Non-dilutive funding is a critical component of the strategic financing mix for innovative start-ups and scale-ups. This short article summarizes the essentials to identify what type of funding is suitable for each product development stage.
Non-dilutive funding for start-ups and scale-ups in Europe.
What are the options?
Non-dilutive financing enables companies to receive money for their product development without giving away any ownership of the company itself. In other words, the funding does not require the owners to sell (a part of) their shares.
This article highlights 6 types of non-dilutive funding for early stage R&D companies, and closes with strategic considerations for later stage companies to leverage non-dilutive funding.
Why companies use non-dilutive funding
Small and Medium-sized enterprises (SMEs) in the Life Science, MedTech and Health finance their business through a smart mix of non-dilutive and dilutive funding to cover the high-risk, long, and costly development path towards delivering a marketable product.
Non-dilutive funding is an essential component of a solid financing strategy to enable the company to overcome unforeseen (scientific) challenges and build value. Non-dilutive funding has important benefits for companies. First, non-dilutive funding sources can provide critical cash when other financial sources are out of reach due to the high risk that is involved in the early development stages. Second, since non-dilutive financing does not require the sale of the company’s voting shares, the founding partners and existing shareholders retain company ownership and control while increasing the company valuation. Third, as many non-dilutive funding sources use expert stakeholders with deep domain knowledge to review a project proposal, the award of such funding provides important validation of the team and technology to also gain the confidence of future expert equity investors.
The risks of Non-Dilutive Financing
When acquiring non-dilutive financing, companies need to be aware of the risks and limitations to keep their businesses safe and focussed on the end goal. Just because the funding bodies do not request an equity stake in the company, does not mean money is provided “for free”.
First, non-dilutive funding schemes often follow a strategic agenda, causing companies to adjust their main development goals to fit the requirements, while prohibiting the effective pursuit of their original business planning. Second, funding agencies may require the company to invest in the project themselves, or request interest payment. Even though this “self funded part” may not have to be fully secured at the start of a multi-year project, major issues will arise when the company cannot demonstrate the own contribution in the administration at the reporting times or pay the interest and may even be requested to payback the granted money. Third, non-dilutive funding is most often accompanied by significant project management and administrative tasks to deliver the required progress reports and coordinate the partnerships in project consortia. To conclude, when applying for non-dilutive funding, it is important to closely read the requirements and not only look at the money that is provided.
Yet, as stated before, non-dilutive funding is an essential component of a solid financing strategy to enable an innovative company overcome unforeseen (scientific) challenges and build value. The following chapter will describe the available types of non-dilutive funding options in Europe.
Types of non-dilutive funding in Europe
1. Government research grants
For example: the upcoming HORIZON EUROPE program, Innovative Medicines Initiative
Certain research focused government grants include the participation of companies in big consortia. In Europe, the HORZION EUROPE program from the European Commission is funding collaborative projects, but also local governments host funding programs. Research grants enable companies to participate in projects alongside university and other stakeholders. Research grants typically fund basic research or its early commercial translation. The specific requirements are detailed in “calls for proposals” in which parties are requested to form consortia and apply project plans focussed on specific topics and development steps. Such grants typically fund salaries and consumables for research and early prototyping, but limit their contribution non-research activities. While the EU provides high funding percentages (70-100%) for SMEs, local government frequently do not pay for the activities performed by the companies and/or even request a contribution from the industry partners.
2. Government industry grants and prices
For example: HORIZON EUROPE EIC Accelerator, and EurekaNetwork .
In Europe, various grants and prices exist to enable SMEs to develop cutting edge and innovative technologies to push research towards marketable products. Project proposals require a strong market argument for the future product and clear focus to deliver market launch. This type of funding covers commercialization activities and final validation of the product, rather than basic research, and sometimes can be partially used to also support the costs of intellectual property (patents), upscaling, and other business development actives. Most industry grants require the applicant companies to provide matching funding in the form of in kind (i.e., additional salary support) or in cash contributions. Moreover, they evaluate the businesses in a similar manner as private investors, requiring the companies to demonstrate that they have strong management teams, financials and commercialisation plans.
