Equity financing has become one of the most widely used forms of financing for founders looking to accelerate the growth of their companies. While it remains popular, many founders are also looking to alternative financing to access growth capital while minimizing equity dilution. In this article, we will explore what “minimally dilutive” means and the types of financing that offer this.
Equity dilution reduces a founder’s ownership as a result of new shareholders.
There is a common misconception that equity is a bad thing. While this can sometimes be true, dilution serves a purpose in growing the company so that the founder’s equity value can grow as well. Many founders see this dilution as a necessary part of growth as long as they prepare for it accordingly.
“Minimally dilutive” has become a popular phrase used by venture debt and revenue-based financing lenders.
The term comes from the warrants issued by the company, which gives the lender the right, but not the obligation, to buy stock from the company at a certain price in the future. Warrants come with an expiry date that typically range from 5 to 10 years. If the lender does not exercise the warrants before the expiry date, the warrants expire.
Warrants are dilutive.
Lenders receive newly issued stock. However, unlike the dilution associated with equity investors, warrants do not pay dividends or come with voting rights. Warrant coverage typically ranges between 10-20% for venture debt loans and 10-40% for revenue-based financing loans. The exact percentage is generally determined by the risk-level of the company.
Example:
Flow Capital, a venture debt lender, provides Company A a $2M loan with 10% warrant coverage with a 5-year term.
This results in a warrant for $200,000 worth of shares in Company A, which expires after 5 years.
Warrants are often given to investors as an incentive for investing and are most often seen in venture debt rounds.
Lenders are attracted to warrants as means of leveraging their positions in a security, limiting their downside, or exploiting arbitrage opportunities. For the company, warrants represent a potential source of capital in the future and as a way of preserving goodwill with shareholders.
“Minimally dilutive” financing through venture debt loans or revenue-based financing offer companies a great opportunity to access growth capital while minimizing equity dilution. As discussed, dilution only occurs in these types of loans when warrants are exercised, which must occur before their expiry date. For more information on venture debt loans or revenue-based financing, please explore our Knowledge Center.
