Fundraising

Understanding the legal and financial mechanisms of fundraising

Fundraising is one of the major challenges for entrepreneurs and company directors seeking external financing. This complex transaction requires a precise command of the legal, financial and strategic aspects on which its success depends. Whether you run an innovative start-up or a growing SME, understanding how fundraising works is essential to structuring your development and avoiding legal pitfalls. This guide sets out the key stages, the possible legal forms and the regulatory obligations that frame the process.

The legal and economic foundations of fundraising

Definition and general principle

Fundraising is a transaction in which a company calls on external investors to finance its development, in return for the allocation of shares or company interests. The transaction necessarily alters the structure of the share capital and dilutes the holdings of the existing shareholders.

Contrary to popular belief, fundraising is not confined to the technology start-up sector. Companies in every sector may use it: industrial SMEs, service companies, retail businesses and liberal professions practising through a company. The challenge is to identify investors suited to your sector of activity and your stage of development. The identification of financing needs and the choice of legal structure are covered in our article on how to raise funds for your company.

Distinction from other forms of financing

Fundraising differs fundamentally from bank credit. The investor acquires ownership securities in the company and bears the entrepreneurial risk, whereas the bank lends funds against security and a fixed return. This difference has a direct impact on governance: the investor generally obtains voting and control rights, unlike the bank creditor.

Start-up financing through fundraising also differs from public grants or crowdfunding. Professional investors bring not only capital but also their expertise, their network and strategic support. In return, they require a high return and visibility on exit prospects.

Types of investors and how they intervene

Venture capital and investment funds

Venture capital is the activity of investing in unlisted companies, generally at the growth or start-up stage. Venture capital funds raise capital from institutional investors and reinvest it in a portfolio of selected companies. On the legal nature, regulatory regime and governance of these vehicles, see our analysis of venture capital funds.

These funds intervene in different ways. Some focus on the seed stage (seed) of newly created companies, others on the growth stage (growth) of established companies. The investment period varies between five and ten years, with a target valuation of five to ten times the amount initially invested.

Business angels and individual investors

Business angels are wealthy individuals who invest their own funds in companies that are being created or developed. Often former entrepreneurs or executives, they contribute their operational experience in addition to their financial investment.

Their involvement is characterised by amounts that are generally smaller than those of professional funds, but by a more direct involvement in strategy and operations. Some business angels join together in networks to pool their expertise and increase their investment capacity.

Strategic and industrial investors

Large groups sometimes develop investment activities in companies within their ecosystem. These investments pursue industrial objectives: access to new technologies, integration of complementary skills, securing of supplies.

The strategic investor brings commercial credibility and may offer preferred outlets. However, this industrial proximity sometimes gives rise to conflicts of interest or exclusive commercial constraints that should be anticipated in the contract.

Legal structuring of the transaction

Suitable corporate forms

The legal form of your company determines how the fundraising can be carried out. The simplified joint-stock company (société par actions simplifiée, SAS) offers the widest flexibility in its articles of association for organising the entry of investors. Its articles may provide for classes of shares with different rights, complex shareholders' agreements and tailor-made governance mechanisms.

The public limited company (société anonyme, SA) suits large-scale projects requiring formal governance. Its more rigid operation reassures some institutional investors, but limits contractual creativity. The private limited company (société à responsabilité limitée, SARL) remains possible for modest fundraisings, despite its restrictions on the transfer of shares.

Valuation and dilution

The pre-money valuation is the value of the company before the injection of new capital. The post-money valuation includes the funds raised. This distinction determines the percentage of the capital transferred to investors.

Take a company valued at €2 million pre-money that raises €500,000. The post-money valuation reaches €2.5 million. The investor holds 20% of the capital (500,000 / 2,500,000). The existing shareholders suffer a proportionate dilution but retain 80% of the ownership.

The negotiation of the valuation is the central issue in any fundraising. Entrepreneurs tend to overvalue their project, investors to undervalue it. The negotiation relies on financial methods (discounting of future cash flows, sector multiples) but remains largely subjective.

Financial instruments used

An ordinary capital increase is the most common form of fundraising. It involves the issue of new shares subscribed by the investors at the price set at the valuation stage.

