Non-Dilutive Capital


FYI – My social media boycott experiment is over.

No one wants to read a detailed account of my highly unscientific study, but I will give you my summary conclusion: My professional and personal lives are unchanged by a reduction in social media usage. I estimate 75% of my time spent on social media provides zero value.

However, I was not and have never been a power user of any social media platform. If I did use social media to share frequent and valuable content or engage in real conversations with many people (liking a post doesn’t count as engagement), then there could be immense value in social media. Maybe next year.

Now, to the newsletter.

Topic of the Week: Non-Dilutive Capital

I have a friend who hates the word “moist.” If you say moist around her, she will physically cringe and ask you to stop. Figuring out ways to sneak “moist” into a casual conversation is an endless source of amusement for me.

Most business owners have a similar reaction to the word “dilution.” Business owners hate dilution. I can feel them cringing through the phone when we talk about post-close ownership percentages.

To avoid dilution, many businesses will explore a “non-dilutive” capital raise. For those not current on financial jargon, “non-dilutive capital” means debt. This includes bank debt, as well as convertible debt.

But is debt non-dilutive?

What is Dilution?

Dictionaries define dilution as the decrease in existing ownership of a business as a result of raising new equity. For a business owner, it’s the % of the company you own before raising capital, less the % you own after raising capital.

Said another way, dilution makes your ownership position in a company less valuable.

Dilution from Non-Dilutive Capital

Unlike equity, debt doesn’t force a decrease in your ownership % on the front end. However, debt can substantially decrease the value of a shareholders ownership position. Let’s look at a few examples.

Sale of a Company: Debt is senior to all equity. In a liquidity event, debt holders will get paid back before any equity holders do. Unless debt holders are made whole, equity holders will experience 100% dilution, receiving zero value for their equity stake.

Opportunity Costs: You have to pay interest and principal repayments on debt. That is cash that could go towards growing the business or paying dividends to shareholders. By paying back debt, you forgo creating more value for shareholders. In theory, the proceeds from a debt raise should fund initiatives that increase shareholder value beyond those payments. But that isn’t always the case. If debt is used inefficiently, value is destroyed and dilutive to the value of your ownership.

Concluding Thoughts

Unless you receive a grant or a gift from your Great Aunt Betty, you will risk dilution to your ownership value when you raise capital.

The question business owners need to ask themselves is this: Based on the current state and risk profile of my business, what type of capital will be less dilutive? Sometimes the answer is debt. Other times, it is equity. This is a topic to cover another day.

Have a great weekend everyone!

About the author

Danielle O'Rourke

Recovering Investor. Mom. Wife.

By Danielle O'Rourke

Danielle O'Rourke

Recovering Investor. Mom. Wife.

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