What is Dilution?

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Stock dilution is a phenomenon that occurs when more shares of stock are issued than previously existed. This reduces the percentage of ownership for existing shareholders. This can happen in various ways, but it’s most often tied to company growth, mergers, acquisitions, and other types of financing.

Stock dilution can be an essential factor for investors to consider when making investment decisions about a company. It can also significantly impact the value of an investor’s holdings in that company.

Part of success in business and investing is understanding financial concepts and gaining a solid foundation. A common question people ask is: what is dilution? We’ll answer that question in this article and explain why it matters.

Definition and Example of Dilution of Shares

Dilution is a decrease in the value of the ownership interest of a company’s existing shareholders. In other words, it refers to a reduction in the percentage ownership each shareholder has of the company.

It is caused by the issuance of equity by the company to raise capital. When a company wants to raise capital, it usually issues new shares or bonds. This dilutes the value of existing shares because it increases the total number of shares outstanding.

For example, suppose you own 10,000 shares in a company that has 1 million shares outstanding. You own 1% of the company (10,000/1,000,000). If the company issues another 100,000 shares, you will own only 0.9% of the company (10,000/1,100,000). The value of your original shares has been diluted by roughly 10%.

It’s best to think of stocks as pieces of ownership in a company. Each share represents a claim on that business’s assets and earnings. Stocks can be traded on the stock market, where they can be bought and sold by investors.

When you buy stocks, you’re purchasing a tiny bit of ownership in a company. A single share of a company like Apple or Amazon means you own a tiny slice of the company’s assets and earnings.

The main reason for dilution is to raise money to fund operations, but it can also occur when investors sell their shares or when employees exercise their options. Dilution is often described as “shareholder dilution” or “equity dilution,” but it can also apply to other forms of ownership, including debt or options.

What Causes Stock Dilution?

The leading cause of stock dilution is issuing new shares to raise capital. The company can either issue new shares or sell a portion of its existing holdings.

Another way stock dilution occurs is through stock repurchases when a company buys back its shares from investors.

Dilution is not synonymous with market loss, though its effect looks similar. When the market causes a stock to drop in price, it’s usually due to decreased revenues, poor sales, or other factors that affect the industry.

Stock dilution can occur in several ways, including:

Stock Options Converted to Common Shares

Stock options are a type of employee compensation that allows employees to purchase shares in the company at a set price. The price is called the exercise price and is typically set at or above the market price of the stock on the date the options are granted.

You agree to purchase shares at this price when you exercise your option. If you don’t exercise them, they will often expire worthlessly and become valueless.

Stock options convert to common shares when exercised by an employee or other holder of a vested stock option. When you exercise your stock option and buy 100 shares of XYZ Inc., you own 100 common shares and any rights that come with being a shareholder. These rights include voting rights, dividends, and interest from your investment return on capital.

When companies issue stock options to employees, those shares may later be converted into common stock if specific requirements are met. Stock options don’t give the holder equity in the company. That doesn’t happen until the option is exercised.

At that point, it’s converted to common shares, increasing the total number of shares the company has issued, causing dilution. 

Creating or Offering New Shares

When a company needs to raise money, it can issue new shares, diluting existing shareholders’ ownership. If the company creates new shares, it’s called “issuing stock.” Issuing stock is a way for a company to raise capital without selling assets or borrowing money.

In other words, issuing stock allows investors to buy company shares instead of borrowing money from other investors.

The most common way to dilute is by issuing additional shares through an offering or secondary sale. This can happen when a company needs more funding or wants to pay down debt.

A company can issue new shares by selling them to investors in an initial public offering (IPO) or after going public. An IPO is when a company sells stock in itself for the first time. After an IPO, a company can also sell additional shares in the open market at any time.

When a company offers new shares, it may have to pay dividends to existing shareholders before paying out dividends to new investors who purchased those shares.

When a company issues stock, it must decide whether to give common stock or preferred stock. Each type of stock has its own set of terms and conditions that apply to it and affect how the company operates and its shareholders’ rights. Common and preferred stocks are both types of equity securities, but they’re not identical in every way.

Vesting of Employer Awarded Common Stock

Those shares are subject to vesting requirements when an employee is awarded equity compensation through an employer-sponsored plan, such as a 401(k) or ESPP.

Employee award plans often include vesting schedules that require employees to retain their shares for specific periods before selling them on secondary markets or receiving cash dividends from them.

For example, an employee may need to work for five years before being able to sell his or her vested shares on secondary markets or receive cash dividends from them.

That equity comes with a vesting schedule, locking in the employee’s service for a specific period. Once the vesting period expires, the stock is awarded to the employee. It essentially works the same as an option, thereby causing dilution.

Mergers and Acquisitions

There are many ways that stock dilution can occur. The most common cause is mergers and acquisitions. When a company experiences significant growth, it may need to raise capital to finance it. This may lead them to merge with or take over another company.

Merging two companies together or one company acquiring another involves combining the stock of each entity into one.

That’s done by the purchasing firm acquiring the company-owned common stock for the acquired company. That stock is often sold at a discount, which dilutes shares for common shareholders.

Mergers and acquisitions are often made to increase market share by entering new markets, acquiring technology or products, and gaining access to distribution channels.

What It Means for Investors

Stock dilution is a primary concern for investors. It means that the number of shares outstanding has increased, and therefore each share you own will be worth less. It reduces the percentage ownership that each investor has in the company. In other words, a 20% stake becomes 19%, or 2% becomes 1%.

When a company raises capital, it does so by issuing new shares to investors. This is known as equity financing. The more shares issued, the more diluted existing shareholders are. It increases the total number of shares available.

This means there are more shares to buy and sell, which helps stabilize prices over time (but doesn’t necessarily help individual investors).

This is bad news for existing shareholders because their ownership stake in the company decreases proportionately to the increase in the number of outstanding shares. 

