WAYS TO FUND YOUR COMPANY
Alternatives to Equity
Most entrepreneurs think the only way to fund their company is through traditional debt from a bank or from equity investments, either from venture capitalists or angel investors. However, there are a number of different ways outside of debt and equity to start or or to grow your business. This is a subset and not meant to be inclusive but tends to be the most popular alternative to equity options.
Alternatives to Equity
Venture debt lenders provide capital to high-growth companies looking to scale their operations. These high-growth companies generate revenue and are scaling rapidly; however, because of the growth, they are not profitable which puts them outside of traditional bank debt.
Venture debt lenders, sometimes in conjunction with equity, will invest money in the form of debt with an equity sweetener such as a warrant, option, or common. The equity sweetener plus a slightly higher interest rate pays the lender for the higher risk. This makes it more expensive than traditional debt but has many advantages over equity.
The debt is mostly non-dilutive in that you give less of your company away in exchange for the capital. This money can be used to become profitable or give the entrepreneur the ability to push off raising a round of equity when the price of the business may be higher. This also can be used with an equity round where entrepreneurs reduce the amount of equity in the round and supplement with venture debt. The equity component of the round gives the lenders comfort that the startup has money in the short term to service the note.
While venture debt is typically associated with a startup, Mezzanine debt is frequently associated with acquisitions and buyouts, for which it may be used to prioritize new owners ahead of existing owners in case of bankruptcy. Mezzanine debt occurs when a hybrid debt issue is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments attached, often known as warrants, which increase the value of the subordinated debt and allow greater flexibility when dealing with bondholders. (1)
Shared Earning Agreement (SEA)
SEA are arrangements with entrepreneurs where entrepreneurs get a salary but share a percentage of earnings over time to pay back the SEA. In addition, investors get a long term incentive by holding the right to convert at a round of fund raising or upon acquisition. In summary, you don’t pay the SEA until you make enough money to pay off the note or the business is sold.
This was made popular by the Calm Fund (calmfund.com) whose fund is investments using their SEAL agreement. SEA are meant to align the investor with the interest of the founder. Investors win when the company wins.
Share Profit and Collaborative Endorsement (SPACE)
Collab Capital pioneered the use of these agreements, also known as SPACE Agreement or Redeemable Equity
SPACE agreements recognize that current investment options fail to align interests between founders and investors which pushes companies towards liquidity events without recognizing alternate definitions of success.
The SPACE agreement provides a path toward successful outcomes for founders who want to
build sustainable, profitable businesses, without pushing towards unicorn status.
Initial investments look like a typical equity investment, with an investor purchasing shares of a company at a specified price. They differ from traditional equity by providing the founder with the ability to redeem shares via cash flow rather than through an exit.
In some circumstances, companies agree to gradually repurchase shares from the very beginning. In others, the decision to repurchase shares is a mutual decision between the founders and their investors.
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