3. Non-profit organizations
For example: Human Frontier Science Program (HSFP), European Science, Foundation (ESF), Bill and Melinda Gates foundation.
Non-profit organisations are an important driver for innovations in the Life Sciences, MedTech and Health. There is a wide variety of worldwide, European and local/regional funds that support research and development towards developing solutions for a specific disease, or purpose. The funds are primarily funded by donors with a connection to the purpose and ensure that end-users (i.e., patients) are part of the evaluation process of proposals, and the advisory board of running projects. For companies, non-profit funds provide a significant opportunity to obtain R&D financing to push forward a technology for a specific disease. In addition, these funds also provide a channel to engage clinical expertise, as well as potential access to patients, stakeholders, and reimbursement parties.
For example: loans from family and friends, local Bank loans, European Investment Fund.
Loans are probably the most well-known and simplest form of non-dilutive financing. However, young start-ups in the Life Sciences, MedTech or Health rarely make use of such (bank)loans, as the scientific risk and long timelines towards generating income makes them ineligible. Even when a bank would be willing to grant a loan, companies need to think twice about the risk they take before engaging in a contract that requires the payback of the loan and interest in a pre-set time frame. A considerable alternative to finance such a company is the use of convertible loans.
Vouchers are a type of government assistance that can be used to access facilities, goods, services, advice, or expertise provided by different organizations. Voucher programmes are granted by local, regional and national governments to SMEs. Vouchers have no cash value, are non-transferable, and are issued in the name of the company to hire a specific service provider or supplier. Various voucher types exist: Innovation Vouchers (to acquire innovative solutions and services, or machinery that facilitates innovation); Digitisation Vouchers (investing in digital solutions, services and/ or machinery); Training Vouchers (strengthening the basic or advanced (digital) skills of employees); Specialised Voucher (to hire very specialised and targeted assistance).
6. TAX credits
Tax credits is a deduction from the tax owing of a company. When a company has personnel on the payroll, tax credits can be a very lucrative source of non-dilutive funding. In the Life Sciences, MedTech and Health sector, companies that are investing personnel hours in R&D activities, may apply for Scientific Research & Experimental Development tax credit that offers a refund in cash on the tax owing for the R&D personnel hours.
Non-dilutive funding beyond early R&D?
When the early stage company development steps have been completed, but a company is not ready to successfully close a fundraising round with a good valuation, several other ways of financing may allow the shareholders to keep control over the company:
Licensing partnerships with industry
Industry partnerships are an important source to finance and execute the final product development steps by SMEs. Through a licensing deal the technology is transferred to a large company in return for cash and/or co-development rights. To successfully complete the full product development and to keep some control, it companies most often include an anti-shelfing clause to allow the SME to collaborate with a new partner when the big company changes focus, and detail precisely what is licensed (narrow-exclusive) to enable long-term growth of the SME by expanding the portfolio of applications for the product.
For example: contract research, early product release.
Generating a successful revenue stream is ideal to finance the core operations of a company, however this is a challenging model for innovation driven companies. When a product requires little to no regulatory approvals (i.e. tools, certain medical devices, industrial or Research Use Only applications), early customers may use and test prototype products. For other products the regulatory approvals prohibit such early sales (i.e. therapeutic, diagnostic, etc.), but a revenue can sometimes be generated through secondary products or services (i.e. contract research or consulting). When choosing such a model, companies need to weight the value of these activities over the delays they will pose towards achieving the overall company goals.
Further non-dilutive alternatives
After the first equity investment rounds have been closed are Venture Debt (for example: European investment bank), convertible debt, and Royalty or revenue-based financing.
If you need help with non-dilutive financing and want know how to maximally leverage a smart mix of non-dilutive and dilutive financing, post your question on our LinkedIn, or contact our biotech business experts for strategic discussion and support at www.ffund.nl. We are here to support you and evaluate your strategic options.
FFUND is a boutique consulting company that provides expert support in securing strategic financing for companies in the Life Sciences, MedTech and Health in Europe. Our team builds on the expertise of entrepreneurs with 20+ years of experience that we leverage to help the field to create more successes in Europe. FFUND: By Entrepreneurs, for entrepreneurs.
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