The company can boost revenue by utilizing that new cash to scale its sales process. Share prices will dip in the short run because of dilution, but the increased profitability will eventually raise them to a new level. That’s a win for common shareholders. In this scenario, dilution is a good thing and should be promoted before issuing the new common stock.

The good news is that this dilution isn’t necessarily permanent. If a company’s earnings grow quickly enough, its share price will eventually rise again, so your investment is worth what it was before the dilution occurred.

Is Share Dilution Good or Bad?

Share dilution is when a company issues shares or securities to raise capital. The company then sells these shares on an exchange, typically at a price lower than their face value. The difference between the market price and the face value is paid dividends to shareholders.

There are many reasons why companies issue more shares than they have in previous years. One reason is that they need more money for business expansion or to pay off debts from previous years’ operations.

For example, a company may need more capital from investors if it wants to buy out another smaller competitor. Another reason for issuing more shares is if the company wants to reward its executives or employees with bonuses or stock options for their work during the year (this can be done by issuing new stock options or selling treasury stock).

3 Tips for Startups to Manage Stock Dilution

You’re probably concerned about your company’s financial health if you’re a startup. A critical aspect of this is stock dilution, which refers to the reduction in the value of existing shares.

When you sell additional shares of ownership in your company, it can cause a drop in the value of existing shares. This is a common concern for new companies looking to raise money from investors or other sources.

Here are some tips for startups on how to manage stock dilution.

Research Different Financing Options

 The cost of starting a business is often underestimated. It can be a significant challenge for startups to raise the necessary funds to cover operating costs, pay employees and invest in their businesses. Some other reasons why startups seek outside funding include:

  • To obtain access to new markets
  • To hire more employees or add new departments or divisions within the company
  • To acquire another company
  • To purchase equipment or tools

There are many ways to fund a startup, including:

Personal savings: This is perhaps the most common way for startups to get started. However, it’s also the most difficult option because most entrepreneurs don’t have enough money saved up, so they need to find other ways to get funding.

Family and friends: Friends and family may be willing to loan you money or invest in your company if they believe in your business idea and trust that you can make it profitable.

Venture capitalists are individuals or groups who invest in new companies in exchange for equity (or partial ownership). This investment is generally reserved for established businesses with proven track records and strong management teams.

Angel investors: Angel investors are private citizens who provide seed funding (small amounts of capital) through venture capital firms or angel networks — organizations made up of accredited investors who pool their money together on behalf of startups that need capital but don’t qualify for traditional financing options such as bank loans or venture capital investments.

Look into crowdfunding sites like Kickstarter and GoFundMe, which allow people to donate directly to projects they believe in (and get rewards for doing so). This is another way to raise money without giving up your company’s equity (i.e., ownership).

Model What Dilution Will Look Like for Different Options

Do the math. Some business owners look at the potential cash flow increase from an equity offering. Still, they fail to consider how this will affect the company’s equity multiplier and its impact on existing shareholders.

Those who buy stock in your company are among your most significant resources. Give them the consideration they deserve by mitigating their potential loss from dilution. 

One of the tools you’ll need for this step is a fully diluted cap table. This will show you the total number of outstanding shares, including the totals for each option if they are exercised. Incorporate these numbers into your dilution model to fully understand the impact of issuing new common stock or offering stock options to new employees or partners.     

Make Dilution Work for Your Company

Dilution is a common issue for many companies.  Dilution is a business term that refers to a reduced share value due to new shares being added to the market. When a company issues new or existing claims repurchased by management, dilution can occur. The latter is sometimes referred to as “shareholder dilution.”

While dilution may sound bad, it’s not always bad news for shareholders. Companies issue new shares all the time — and often, it’s because they have a good reason for doing so.

The first step is ensuring that all your shares are correctly accounted for. This means ensuring that any shares held by founders and other employees are vested adequately so they cannot be sold without approval from management.

The second step is to make sure that the company has a good vesting schedule in place. This will prevent employees from selling their shares too early on in the life cycle of the company.

Finally, you should consider setting up an employee stock purchase plan (ESPP) so employees can buy shares at discounted rates with pre-tax dollars or through payroll deductions. This allows employees to become investors in their own company while also helping them get more involved in its success.

What Is Burn Rate, and How to Calculate It?

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Burn rate is the rate at which a company is spending its capital. It’s a valuable metric for those in the startup world because it shows how quickly a company is depleting its cash reserves.

This number is significant because it shows how fast a company is burning through its funding. If a company burns more than it makes, it will eventually run out of money and shut down.

Burn rate is a key metrics in your startup’s life cycle. It tells you how fast your company is burning through the capital.

Burn rate helps you understand how soon you can expect to reach cash-flow break-even when refinancing will be needed and what impact your decisions will have on future cash flow.

What is Burn Rate?

Burn rate is a metric used by startups and small businesses to track how much cash they’re burning through each month. As the name suggests, it measures how quickly the company is draining its bank account or other sources of funding (e.g., credit cards).

Burn rate is calculated by taking your monthly expenses and dividing them by the number of months until you run out of cash. For example, if a company has $1 million in monthly costs and 12 months of runway left, its burn rate is $83,333 per month ($1 million / 12 months).

Why does this matter? Because it tells founders how much time they have left in terms of cash before they need to raise more funding or shut down their business.

The first step toward improving your burn rate is understanding precisely what it is — and why it matters so much to your startup’s future success or failure

Who Needs to Worry About Burn Rate?

The term burn rate has come to be associated with startups. High burn rates can cause problems for small businesses, especially those relying on venture capital funding.

Venture capital firms typically want to see their investments turn into profitable companies within five years, so they tend to invest in businesses with low or moderate burn rates.

High burn rates can also cause problems for startups because they don’t have much room for error regarding cash flow management — if something unexpected happens, such as an employee quitting or losing an important client. There may not be enough money to cover unforeseen costs without debt.

