDC for cash financing to support its growth without diluting the ownership of the founder and early investors. If the company wants to raise equity later, it will be able to do so with a much higher valuation and a more solid customer base.
The company will have to pay interest on the debt over the next few months, but the return on the value of the founders' equity will be much higher than the amount paid to service the debt.
2. Financing market expansion
Another company we were able to help is in the wellness space . It has created software that encourages people to adopt healthy habits while sharing the data with insurance companies and private companies that can reward their progress. The company needed funding to strengthen its management and expand its sales and marketing.
We were able to help finance her expansion with a three-year quasi-equity loan , under which she pays only the interest and will make a full lump sum payment at maturity.
At maturity, the company will have the choice of repaying the capital using its cash, refinancing the loan or raising equity on more favorable terms that take into account the company's increased revenues. It can also choose a combination of these three options.
3. Development of a new sector of activity
The third business we helped was a traditional retailer with a physical location and a growing online store. The business needed money to set up distribution for its products, update its software, and purchase inventory.
We were able to fund the company with growth capital as it expanded its online operations in Canada, growing them from $ 5 million to $ 30 million . Having demonstrated that its model could succeed, it is now looking to raise equity capital to expand its operations in the United States .
What are the benefits of delaying equity financing?
Delaying raising equity capital can allow you to advance your strategy and take some critical steps that will make your company more attractive to investors. While your company may be attractive to investors now, it could become more attractive if you can show a year of solid growth, improved EBITDA results, or increased customer interest thanks to a few new deals in your target market.
As your business grows and you increase your revenue, you should be able to attract better investments on more favorable terms.
Non-dilutive financing can also be used to reduce risk for investors. The company can show that serious partners have done their due diligence and believe in the company’s vision and management team. The time saved can also be used to strengthen the company’s corporate governance or accounting practices.
Companies that choose to delay their equity financing also retain the full range of options to:
raise equity later at a higher valuation;
sell the business at a higher value while retaining a veto over the potential acquirer;
continue their long-term operation without external partners participating in its daily management.
For companies that have been hit by the COVID pandemic, delaying raising equity through non-dilutive financing can help bridge the gap until better days when their value will be higher.
Why Debt Financing Costs Less Than Equity Financing
You will often hear that debt financing is less expensive than equity financing. But what does this mean in concrete terms for an entrepreneur? To help you better understand, we have created a simple example.
Consider a sole proprietorship. The business is valued at $ 10 million and is growing rapidly, at 25% per year. The business is considering three scenarios for raising additional capital.
Raise $ 3 million in equity now.
Take out a $ 1.5 million mezzanine loan now to delay raising equity by one year, then raise $ 3 million in equity.
Take out a $ 3 million mezzanine loan now and forgo equity financing.
blog-162-tableau-financing-founder-960x580
As can be seen in the table above , scenarios two and three are the most profitable for the founder in this specific case.
By obtaining mezzanine financing to delay raising equity by one year, the owner of the business will be able to keep 6% more of the equity ( 83% versus 77% ) because he or she will be able to raise the equity when the company is valued higher. The additional value of the founder's equity is equivalent to about 15% of the current value ( $ 1.5 million on $10 million ), including the cost of debt.
At the same time, by raising mezzanine financing instead of equity, the owner can retain 100% of the business. In this scenario, the founder's equity after year four is worth 10% more than if the founder had chosen to raise the same amount of equity.
As you can see in these scenarios, all else being equal, the cost of debt is much lower for the founder than the cost of equity.
A scenario to consider
We’re not saying that all companies should immediately stop raising equity and turn to debt to finance growth. Investors bring more than just money to the table when they invest in a company. They’re also much more appropriate for companies that haven’t yet made revenue or companies that don’t have a predictable timeline for reaching profitability.
In our experience, business owners looking for growth capital first think of reaching out to venture capitalists, private equity investors, angel investors, or even the public markets. After all, many of the world’s largest companies have grown this way, so why wouldn’t you ?
There are some drawbacks to equity investments, however. By selling off part of your business now, you are giving up a portion of your business and its future profits, and you may lose control over the direction and governance of your business.
By delaying raising equity for a while and opting for non-dilutive financing, you can get much more from your investors and thus maintain better control over your business.
What is non-dilutive financing?
Non-dilutive financing refers to debt that does not require you to give up any ownership of your business. BDC offers traditional debt financing and flexible financing – through its BDC Capital division – in the form of:
cash flow loan , which is a term loan that does not require business assets or personal property to be pledged as collateral. In the case of a cash flow loan, banks typically provide the loan based on past and projected cash flows. The principal is typically repaid through scheduled monthly payments and monthly interest;
mezzanine financing , which is often structured as lump sum payments and cash flow sweeps (based on a percentage of available excess funds);
quasi-equity financing , which has customized repayment terms and a term of two to eight years. This type of loan is often structured so that the majority of the principal repayment is made at the end.
