Beyond Bank Loans: Exploring Alternative Capital for Modern Startups

Most early-stage founders typically make one default assumption. Either you get a bank loan or you give away equity. Spoiler: The bank loan doesn’t come through, so equity it is. The problem is that this seeming no-brainer logic will cost you way more ownership of your company than you think. Worse, it’s a cost that compounds itself over time.

Rather, raise equity as if it were one of your scarcest resources. Because it is. There are alternative sources of capital available that are specifically tailored to fuelling growth and scaling operations without burning through equity before you actually need to.

The Bank Loan Problem Isn’t Just About Rejection

Banks are not suitable for startups. Their loan evaluation models were created based on existing companies with two or more years of profit, physical guarantees, and revenue estimates. A growth company that burns cash to win customers does not meet these criteria, no matter how solid the business is.

The mortgage-to-loan equity ratio is taken into account. A credit score could hardly be found under the company’s name. If there are accounts receivable, they are not eligible for lending based on assets. The bank refuses the request, or presents conditions that are acceptable only if you don’t really need the loan.

The founder does not fail here. It is a situation where the bank’s purposes do not match what an early stage company requires.

The Dilution Trap

This is where the situation becomes costly. When bank funding is no longer an option, many entrepreneurs resort to venture capital or angel funding. While this may be necessary in some cases, most of the time it isn’t.

The challenge arises when you use equity to cover operational and repeat costs – like customer acquisition, inventory, or payroll when growing your business. These don’t warrant sharing ownership since these are expenses connected to predictable results. The only price you pay by using equity for funding such expenses is that your share in the company gets smaller.

Over 50% of small and medium-sized enterprises now rely on alternative or non-bank funding sources (British Business Bank, 2023). This trend is not by chance. Entrepreneurs are increasingly effective in identifying the right type of funding for their needs.

How Revenue-Based Financing Actually Works

Revenue-based financing changes how you repay capital. Instead of paying the same amount back every month regardless of how your business performs, repayments are based on a percentage of your monthly revenue. Have a good month? You repay more. Have a slower month? You repay less. The total amount you repay is agreed in advance, often as a fixed fee on top of the amount you draw down, so there’s no compounding interest.

For businesses with monthly recurring revenue like SaaS companies, this type of repayment makes complete sense and the cost of the capital works in your favor, increasing and decreasing with your revenue performance.

For founders managing fluctuating monthly cash flows, flexible revenue based business funding ties repayment directly to real-time performance, which removes the pressure of a fixed obligation during a slow quarter. This structure removes the short-term stress.

When Alternative Capital Makes The Most Sense

There are certain times when opting for non-dilutive capital makes the most sense. Identifying those times is the nitty-gritty essence of good financing advice for owners of businesses that are scaling.

For instance, if you regularly have a lot of cash tied up in seasonal inventory spikes, a revenue-based draw can be used to finance that inventory and is repaid as sales are made. You don’t dilute your equity, nor are you left paying back a traditional loan during the slow season.

Or, if you need to spend money on marketing to generate revenue, you can use alternative capital to finance that expense until it pays off. Then repay that loan as a percentage of your revenue.

Perhaps you have rapid growth between equity rounds. You know where you can take your business and are planning to raise equity to get there but need to make a few moves in the meantime. Taking on a loan will leave you juggling two rounds worth of paperwork, not to mention repayments.

The Hybrid Approach To Building A Capital Stack

Equity and alternative debt aren’t in competition. They are a great combination when used correctly.

The best way to think of this is to use equity for what equity is the best capital for: long-term R&D, entering new markets, and building the kind of infrastructure that won’t generate a return for two or three years. These are real long-horizon bets where an investor’s long-term hat and their network of successful investments justifies their piece of the company.

Use alternative debt for the repeatable, measurable work – customer scaling, operational scaling, inventory cycles. The returns on that spend are clear and relatively quick. That’s what revenue-based financing is designed to finance.

Protecting equity isn’t about saying no to investors. It’s about making sure if and when you do say yes to something that’s going to reduce your ownership share in the company, it’s for something you actually need the help and ownership stake for. Most scaling operationally doesn’t. A founder who walks into their Series A with 10% more of their company than they would have under a different strategy has actually made a choice, not just taken the default financing strategy. The resources are out there. The question is whether or not you reach for them before hitting the cap table.