Burn rate is a critical metric for three types of businesses:

Startups With Venture Capital Funding

If your startup is funded by venture capital, you should be very concerned about the burn rate. This is because venture capitalists expect their money to be used wisely. If you’re burning through capital too quickly, it puts pressure on your company to hit product-market fit and earn revenue as soon as possible.

In addition, venture capitalists expect a return on their investment within ten years. If you’re spending too much money and not bringing in enough, it can be challenging to show them a path toward profitability. In some cases, they may even ask for an exit before you’ve reached that point.

Taking all of this into account, it’s important for startups with VC funding to track their burn rate carefully. They need to know how much they’re spending each month and how long they have until their next funding round arrives.

They also need to know how much cash they’ll have left when the current round runs out — so they can decide whether or not to raise more money from investors or try another source of financing (such as debt).

New Companies Getting Started

Burn rate is significant for startups that have just launched their products or services and have yet to generate revenue. These companies often spend heavily on marketing, sales, and other expenses trying to find and retain customers.

As long as these expenses are temporary, these startups still have plenty of time before they run out of cash — so long as they can show positive signs that their business models are working and leading them toward profitability.

New companies getting started often have high burn rates because they lack the revenue or profits needed to sustain their operations without external funding sources like venture capital or loans from friends and family members.

In that situation, an early-stage startup should focus on reducing its burn rate as much as possible to conserve precious capital for later stages when it needs it more urgently to grow quickly enough to survive the competition and evolve into a sustainable business model.

Established Businesses Borrowing Money

Burn rate can be an essential metric for companies raising money from investors, but it’s also useful for established businesses borrowing money.

If you’re an established business and take out a loan, you’ll probably be required to provide financials to your lender. That’s because the lender wants assurance that you can repay the loan.

The lender usually looks at your cash flow and burn rate (how much cash you spend each month) to determine whether you can repay the loan. If your burn rate is too high and you don’t have enough money, the lender might not lend you money.

If you’re not sure how much money you’ll need in the future, it’s essential to know how quickly your burn rate is growing to figure out when you’ll run out of cash and have trouble paying back what you owe.

Importance of Metric in Venture Capital (VC)

Burn rate is a critical metric in the venture capital (VC) business. It’s a ratio that shows how much cash a startup spends every month. VCs use this metric to determine whether they should invest in a startup and, if so, at what valuation and terms. If you’re looking for funding, it’s essential to know how much money you’ll need to get off the ground and how quickly you need to raise it.

In the VC industry, investors usually want to know everything about your business — from how many customers you have to how many people are using your product each day.

They want to know everything about your financials, too — how much money you’ve raised from investors, how much cash you’re burning through each month, etc.

That’s why startups need to be prepared with these types of metrics when they present their businesses to investors for funding.

VCs use burn rate to assess whether a startup has the potential to succeed or not. The specific number used for this calculation varies depending on what type of VC firm you are dealing with. If your startup has a higher burn rate than their internal benchmarks, it may be too early for investment because you won’t have enough money to scale up your business operations once you’ve reached profitability.

Burn rates are significant for startups because they indicate how long an entrepreneur thinks their company will last before running out of cash. The higher the burn rate, the faster that company may need additional capital — which could be obtained through another round of financing or other sources such as grants.

What Are the Implications of a High Burn Rate?

Burn rate is the amount of cash a company spends per month. It’s essential to track burn rate because it tells you how long your company can survive if it doesn’t receive additional funding.

Burn rates are often used in business planning and fundraising, but they can also understand how much money you need to keep your business running.

The burn rate is all about cash flow, so if you have a high burn rate and no new money coming in, you’ll eventually run out of funding and shut down.

If your burn rate is high, it can be difficult to predict when you’ll run out of cash. Companies like Amazon, which has historically operated with a high burn rate, keep their cash balance high to keep themselves from getting in trouble.

The primary implication of a high burn rate is that it makes it harder for startups to raise additional funding because investors are more likely to be concerned about short-term profitability rather than long-term growth potential. Here are some more of the potential implications:

Cash Flow. The speed at which you’re spending money will determine how many months you have to fund your company before you need to raise additional capital. Suppose you need to raise money in less than six months. In that case, it’s unlikely that investors will be interested in providing the funding because they don’t want to enter into an investment without knowing how long their money will be tied up in your business.

Credit Lines. Suppose you use credit lines (i.e., credit cards, line of credits, etc.) for working capital. High burn rates may lead to increased interest expense and penalties for late payments, which could ultimately hurt your ability to secure additional money if there isn’t enough cash flow from operations to pay off those debts.

Existing Investors. High burn rates may cause existing investors and lenders to question whether they should continue investing more money or extend more credit lines to your company — especially if they already have concerns about its financial health due to poor performance or low sales volumes.

Top Talent. High burn rates can also make it difficult for companies with high burn rates to hire top talent because potential employees may feel that they might think that the company won’t be able to afford their salary demands or their equity will be worthless when the company shuts down.

Gross Burn Rate vs. Net Burn Rate

The gross burn rate is the total amount of money spent per month on expenses, including salaries, rent, and other costs. It includes:

Your monthly expenses — rent, utilities, payroll, etc.

Cost of goods sold (COGS) — this is your inventory or the number of units you produce and sell each month. If you’re selling products or services, COGS is the cost of creating or delivering those services. 

The net burn rate is the money left to cover all expenses, including salaries. The net burn rate is also the gross burn rate minus cash inflow from clients, investors, or partners.

This number represents how much money you need to raise each month or quarter to stay alive — or how much money it costs to run your company per month or quarter before generating any revenue.

The Gross burn rate helps understand how much money a startup is spending. It can also indicate if your company has enough capital to support its current level of operations. However, the gross burn rate is not a good measure of profitability because it doesn’t include revenue or other income sources.

Net burn rate gives you a better idea of how long your company will be able to sustain itself before running out of cash. If your business is profitable and has positive cash flow, your net burn rate should be zero or negative. 

