Bridge the Gap: Short-Term Capital Options to Grow

In Short

• Convertible notes and SAFE agreements provide flexible funding for businesses, with options for future equity conversion without immediate valuation.
• Non-dilutive funding offers quick access to capital without equity loss or complex reporting requirements.
• Each option has unique advantages but also requires careful consideration of potential dilution and legal costs.

Tips for Businesses

To optimize short-term funding, evaluate convertible notes for hybrid debt-equity benefits, SAFE agreements for lower risk, and non-dilutive solutions for faster access without dilution. Always consult legal advisors to ensure compliance and draft investor-friendly agreements tailored to your growth needs.

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Table of Contents

• Convertible Notes
• SAFE Agreements
• Non-Dilutive Funding Solutions
• Key Takeaways

All businesses are unique in their own way. Still, there is something fundamental and common to all: a need for sufficient working capital to manage daily operations, meet short-term obligations and seize growth opportunities. Without adequate working capital, businesses cannot achieve their full potential. More recently, it has become increasingly challenging for businesses to obtain access to both equity and debt capital options. Traditional banks have tightened their lending requirements and processes, and equity funds are slower and have a steeper climb to close. These conditions mean businesses are struggling to raise funding to manage short-term cash bottlenecks and execute their growth plans. 

Fortunately, there are various short-term capital options available to business owners. There are numerous ways to construct the capital stack, and alternative funding options are increasingly important. This article takes a closer look into some available options for your startup, including:

• convertible notes;
• SAFE agreements; and
• non-dilutive funding solutions. 

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Convertible Notes

A convertible note, also known as a convertible loan, is a hybrid security. It is a type of financial instrument that combines elements of debt and equity. An investor provides funding in the form of a loan with a predetermined interest rate and a maturity date (like a regular loan). On maturity, the investor can elect to be paid back the loan and interest in cash or convert the outstanding balance into equity.

Main Benefits

• Much quicker and simpler process to raise funds via a convertible note than a priced equity round.
• Companies can raise funds without needing to determine a valuation or give away equity immediately. 

Key Considerations

• Future dilution – while there may not be any immediate equity dilution, there is always a possibility that severe dilution may occur in future funding rounds, particularly when companies raise multiple rounds of funding.
• Conversion discounts – convertible notes may come with a conversion discount. This discount allows the investor to convert their debt into equity at a lower price than the price per share to be paid by subsequent investors during future capital raises.
• Costs – there can be considerable legal and administrative costs to facilitate the agreements.
• Funding from investors – generally, business owners will gauge initial interest with existing investors before going to other external investors, though this will still require lots of time and effort.

SAFE Agreements

A SAFE (Simple Agreement for Future Equity) has similar characteristics to a convertible note. However, it does not carry any interest costs or maturity date. An investor agrees to invest in the business in exchange for the right to convert this amount into shares at a qualified event, typically a priced funding round or acquisition. 

Main Benefits

• No debt – SAFE agreements do not accrue any interest costs.
• No repayment requirements on failure – investors are treated as equity in the case of a company wind-up.
• No time pressure – agreements are not time-bound to convert into equity.
• Quicker than raising a priced round – agreements are fairly standard and can raise funds without needing to determine a valuation which can save time.

Key Considerations

As convertible notes, the key considerations for SAFE agreements include:

• future dilution – while there may not be any immediate equity dilution, there is always a possibility that severe dilution may occur in future funding rounds, particularly when companies raise multiple rounds of funding;
• conversion discounts – SAFE notes may come with a conversion discount, allowing the investor to convert their debt into equity at a lower price than the price per share to be paid by subsequent investors during future capital raises;
• costs – there can be considerable legal and administrative costs to facilitate the agreements; and
• funding from investors – business owners will gauge initial interest with existing investors before going to other external investors. However, this will still require lots of time and effort.

It is imperative to engage legal professionals to ensure compliance with relevant regulations. Likewise, you want to draft a comprehensive agreement that meets investor needs as well as your own.

Non-Dilutive Funding Solutions

Rather than trying to converse with a diverse group of investors, wasting time pitching and undergoing the often-strenuous process of raising capital, startup companies can explore taking non-dilutive bridge capital. 

Some of the key benefits of non-dilutive capital include:

• speed – the onboarding process is simple, and your business can receive funding in as little as 24 hours;
• flexibility – there is no commitment to drawing all the funds made available, and you only need to pay the funds your business uses;
• no reporting or administrative headaches – avoid needing to speak to existing or new investors;
• no equity dilution – raise funds without requiring any current or future equity dilution; and
• no personal/director guarantees are required.

LegalVIsion partner, Fundabl, offers quick, non-dilutive funding via a facility you can use as your business grows.

Key Takeaways

There are many attractive alternatives to traditional finance options, such as convertible notes, SAFE agreements or non-dilutive capital. Researching the various characteristics of each short-term option is vital to understand what is best for your business. Contact us if you require legal assistance.