Version française/French version: LINK
This article explores the act of opening a company’s capital and its diverse motivations, such as the desire to involve talents in business development or the necessity of seeking capital for growth. Prior to analyzing the opportunity for one or multiple capital increases, the initial capital distribution carries valuable insights. It often reflects an entrepreneur’s intention to surround themselves and share power within the company, extending beyond future dividends and potential stock gains.
E. Krieger
Some companies are founded and led by entrepreneurs who control a significant portion or even the entirety of the capital. Nonetheless, few growth-oriented companies can forego the addition of new associates and investors, whose contributions would inevitably decrease the founder’s ownership percentage.
Surrounding Oneself with Those « Better Than You » to Grow
An entrepreneur who had created, developed, and sold multiple businesses frequently stated that he surrounded himself with individuals « better than him » in various domains. He preferred to « own 1% of a multinational corporation rather than 100% of a microenterprise. » This commitment to innovation and rapid growth led him to finance his ventures through leading venture capital firms.
Five years later, after an IPO of one of his startups, this same executive held only 5% of the capital along with some stock options. However, the stock market capitalization of this listed company reached nearly a billion Euros. From a strictly asset-based perspective, this decision was exceptionally pertinent. But reaching that point required managing continuous growth and sharing power within the board of directors with particularly demanding investors who ultimately enjoyed a very successful financial outcome.
Dividends or Capital Gains?
However, most entrepreneurs do not establish a company to swiftly drive its growth and sell or go public within less than seven years.
The decision to open capital is a critical choice, requiring founders to select and persuade investors who share similar financial objectives.
From a strictly financial standpoint, two types of shareholders can be distinguished: those who seek regular dividends as a return on investment, and those who aim for substantial capital gains upon selling the company in the medium term.
If your company’s activity and/or stage of development do not align with generating distributable results in the form of dividends, the first category of investors is irrelevant.
On the other hand, other investors will be willing to wait a few years, anticipating capital gains through an IPO or the sale of your company.
This is particularly true for certain business angels and, by nature, venture capital funds and development capital companies. These investors hope to recover more than three times their invested amount within five years, while accepting the risk of losing their entire investment.
You can welcome new shareholders into your company by selling some of your shares and realizing a capital gain equal to the difference between the sale amount and the value at which you acquired/subscribed to these shares. Such a transaction has a neutral effect on your company, as it doesn’t involve the company receiving the proceeds from the sale.
However, a cash capital increase entails inviting investors who will contribute new capital essential for your company’s development. Existing shareholders who do not participate in the operation will continue to hold the same number of shares, but their ownership percentage will be diluted (*).
Confirm Convergence of Objectives Among Shareholders
If you proceed with one or multiple capital increases without following these operations in proportion to your ownership percentage, you will experience dilution as in the example mentioned earlier. In activities heavily reliant on capital, shareholders may ultimately lose control of their company or even their blocking minority. Thus, aligning visions and respective interests is essential.
Opening your company’s capital is anything but neutral. While this operation offers numerous advantages, it requires clarifying objectives, both for founders and the company itself.
Drafting a well-prepared business plan accompanied by forecasted financial statements is a necessary step for welcoming new shareholders and ensuring alignment on objectives and strategy.
Once you’ve decided to open your capital, you’ll also need to evaluate your company to determine the basis for this operation. Beyond financial valuation tools that can support this consideration, it is desirable, and even necessary, to achieve an equitable transaction. If you were in the investor’s or new associates’ position, would you accept the proposed valuation, given your potential for growth, profitability, and liquidity? Naturally, without overlooking the prospect of participating in a human adventure that adds the flavor to the creation and development of every enterprise…
(*) Dilution refers to the decrease in the existing shareholder’s ownership percentage during a capital increase. For instance, if a shareholder owns 10% of a company’s capital and does not participate in a capital increase that grants 30% of the capital to new investors, their ownership will decrease to 7%.