How to Calculate Gross Burn Rate

The gross burn rate is the total monthly cost of operating the business, including rent, payroll, and marketing. It’s one of the most critical metrics for SaaS companies.

The gross burn rate is calculated by adding up all the expected expenses in a given month and dividing them by the number of months remaining until you achieve your break-even point. The gross burn rate calculation requires two values: your monthly operating expenses and starting capital or total cash.

For example, if your company has $3,500 in expenses per month and you funded your business with a $50,000 loan, then calculate the gross burn rate:

  1. Add up all your monthly payments (salaries, office rent, customer support, etc.).
  2. Divide by the amount of your money you’re funded your business

$3,500 / $50,000 = 0.07

Multiply by 100, and you get 7%. So, your monthly burn rate is 7%. Every month in business, you spend 7% of your initial investment.

The equation for it is:

Gross Burn Rate (%) = Monthly Operating Expenses / Starting Capital x 100

How to Calculate Net Burn Rate

Calculating your net burn rate is just as important as calculating your gross burn rate. It’s an indicator of how much runway you have left in your bank account, and it helps you make smarter decisions about the future of your business.

The net burn rate is calculated by first subtracting all revenue from the total amount of money spent over some time. This figure represents how much money was spent on operational expenses like payroll and marketing during that period.

The formula for calculating net burn rate percentage is:

Net Burn Rate (%) = (Revenue – Operating Expenses) / Starting Capital x 100

Let’s take an example. You own a store, and you’re earning revenue but still spending $3,500 a month, and last month you only made $2,000. You also invested $50,000 capital in starting your business. Your net burn rate, in this case, would be:

($2,000 – $3,500) / $50,000 = 0.03

Multiply the result by 100, and you get a net burn rate of 3%.

How to Reduce Burn Rate

If you’re running a startup, you know that burn rate is one of the most critical metrics. Your burn rate is how much money you spend each month, and it’s usually measured in dollars per month or dollars per week.

If your burn rate is too high, you won’t have enough money to make payroll or pay for other expenses like office space. If your burn rate is too low, you might be spending less than you need to run a profitable business.

A high burn rate can be disastrous for any company. It means that they’re spending more than they’re earning and burning through their cash reserves at an unsustainable pace.

However, there are ways to reduce your burn rate without sacrificing growth.

Re-evaluate Your Recurring Costs

If you have monthly or annual recurring costs, such as hosting fees or software licenses, it’s good to re-evaluate those costs every three months.

You might not need all the features they offer, so consider switching to less expensive alternatives or reducing the number of users who need access.

The same goes for services like accounting software — if you don’t use all its features and only use it once a year to file taxes, find something cheaper that works just as well (or better).

Layoffs and Pay Cuts

To reduce your burn rate, you need to cut costs. The first place to look is at the payroll. If you have an underperforming staff or aren’t utilizing them properly, it’s time to let them go. Don’t be afraid of making the tough call — sometimes it’s better to let someone go than keep them around and pay them for their lack of contribution.

Layoffs can be sensitive, but they can also help reduce your burn rate by removing employees who aren’t contributing as much as they should. If you have a team of 10 developers who are only working on one product, you could potentially replace them with five developers working on two products.

Another way to reduce your burn rate is by cutting salaries. This can be a difficult decision as it often involves reducing the wages of your most senior employees. Still, if you can’t afford these salaries anymore, you have no choice but to make cuts. Pay cuts can also help reduce your burn rate if you can cut other expenses along with it.

For example, if you had five developers working full-time at $100k each, and you were able to cut their salaries down to $80k each while keeping their hours the same, that would save your company $200k per year without reducing the number of hours worked or the quality of the work product.

Marketing (Sales Fixes All)

Marketing is the only thing that will help you grow your sales enough to reduce your burn rate. This isn’t suggesting that you throw money at the problem, but rather thoughtfully drive revenue through marketing.

This could mean hiring amazing salespeople and incentivizing them properly. Other ideas like focusing on driving down your CAC and initiating growth hacks that are free or low cost to drive high-value sales and so on.

Look For Additional Funding

Consider looking for additional funding if your burn rate is high and your revenue isn’t keeping pace.

You might be able to find angel investors or venture capital investors willing to invest in your business early if they believe they can make a return on their investment by helping you grow faster than you could on your own.

The key is finding someone with experience working with startups like yours — someone who understands the risks involved and can advise you on how to avoid common pitfalls.

Manage Your Burn Rate and Survive

Burn rate is the amount of money you spend each month. It’s the cash flow you need to grow and run your business, and it’s a critical metric for any entrepreneur.

This may seem obvious: You need to spend money to make money. But it’s essential to understand how much you’re spending and how you can reduce the burn rate to plan for growth and know when to stop spending.

Ultimately, reducing your burn rate requires an exceptional understanding of your team’s assets. Please keep track of the various assets you have at your disposal and where they are.

By identifying opportunities for cross-departmental resource sharing and strategic cost-cutting, it will be easier to keep a handle on your startup’s finances. It may not happen overnight, but by being proactive, you can better avoid asking for large sums of money before running out completely.

What is ABL?

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Asset-based loans are a type of financing that allows businesses to obtain loans based on the value of their assets. The lender uses the value of your business’ assets as collateral for the loan.

Asset-based lenders lend money based on an asset’s value rather than relying strictly on a borrower’s credit score. 

The primary benefit of using asset-based lenders is that they don’t rely on traditional credit scoring methods. Instead, they look at the value of your assets as collateral for the loan.

This can be helpful if you have a poor or limited credit history because it will allow you to access funding that may not be available through traditional means. 

However, it also means that your application will be subject to more stringent scrutiny than traditional loans.

What Is an Asset-Based Loan?

An asset-based loan is a type of financing that uses your business’s assets as collateral to secure the loan. If you have valuable equipment, real estate, or other items that can be sold if you default on the loan, an asset-based lender can help you get funding for your business. The lender may take possession of the property if you fail to make timely payments.

