All companies, over the course of their existence, need to attain financing. Such financing may be external, i.e., the investor is kept independent of the company and does not join the company´s capital (the most common means is through a loan); or internal, which entails giving entry to the capital of the company to a third party, thereby acquiring the status of shareholder. This second possibility is developed in this paper through stages and scenarios that the company can follow or not, but the steps described are the normal path for an entity that seeks high continued growth during the first 10 years of its existence.

Different type of financing

The first phase is carried out by the partners by modifying the capital structure and agreeing to a capital increase or the setting up of a corporate structure that supports the investment. The mayor advantages of this type of funding are: the know-how of the company is still owned by the partners, and the possibility of exit for a shareholder is much greater than at a later time. However, it has a major limitation, since usually the equity of the partners is limited, and external financing is a needed to address sustainable and controlled growth.

A derivative of the first method of funding is through the method known as “Friends, Family and Fools“. This type of investment is only recommended at an early stage, in which the entrepreneur cannot qualify for bank financing or is subject to certain liquidity tensions. In this case, the entry into the capital is optional and it is possible to both sign a loan with the entrepreneur and become part of the capital. The way to solve a very low capitalization and not dilute the founding shareholders would involve increasing the capital with an issue premium.

The second stage of funding is “Crowdfunding“. This type of micro-finance is not currently regulated by Spanish law. However, there is a legal draft to regulate these entities, establishing certain capital requirements. In this type of financing, the entrepreneur finds himself at an initial stage and does not have access to Friends, Family and Fools that meet the capital needs. Therefore, he seeks financing that must be properly explained and for the first time a closed period of investment is established. However, nothing prevents multiple rounds of financing being made by setting different values for the company. The great disadvantage of this type of financing is that there is no guarantee that the necessary capital will be raised.

The third stage are the so-called Business Angels. This kind of financing is much more professional than the previous type, as the Business Angels invest their own funds. The great advantage is that the Business Angel becomes part of the management team and gives free support to the company in a phase of consolidation in the market. For the development of this type of investment, the Business Angel will be obligated to set up a corporate structure, and the company will accept the conditions of the Business Angel in order to have access to more bank financing. Finally, relations between the Business Angel and the entrepreneur will be governed by a shareholder´s agreement.

The fourth stage involves the entry of Venture Capital and Private Equity. In this case, the business model is fully established and the business has a certain level of development. Such companies are governed in Spain by Law 25/2005, of risk capital entities, offering a professional financial capital to the company and participating in the management team as Business Angels, not participating on a daily basis but providing the expertise in the development of similar businesses. Normally, to acquire the attention of these investors it is necessary that the business have a double-digit growth during entry of the Business Angel and it needs further capital injection to carry out their investments. In this case, the drafting and signing of a Shareholder´s Agreement is essential, since the distribution of political and economic rights, and the management of the company in the different stages will be decisive.

Finally, the last step will imply the listing of the company in a stock exchange though a “Simple listing on the Exchange” with persisting shares, or a “Traditional public offering”, offering new shares on the market. This funding has undergone major changes in the last reform of the Corporations Act, affecting the management and the rights of the shareholders.

For more information about the types of financing or in case of any doubts, please contact us. The first consultation is free.