All three types of loans can be structured as subordinated loans, which will be repaid after the secured creditors and lenders if the company were to restructure or liquidate. By structuring the financing in this manner, the company will have access to additional funds to support its growth. In terms of pricing, the cost will typically be lower than equity, but higher than loans secured by hard assets such as equipment or real estate, because the bank is taking on additional risk.
Three Examples of Deferred Equity Investments Using Non-Dilutive Debt Financing
There are many examples of situations where a company rich people database may want to delay raising equity capital by using debt financing. Here are three examples of companies we have worked with over the past year.
1. Financing sudden growth
We recently worked with a company that developed technology to help the long-term care market implement more efficient workflows and content delivery mechanisms. Due to the COVID -19 pandemic , demand for their product doubled in a matter of months.
The company turned to BDC for cash financing to support its growth without diluting the ownership of the founder and early investors. If the company wants to raise equity later, it will be able to do so with a much higher valuation and a more solid customer base.
The company will have to pay interest on the debt over the next few months, but the return on the value of the founders' equity will be much higher than the amount paid to service the debt.
2. Financing market expansion
Another company we were able to help is in the wellness space . It has created software that encourages people to adopt healthy habits while sharing the data with insurance companies and private companies that can reward their progress. The company needed funding to strengthen its management and expand its sales and marketing.
We were able to help finance her expansion with a three-year quasi-equity loan , under which she pays only the interest and will make a full lump sum payment at maturity.
At maturity, the company will have the choice of repaying the capital using its cash, refinancing the loan or raising equity on more favorable terms that take into account the company's increased revenues. It can also choose a combination of these three options.
3. Development of a new sector of activity
The third business we helped was a traditional retailer with a physical location and a growing online store. The business needed money to set up distribution for its products, update its software, and purchase inventory.
We were able to fund the company with growth capital as it expanded its online operations in Canada, growing them from $ 5 million to $ 30 million . Having demonstrated that its model could succeed, it is now looking to raise equity capital to expand its operations in the United States .
What are the benefits of delaying equity financing?
Delaying raising equity capital can allow you to advance your strategy and take some critical steps that will make your company more attractive to investors. While your company may be attractive to investors now, it could become more attractive if you can show a year of solid growth, improved EBITDA results, or increased customer interest thanks to a few new deals in your target market.
As your business grows and you increase your revenue, you should be able to attract better investments on more favorable terms.
Non-dilutive financing can also be used to reduce risk for investors. The company can show that serious partners have done their due diligence and believe in the company’s vision and management team. The time saved can also be used to strengthen the company’s corporate governance or accounting practices.
Companies that choose to delay their equity financing also retain the full range of options to:
raise equity later at a higher valuation;
sell the business at a higher value while retaining a veto over the potential acquirer;
continue their long-term operation without external partners participating in its daily management.
For companies that have been hit by the COVID pandemic, delaying raising equity through non-dilutive financing can help bridge the gap until better days when their value will be higher.
Why Debt Financing Costs Less Than Equity Financing
You will often hear that debt financing is less expensive than equity financing. But what does this mean in concrete terms for an entrepreneur? To help you better understand, we have created a simple example.
Consider a sole proprietorship. The business is valued at $ 10 million and is growing rapidly, at 25% per year. The business is considering three scenarios for raising additional capital.
Raise $ 3 million in equity now.
Take out a $ 1.5 million mezzanine loan now to delay raising equity by one year, then raise $ 3 million in equity.
Take out a $ 3 million mezzanine loan now and forgo equity financing.
blog-162-tableau-financing-founder-960x580
As can be seen in the table above , scenarios two and three are the most profitable for the founder in this specific case.
By obtaining mezzanine financing to delay raising equity by one year, the owner of the business will be able to keep 6% more of the equity ( 83% versus 77% ) because he or she will be able to raise the equity when the company is valued higher. The additional value of the founder's equity is equivalent to about 15% of the current value ( $ 1.5 million on $10 million ), including the cost of debt.
At the same time, by raising mezzanine financing instead of equity, the owner can retain 100% of the business. In this scenario, the founder's equity after year four is worth 10% more than if the founder had chosen to raise the same amount of equity.
As you can see in these scenarios, all else being equal, the cost of debt is much lower for the founder than the cost of equity.
A scenario to consider
We’re not saying that all companies should immediately stop raising equity and turn to debt to finance growth. Investors bring more than just money to the table when they invest in a company. They’re also much more appropriate for companies that haven’t yet made revenue or companies that don’t have a predictable timeline for reaching profitability.