Here’s how it works: You pledge some or all of your assets, such as cash, stocks, bonds, and real estate, as collateral for a loan. The lender will evaluate the value of your help and determine how much money you can borrow based on those assets’ value. 

An asset-based loan has several advantages over traditional loans. For example:

They often come with lower interest rates than other types of loans. The lender has to take certain risks when issuing an asset-based loan. But they are assured that they can recover all or part of their money when they hold your assets as collateral. 

Second, asset-based lenders may be more willing to work with you if you have bad credit or no credit history.

Even if you don’t qualify for traditional loans based on your income or credit score, some lenders may still consider issuing an asset-based loan based on the value of your assets and the likelihood that you’ll make good on your payments over time.

Finally, many asset-based lenders offer flexible payment plans that align with seasonal fluctuations in business revenue and expenses. You don’t have to make regular monthly payments like other loans.

Who Uses Asset-Based Lending?

Asset-based loans are not available to just anyone, however. It would help if you had a business with valuable assets that could be used as collateral for the loan.

For example, if you own a car dealership, the cars you sell can be used as collateral for an asset-based loan. If you own a repair shop, the tools and machinery in your shop could also be used as collateral for an asset-based loan. 

In most cases, asset-based lenders require that you have been operating your business for at least six months before they will consider giving you an asset-based loan. If you’re starting with your business idea, it may take some time before you qualify for an asset-based loan.

The asset-based lending process is used by a wide variety of businesses, including:

  • Companies that need financing for equipment and machinery.
  • Businesses need funding to purchase a new building or add to an existing one.
  • Businesses that need financing for inventory purchases.
  • Companies that need working capital loans to support their day-to-day operations.

In general, asset-based lenders provide merchant cash advances, business lines of credit, and invoice factoring services to small business owners with good credit and ample assets to put up as collateral.

Who Qualifies for Asset-Based Loans?

Asset-based loans are a great way to help build your business credit. Small businesses and startups often use them, but established companies with solid assets can also use them. The key is to have assets such as inventory, equipment, or accounts receivable that can be used as collateral against the loan.

If your business has been in operation for at least six months and you’re looking for a short-term loan, an asset-based loan might be right for you.

The good news is that you don’t have to be a millionaire to qualify for asset-based loans. The bad news is that it’s not as easy as it may seem. Asset-based lenders require borrowers to have an established business or a viable business plan.

They also look for signs of financial stability, such as personal income and existing assets. 

The requirements to qualify for an asset-based loan are the same as those for any other type of business loan. The lender will look at your credit score, income, and personal debt load. However, other factors impact your eligibility.

Business Collateral

This is where the asset-based loan gets its name: you must have assets that can be used to secure the loan. It could be real estate or a piece of equipment or machinery for your business.

If you plan to purchase these items with an ABL, the lender will want proof that you can do so, such as a letter from the seller or title company stating they have accepted your offer on the property in question.

For example, if you want a $100,000 asset-based loan, you need to have $100,000 worth of assets that can be used as collateral. This could be equipment, vehicles, or even real estate like land or a building your business owns.

Once the bank has this collateral, they will lend you money against it so that you can use it as capital for your business.

Business Profitability

The lender wants to know that your business will generate enough money every month to pay back what it owes them. They’ll look at your current financial records — including income statements and balance sheets — to make sure you’re making enough money (or are capable of doing so).

Liquid Assets That Are Available for Collateral

Assets such as stocks and bonds, real estate investments, or other items that can be sold quickly are often used as collateral in asset-based loans. These types of assets can be sold if you don’t pay back your loan on time.

A Good Credit Score

A good credit score will help you get approved for a more considerable loan amount because lenders see this as a sign that you’re less likely to default on the debt.

You also need to provide proof of insurance on each item being used as collateral, along with an appraisal report from an independent third-party appraiser who has been licensed by a state agency or department of insurance.

What is the Cost of an ABL?

The cost of an ABL is not a one-size-fits-all solution. The interest rate and monthly payments are dependent on several factors that are unique to your business, including:

The amount you borrow. Larger loans typically have lower interest rates. For example, the average small business loan is about $50,000 and has an annual percentage rate (APR) of 9 percent or less.

How long do you take to pay back the loan? Longer terms generally mean lower monthly payments but higher interest rates. If you’re unsure how long it will take to pay back your loan, check out this handy calculator from Freddie Mac that can help estimate how much money you may owe at the end of different terms.

Your credit history and income. Borrowers with solid financials will likely qualify for better rates than those applying with a subpar score or income level.

The cost of an ABL is typically a fixed-rate, meaning that it does not change over time. However, there are some cases where the interest rate can be variable based on changes in market rates. 

How is an Asset-Based Loan Different from Factoring?

If you want to know the difference between asset-based lending and factoring, it’s essential to understand the basics of these two lending methods.

Asset-Based Lending

Asset-based lending is a type of financing that uses your business’s assets as collateral for loans. The lender uses your company’s accounts receivable, inventory, equipment, and other assets as collateral for a loan. The lender then holds on to these assets until you repay the loan.


In contrast, factoring is a cash flow solution that allows your business to sell your accounts receivables to a third party. Instead of waiting 30 or more days for your customers to pay their bills, you can immediately receive an advance on those payments.

The third party will purchase your invoices at a discount, usually around 90% of the face value of each invoice, and then collect payment directly from your customers.

This type of financing allows your company’s working capital needs to be met immediately without waiting for customers’ payments or sitting on large amounts of money in accounts receivable.

While it is similar to factoring, you get paid immediately; there are some differences.

The main benefit of an asset-based loan is that it allows businesses with irregular cash flows to obtain capital quickly and easily — without having to wait months or years for approval from a bank or other financial institution.

A factoring company buys your invoices at a discount and sells them to investors as promissory notes at total face value. They usually charge fees for this service, but it can be quicker than waiting for payments from slow-paying customers who have gone out of business altogether — especially if you have large accounts receivable balances or high-risk customers (e.g., those who frequently go bankrupt).