Convertible bonds offer an interesting alternative. The investor initially subscribes to an interest-bearing debt claim, convertible into shares under certain conditions. This formula defers the final valuation and protects the investor in the event of difficulties.

Share subscription warrants (bons de souscription d'actions, BSA) make it possible to acquire shares at a predetermined price during a defined period. They often supplement the main investments and serve as incentive tools for key executives and employees.

Due diligence and negotiation

The verification process

Due diligence is the in-depth audit carried out by the investor before taking a stake. The verification covers every aspect of the company: legal, financial, commercial, technological, social and environmental.

The legal audit examines the validity of commercial contracts, intellectual property, regulatory compliance and the absence of significant litigation. The entrepreneur must set up an electronic data room containing all relevant documents: articles of association, minutes of meetings, customer and supplier contracts, patents and trade marks, commercial lease.

This phase often reveals weaknesses overlooked by the entrepreneur. A lack of trade mark protection, an unfair term in a customer contract or a GDPR non-compliance may delay or jeopardise the investment. Anticipating these checks is therefore an essential prerequisite.

Key negotiation points

The letter of intent (term sheet) formalises the main terms negotiated before the final documents are drafted. It sets out the valuation, the amount invested, the governance and the specific rights granted to investors.

Pre-emption rights guarantee investors priority to acquire shares when other shareholders sell. Tag-along rights allow minority shareholders to sell their securities on the same terms as the majority shareholders. Drag-along rights allow majority shareholders to compel minority shareholders to sell on a buy-out offer. These provisions are among the essential clauses that we examine in our guide to drafting the shareholders' agreement.

Liquidation preference clauses give investors priority repayment on a sale or liquidation. These mechanisms protect the investment but may drastically reduce the founders' capital gain if the exit valuation disappoints.

Warranties and representations

The shareholders' agreement generally requires the entrepreneur to give warranties on the company's position. These representations cover the accuracy of the accounts, the absence of hidden liabilities, the validity of commercial contracts and the ownership of assets.

Asset warranty insurance protects the investor against the later discovery of undisclosed liabilities. This insurance policy, taken out by the company, covers claims up to a certain amount and for a determined period.

Tax aspects and optimisation

Tax regime for capital gains

Capital gains on the sale of shares benefit from a favourable tax regime subject to conditions. For executives and employees, the allowance for length of holding may significantly reduce the tax payable. The fixed allowance of €500,000 on sales of shares in SMEs also applies, subject to strict conditions.

Individual investors may benefit from the ISF-PME scheme (now IFI-PME), which reduces their real estate wealth tax. These tax advantages motivate some investments but should not obscure the economic analysis of the project.

Structural optimisation

Holding shares through a personal holding company allows executives to optimise the taxation of future capital gains. This structure separates business assets from personal assets and facilitates transfer within the family.

Carried interest mechanisms in investment funds allow managers to receive a share of the capital gains realised. This variable remuneration aligns the managers' interests with the fund's performance.

Post-investment governance

Changes to the management bodies

The entry of investors necessarily changes the company's governance. The board of directors or supervisory board includes representatives of the investors, in proportion to their holding. These directors have an enhanced right to information and take part in strategic decisions.

Certain important decisions require the prior consent of the investors: appointment of executives, significant investments, change of strategy, sale of assets. This joint decision-making protects the investment but may slow down decision-making.

Reporting and monitoring

Investors require regular reporting on the company's activity and performance. This reporting includes monthly accounts, commercial indicators, changes in the teams and key events. This transparency facilitates support but represents an additional administrative burden.

Strategic committees bring together executives and investors to examine major directions. These informal bodies supplement formal governance and make it possible to draw on the investors' experience.

Preparing for and anticipating later fundraisings

Multi-round growth strategy

Most companies carry out several successive fundraisings to finance their development. This multi-round strategy requires rigorous planning to avoid excessive dilution of the founders.

Each financing round generally corresponds to the achievement of operational milestones: product development, first customers, geographic expansion, profitability. This staged approach reduces the risks for investors and optimises successive valuations.

Preparing the exit

Venture capital investors aim for an exit within five to ten years, either through a trade sale or through a stock market flotation. This exit prospect influences all strategic decisions and shapes the investors' support.

