Anyone who does or has done business has, at least once, wondered what tools and channels are available on the market to obtain new finance from third parties. Whether it is to support new investments or accelerate existing marketing and business development activities, the question that every entrepreneur asks himself once he has determined when and how much financing he needs is “how and from whom?”
The first aspect to note is that the “how” (the available financing tools/channels) and the “who” (the lenders) are often dependent on each other; in fact, there are tools that are more or less on target with certain lenders.
A first major division that can be made between the available financing instruments and channels is between those related to debt and those related to risk capital (also called equity). If the former are known to most, as are the partners who are used to underwrite them, there is usually more confusion and uncertainty with the latter.
Here are the main options available to entrepreneurs wishing to raise venture capital and who most frequently uses them among the operators of the Venture Capital ecosystem.
Capital increase is an extraordinary operation that allows the entry of new financial resources within the company, opening the capital to third parties who, by subscribing, become shareholders of the same.
In order to proceed with the operation, a notarial resolution is required which establishes the terms and conditions of the issue and subscription of new shares/quotas of the company. Subject to the waiver by existing shareholders of their right of pre-emption (i.e. pro-rata participation in the capital increase in order not to be diluted), third parties who wish to become shareholders must subscribe to the capital increase by paying the agreed amount and adhering to the terms of the resolution and the company’s articles of association. The operation in question can take place with or without a share premium (i.e. recognizing a surplus value with respect to the company’s nominal share capital, in which case a pre-money and post-money valuation of the company must be established) and can be, in part or in full, divisible or inseparable (i.e. it can also take place only in part or only upon complete subscription of the entire amount resolved).
Transaction: €100,000 invested in a capital increase totaling €500,000 at a pre-money valuation of €1,500,000
Company shares obtained by new investors: 5% = €100,000/(€1,500,000+€500,000)
The Convertendo is a quasi-equity instrument that provides for the conversion of the capital invested in the company’s equity at pre-established conditions and, typically, at a later date than when the investment transaction takes place. Unlike a capital increase, this does not require a notarial resolution as it is a simple private agreement between the existing shareholders and the new lenders. Another difference with respect to the capital increase is that by subscribing to the Convertendo, one does not immediately become a shareholder of the company but acquires an obligation to convert (hence the name “convertendo”) new shares/quotas of the company upon the occurrence of certain conditions (called “trigger events”) and pre-defined conversion terms. The conversion terms normally present in a converting contract are a DISCOUNT on the valuation of the subsequent capital increase (on average between 15% and 25%), a conversion CAP equal to the maximum conversion value (a clause typically inserted to protect the investor) and a conversion FLOOR equal to the minimum conversion value (a clause typically inserted to protect the founders of the company). Finally, the converting contract may or may not provide an interest rate that accrues on the sum subscribed and paid up to the moment of conversion into equity of the company.
Transaction: €100,000 invested through a Convertendo with the following characteristics: discount = 20%; CAP = €5M; no interest rate; conversion term = 5 years; Trigger event = AUCAP of at least €1M and/or change of control.
Company shares obtained in case of AUCAP €2M at pre-money valuation of €8M after 2 years: 1.42% = €100,000/(€5,000,000+€2,000,000)
The Convertible is a quasi-equity instrument that offers investors the dual option of repaying their capital or converting it into equity in the company. Both options, alternatives to each other, occur under pre-established conditions and, typically, at a later time than when the investment transaction takes place.
The Convertible is therefore entirely the same as the Convertendo, except for the option and not the obligation to convert the amounts subscribed and paid in into Equity. If the conversion does not take place, the amount paid in, together with the interest accrued (if any), must be returned in cash by the company in the same way as a bank loan.
Transaction: €100,000 invested through a Convertible with the following characteristics: discount = 20%; CAP = €10M; FLOOR = €4M; interest rate = 10%/year; option term = 5 years; Trigger event = AUCAP of at least €1M and/or change of control.
Company shares obtainable in case of AUCAP €2M at pre-money valuation of €8M after 2 years: 1.40% = €120K/(€6.4M+€2M) = €140K > €120K (no conversion)
If you need clarification or want to receive more information do not hesitate to contact us!
The BizPlace Team