Should I Choose Factoring or Asset-Based Lending for My Business?

If you have a business, chances are you might need some financing. There are many ways to get credit for your company, but there are two main categories: factoring and asset-based lending.

Factoring is a type of financing that allows your business to receive cash upfront on invoices that you have already been paid. Factoring is often referred to as invoice financing or accounts receivable financing.

The other major category is asset-based lending, which provides loans based on the value of assets owned by your business. Assets can include real estate and equipment and collateralized receivables such as accounts receivable (money owed to your company).

The big question for entrepreneurs is which type of financing is suitable for their situation? 

Whether to use factoring or asset-based lending for your business depends on several factors. The first thing you need to do is determine how much working capital your business needs or how much cash flow you need at any given time.

Factoring is a great way to get cash in your hands quickly, and it can be beneficial if you want to grow your business quickly. It’s also ideal if you have a lot of accounts receivable that are coming due soon and need cash before the end of the month. 

The benefit of factoring is that it helps businesses avoid working capital shortages and allows them to focus on growing their business instead of chasing down payments from clients. Factoring is perfect for companies with a lot of accounts receivable because they can generate quick cash without waiting for a customer to pay. This enables them to grow their business faster and expand into new markets or product lines.

The downside of factoring involves some risk, such as increasing bad debt and fees.

Asset-based lenders typically offer longer repayment terms and higher interest rates than other lenders, so they’re not always the best choice to get funds quickly. 

On the other hand, asset-based lending makes sense for companies that want to maintain control over their assets without selling them outright and taking on debt to get funding for their business needs.

Sometimes it makes sense to take out a loan from an asset-based lender when you have multiple projects coming up that require funding over time — such as building out new offices or purchasing equipment — not just one big purchase like building a new warehouse or purchasing inventory for the holidays.

Questions to Ask Yourself About ABL Loans

If you’re thinking about taking out an ABL loan, it’s essential that you know what you’re getting into before making any decisions. Here are some questions that you should ask yourself about ABL loans before deciding whether or not to pursue them:

Is Your Company New?

Many lenders require that the business be more than six months old before considering an ABL application. This is because ABLs are deemed riskier than traditional loans, so the bank wants to see that your company has been around long enough to be successful.

If you’re just getting started in business, it might not be the best time to take on more debt than you can handle. While ABL loans are usually smaller than traditional bank loans, they still require collateral.

If your startup isn’t generating revenue yet or doesn’t have any assets to use as collateral, an ABL loan may not be the right choice for you right now.

Do You Need Money Fast?

If your answer is yes, an ABL loan is probably right for you. These loans are designed for people who need money fast and don’t want to wait weeks or months for their application to be processed.

If you have good credit and can afford monthly payments, an ABL loan may be the best option for your situation.

How Much Money Do You Need?

This is the most critical question to ask yourself when thinking about taking out an ABL loan. If you don’t know how much money you need, it will be hard to figure out whether or not an ABL loan will work for you.

Before determining how much money you’ll need for expenses like tax payments, utilities, and maintenance costs, before deciding how much of a debt load you can handle.

Do You Want a Flexible Arrangement?

An ABL loan can be a great option if you need flexibility in how much money you receive and how much time you have to pay it back. If you’re planning on buying something that may go over budget and want more time to pay it back, this can be an excellent choice.

With an ABL loan, you can draw down the funds in small increments—as little as $10,000—and repay them when needed. This makes these loans ideal for businesses that need financing on an ongoing basis.

Advantages of Asset-based Lending

Asset-based loans offer many advantages over traditional financing methods such as personal loans and credit cards:

You do not need good credit to qualify for an asset-based loan. Some lenders will even consider lousy credit applicants with poor scores and high debt loads because they know that these people have something valuable that can be used as collateral for their loan applications.

It is easier to get approved for an asset-based loan. There is no need for extensive paperwork or formal verification from banks and other financial institutions who may be reluctant to lend money without seeing proof that they will get it back one day!

Lower interest rates. One of the most significant advantages of an asset-based loan is that it usually carries a much lower interest rate than other types of financing. This makes it easier for your business to manage its debt load, which can help you avoid costly problems like missed payments.

Flexible terms. Asset-based lenders allow you to borrow money against your assets instead of your credit score, so they’re often more relaxed about what kind of terms they’ll offer you and how much money they’ll lend. You may get a more significant loan amount with a more extended repayment period than other financing options — especially if you don’t have great credit or haven’t been in business long enough to qualify for a traditional loan.

Final Thoughts on ABL Loans

ABL loans are a great way to get access to funds for your business. These loans are ideal for small businesses and startups that don’t have enough cash to qualify for traditional financing but have valuable assets such as real estate, equipment, vehicles, or inventory. They offer low-interest rates, flexible terms, and the ability to repay early without penalty.

The main drawback of ABL loans is that they may not be available to all businesses. To qualify for an ABL loan, you need a healthy company that can repay the loan on time. If you have trouble getting approved for an ABL loan, consider applying for a conventional business line of credit instead.

If you have good credit and a solid business plan, an ABL loan can help your company grow and take advantage of opportunities.

How to Raise Pre-Seed Funding

Pre-Seed Funding Meeting Finance Hire

When you’re working on your startup, you’re going to need to raise some money. Raising capital is a necessary step if you want to get your business off the ground and make it a success. You’ll be looking for investors who are willing to take a chance and put their money behind your idea. 

But what if you haven’t launched your business yet? What if you just have an idea that is still in development? In these cases, you might be looking for pre-seed funding.

The pre-seed funding process can be challenging, but it isn’t impossible. While it can be an uphill battle to get the backing of investors for an unproven business model, there are things you can do to help increase your chances of finding someone who believes in your idea enough to give it a shot.

If you’re thinking about raising pre-seed capital for your startup, then this guide will cover how to raise pre-seed funding.

What is Pre-Seed Funding?