Preparation of the exit begins with the initial investment. Process optimisation, legal structuring, protection of intellectual property and international development make the company more attractive to potential acquirers.

Legal risks and pitfalls to avoid

Valuation errors and over-dilution

Overvaluation in the early rounds jeopardises later fundraisings. An unrealistic valuation produces down rounds (rounds at a lower valuation), which demoralise the team and disadvantage the initial investors.

Excessive dilution of the founders raises problems of motivation and governance. Retaining a significant holding remains essential to maintain entrepreneurial commitment. Incentive schemes and stock options can partly offset this dilution.

Conflicts of interest and disagreements

Strategic differences between entrepreneurs and investors sometimes lead to deadlock. Anticipating these situations in the contract through dispute resolution mechanisms avoids decision-making paralysis.

Exclusion clauses make it possible to remove a defaulting shareholder against compensation. These mechanisms protect the company but must respect the contractual balance and the shareholders' fundamental rights.

Regulatory compliance

Public offerings of securities remain strictly regulated by the Autorité des marchés financiers (AMF, the French financial markets authority). Exceeding the regulatory thresholds triggers heavy prospectus and financial disclosure obligations.

The regulation of payment services and crowdfunding is evolving rapidly. Crowdfunding platforms must comply with precise rules on investor protection and information.

Alternatives and complementary solutions

Crowdfunding

Crowdfunding makes it possible to raise funds from the general public through specialised platforms. This approach suits projects with strong communication potential but remains limited in amounts and complex in terms of shareholder management.

Share-based crowdfunding (equity crowdfunding) democratises investment in start-ups but produces a very dispersed shareholder base. This dispersion complicates governance and later fundraisings.

Public aid and support schemes

Bpifrance offers public investment solutions as a complement or alternative to private capital. These public schemes accept higher levels of risk and longer horizons than private investors.

Innovation competitions and public incubators offer structured support for new projects. This endorsement facilitates access to private investors and lends credibility to the project.

Fundraising is a complex exercise requiring careful preparation and suitable professional support. The legal, financial and strategic issues combine to determine the success of the transaction. The prudent entrepreneur surrounds themselves with specialist advice from the very start of the process in order to optimise the negotiation and secure the company's development. Mastery of these mechanisms is essential in an economic environment where access to capital determines the growth and survival of companies.

Frequently asked questions

At what stage can a company consider raising funds? A company can raise funds as soon as it has a structured project and an established team. Seed investors sometimes come in even before the commercial launch, on the basis of a prototype and a market study. What matters is the ability to demonstrate significant growth potential and a credible development strategy.

What percentage of the capital should be sold in a first fundraising? Dilution in a first fundraising generally ranges between 15% and 30% of the capital, depending on the financing needs and the negotiated valuation. Founders must retain a majority holding to keep control while leaving room for later rounds. Excessive dilution in the first round undermines entrepreneurial motivation.

How should you value your company before a fundraising? The valuation relies on several methods: discounting of future cash flows, comparison with sector transactions, revenue multiples. For young companies, the assessment remains largely subjective and depends on the potential perceived by investors. Support from an experienced professional facilitates this delicate negotiation.

Can investors impose changes of management? Investors generally obtain governance rights proportionate to their holding, sometimes including a right of veto over certain strategic decisions. Replacing an executive remains exceptional and requires serious grounds or a manifest loss of confidence. Shareholders' agreements regulate these situations precisely in order to prevent abuses of power.

How long does a fundraising generally take? A structured fundraising takes six to twelve months, from initial preparation to the signing of the final documents. This period includes the phase of approaching investors, the commercial negotiations, the due diligence and the legal drafting. Preparing the data room and the financial documents in advance speeds up the process significantly.

Can funds be raised without giving up share capital? The issue of convertible bonds makes it possible to defer dilution while raising funds. The investor initially lends capital against interest, with an option to convert into shares under conditions. This formula suits fast-growing companies that will negotiate a better valuation on the later conversion.

What are the main causes of a failed fundraising? Failures result mainly from initial overvaluation, insufficient preparation of the financial documents, an incomplete management team or a poorly sized market. Ignorance of investors' expectations and the absence of professional support aggravate these difficulties. A realistic and structured approach maximises the chances of success.