A company that has not yet generated any revenue, but is looking to expand its operations, needs funding. You might have heard of seed funding, which is usually the first round of financing after a company incorporates and before it generates any revenue. Pre-seed funding occurs before seed funding and is the first money a startup receives.

The pre-seed stage is the first stage of capital raising for startups. It’s also called angel funding or angel investment. It’s not a loan; it’s a cash infusion to get your business started. Sometimes it can be a gift from family or friends who want to help out. Other times it can be that initial investment from an angel investor—a wealthy individual willing to risk their own money on your business idea.

This early funding can help get a product to market, develop a prototype, or prepare for seed-stage financing. Money raised in this stage is also used to help get the company off the ground, such as hiring an initial team and starting to build partnerships and relationships with potential customers.

The key to this stage is not about how much money but about having enough money to prove your idea works and that you have a viable business model. The goal here is not to scale but convincing investors that you can successfully scale with the right amount of capital. Your pre-seed money will cover whatever you need – office space, equipment, marketing materials, and maybe even salaries for your first employee or two.

What’s the Difference Between Pre-Seed and Seed Funding?

The two most essential fundraising rounds for a startup are the pre-seed round and the seed round. The success depends on how much money can be raised, which investors the company can get to support them, and how much equity or stake in the company the startup is willing to give up. As you can imagine, these three components are interrelated.

Pre-seed funding is the earliest stage of venture capital (VC) funding. It typically comes from angel investors or founders themselves and is used to pay for market research and product development. This is generally the first outside money raised by a startup, though it’s often supplemented by other sources of financing such as personal savings or loans from friends and family.

Entrepreneurs are still refining their business model and proving their concept in this stage. They may not have an actual product yet, but they do have a plan for the development that needs to be tested to move forward.

Seed funding is raised after a company has launched its product and is looking to build traction and scale. Seed money is generally used to improve marketing and sales, grow the team, and improve the product. This round of funding typically comes from angel investors and VCs as well.

What Is the Purpose of Pre-Seed Funding?

Pre-seed funding is a type of startup financing an individual or group of investors usually provides that enables the entrepreneur to get their idea off the ground, generally in exchange for equity in the company.

Pre-seed funding aims to help entrepreneurs take their ideas and make them a reality. A lot goes into making a business happen. It takes money, time, and resources to bring an idea to fruition, and pre-seed funding provides all three of these things.

Pre-seed funding allows entrepreneurs to hire a team before making any sales. Without this money, they would be unable to recruit employees or pay them while they work on building their company’s infrastructure. It also provides the funding needed to build a prototype or demo, which could be very expensive depending on the industry it’s being used for. Often, there are additional costs associated with starting a business that must come out of pocket without this type of investment.

Hypothesis Validation

When you’re starting a business and developing your product, it makes sense to test your hypothesis.

A pre-seed round is a relatively small amount of funding that can be used to validate your product, service, or business model before you go and raise a seed round. Investing pre-seed funds enables you to prove your hypothesis, test your assumptions, and demonstrate your business model’s viability before you raise a larger round.

Gaining Key Stakeholders

One reason pre-seed funding can be so valuable besides the obvious one of gaining cash is that it helps attract other stakeholders who might not otherwise invest in your vision. 

When venture capitalists see that someone else has already expressed interest in your startup, they’re more likely to do their homework and investigate what’s going on with your company. Once they see that you have some momentum, they’ll be more likely to offer additional funding for the following stages.

When Is the Right Time to Raise a Pre-seed Round?

Not all startups need pre-seed funding. They might already have enough capital to complete their first product cycle, or they might not have much more than an idea and a firm founder’s vision. But if you’re at the beginning of putting together your team and have a minimum viable product that you need more cash to develop, you may consider raising some pre-seed funding. 

There are a few signs you can look for to determine if this is the right time for your company.

You Have a Well Defined Idea

The most important thing about raising pre-seed funding is having a solid idea with an outlined plan for its development and eventual market entry. It’s hard to convince investors that you’ll be successful without a clear picture of how you’ll turn your concept into reality.

You Have Some Traction

Ideas are great, but pre-seed investors want proof that there’s demand for what you’re building, which means you should have evidence of users engaged with your product or service in some capacity. This doesn’t mean your service needs to be fully operational; it could just mean that people have signed up on a mailing list and are waiting for beta testing to begin or downloading some of your software.

The right time to raise a pre-seed round depends on your goals, but in general, it’s the point at which you have a clear idea of what your company does and why it’s going to be valuable to consumers; you’ve tested the idea with consumers yourself; you’ve got some initial traction on your product, and you’ve laid out a plan for how you’ll use the money.

It’s essential that all these things are in place before you begin the fundraising process because they can take months to prepare and perfect.

How Much Pre-Seed Money Should You Raise?

You’re thinking about raising a small amount of money (less than $1M) to get your idea off the ground at the pre-seed stage. Your goal is to raise just enough to get your product up and running so you have a proof of concept to show investors that your product is viable.

You’ll probably also need some extra money for living expenses for yourself and any co-founders. You should also try to raise enough money, so you have enough runway to raise the next round of funding.

For example, if investors typically take three months to make an investment decision, then you’ll want at least six months of runway in case you don’t get the next round of funding.

Now, let’s say your company is building a social network app, and your goal is to launch a beta version of the app in 6 months. Let’s assume your burn rate is $20k per month.

This means you’ll need ($20k x 9 months). So you’d need at least $180k total, but it’s probably safer to raise more than that so you can have a rainy day fund or hire an additional team member if you need one later on.

5 Reputable Sources of Pre-Seed Funding

Many founders want to know how to get to the next stage—but getting your first dollars is just as important. Without some form of pre-seed funding, you’re stuck at square one, with no way to get your idea off the ground.

For this reason, aspiring entrepreneurs need to learn about all the different sources of pre-seed funding available. Here are five options to consider.

Angel Investors

Angel investors are high-net-worth individuals who invest their own money in a business. They’re called “angels” because they’re the ones who step in to provide the initial funding when no one else will, and they’re great at what they do because they’re usually seasoned entrepreneurs themselves.

Angel investors can be a great source of funding because they’re generally easier to deal with than venture capital firms since angel investors make up a much smaller community than venture capitalists do and are more likely to understand your company’s vision than an institutionalized venture capital firm that might be less personal.

Angel investors tend to spend a lot more time with the company they invest in, which can be very helpful when you’re starting. On the other hand, angel investors can be challenging to find because their networks aren’t as established as venture capitalists. 

Angel Investors are a great source of pre-seed funding, but they can be challenging to get. You’ll need to convince them that your company is worth investing in, and they’re often looking for companies that have a chance to go big—or at least bring in a lot of money. Angel Investors will typically be interested in seeing your business plan and knowing that you’ve done your market research, so make sure you have those things in order before approaching anyone.

If you want to get in front of Angel Investors, the Angel Capital Association (ACA) is a great place to start. The ACA is a national network of angel investors committed to growing investment in startup companies. The ACA also hosts conferences where you can meet and pitch to potential investors, and their website has tools for connecting with angels when you’re not able to make it to a conference.

AngelList is another resource for finding Angels. The site allows you to create an online profile describing your company and capital needs. You can then browse through the profiles of accredited investors who have signed up on the site and are willing to invest in your industry or region. When you find someone who might be interested in your company, you can reach out directly from the site itself.

You can also check out local resources for entrepreneurs like incubators and accelerators, which often help connect their members with Angels by hosting events like pitch nights or office hours.

If there are any business schools near you, look into their entrepreneurial programs; they also often host events where Angels can meet entrepreneurs and vice versa. 

Pre-Seed VC Funds

Venture capitalists make money by investing in startup companies and small businesses with strong growth potential. As you can see from the name, venture capitalists take a “venture” into your business, believing that you have a great concept and predicting that the company will grow and be profitable.

The venture capitalists will typically get equity (ownership) in your company in return for their investment. A venture capital fund is a pooled investment vehicle that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans.

Venture Capitalist funds like Y Combinator, Accel, and Sequoia Capital are one of the most popular sources of funding for seed-stage startups. They usually invest in startups with a strong founding team with a proven track record or solving a problem in an area the VC is familiar with. 

If your startup meets either of these criteria, you have a good chance of landing funding and getting access to their network.

Friends and Family

A little bit of money from someone close to you can go a long way, and if you’ve got friends and family who are willing to invest, why not take advantage? It’s not always easy asking for favors, especially when it involves asking a lot of money, but if you approach it correctly, getting pre-seed funding from your friends and family can be one of the best options to raise funds for your startup.

When starting your business, it’s normal to turn first to the people you know and trust but be careful. When someone invests in your company, even if it’s just $1,000, they are now part owners of the business, and their investment has the potential to fail.

Unfortunately, not all friendships or family ties can survive the stress of a failed business. 

Do everything you can to protect your relationships when seeking funding from those closest to you. Get all details in writing, have a lawyer draw up an agreement, and make sure everyone understands what they are getting into before handing over any cash.


Crowdfunding, a process of raising funds from a collection of people over the internet, has become one of the most popular methods of obtaining financial support from investors. 

Crowdfunding sites like Kickstarter and Indiegogo have become go-to spots for hopeful entrepreneurs looking to raise money for their start-ups.

If your product will appeal to a large group of people, crowdfunding is a great way to raise money for your startup. Using a site like Kickstarter or Indiegogo, you can set a funding goal and deadline for contributors to reach that goal.

If you do not get your goal by the deadline, no money changes hands, and the campaign fails.

If you meet or exceed your funding goal, then those who contributed get their money back plus whatever perks they were promised in return for their investment. 

The best part is that if enough people think your idea is worth investing in, they will pay what it takes to make it happen—even more than you asked for.

Accelerators and Incubators

If you’ve got a promising, early-stage idea and need some help getting it off the ground, one option is to find an accelerator or incubator that you can partner with. 

Startup accelerators and incubators are programs that focus on mentorship, networking, and assisting new entrepreneurs in honing their skills and growing their businesses. An accelerator is usually a short-term program that focuses on rapid growth and has a set beginning and end date. They generally require you to be present for the duration of your participation but don’t take any equity in your company. In some cases, they’ll provide funding as well.

Incubators offer similar services but usually don’t invest any money. Incubators, on the other hand, tend to give you more space to grow at your own pace and have a larger focus on networking opportunities than accelerators do. It’s common for them to take equity in exchange for their services. 

Startups enter generally these programs at an early stage of development. To get into most accelerators or incubators, you’ll need to apply—sometimes, there’s an application fee.

What You Need to Raise Pre-seed Funding

It’s no secret that most new startups have to raise money at some point to grow. One of the first stages in this process is the pre-seed stage, where a company raises capital to get things moving and prepare for more severe growth.

This stage can be challenging for any entrepreneur because at this point, you probably don’t have anything much more than an idea. But with a bit of careful planning and foresight, you can set yourself up for success and hopefully get the boost your business needs to flourish.

To get pre-seed funding, the first thing you’ll need is a product. You don’t necessarily have to have a fully functioning beta, but you’ll need something tangible to demonstrate your product’s viability to your potential investors.

If you’ve got an idea that’s still being ironed out, that’s okay too—you just might want to wait until it’s more solid before requesting funding.

You’ll also need some sort of solid traction—that could be a large social media following and high traffic to your site, or it could be testimonials from people who have used and enjoyed your product.

This is especially important if you’re trying to raise money for a product that doesn’t yet exist. It’s proof that the demand for what you do or sell is there, and it can help back up your claim that your business will be profitable.

Finally, you’ll need an investor deck. This is basically like a resume for your business. It will include detailed descriptions of the problem your product solves, information about the market you’re targeting, and profiles of everyone who works at the company, including their experience in related fields.