Optimising the capital stack for closely held companies

Rapporteur

Moksha Bhat

AP & Partners, New Delhi

Co-chairs

Martin Viciano Gofferje

Gleiss Lutz, Berlin

Toomas Prangli

Sorainen, Tallinn

Speakers

Alethea Au

Stikeman Elliott, Toronto

Annalise Papa

Ganado Advocates, Valletta

Alastair Peet

Shoosmiths, London

Arina Shulga

Fox Rothschild, New York

The panel opened with a discussion about how closely held companies should choose among the wide range of financing options now available to them. Alethea Au pointed out that the right choice depends on what owners will give up, including in terms of control, governance and information rights, the company’s stage and assets, as well as how quickly cash is needed. Arina Shulga added that owner objectives also shape the decision: founders seeking a fast exit accept dilution, others, like Mailchimp’s founders, avoid outside equity altogether, and established family businesses tend to prefer bank debt to protect control. The appropriate choice also varies from jurisdiction to jurisdiction. Annalise Papa provided an overview of recent trends in Malta. Venture debt was highlighted as a middle route for scaling businesses with recurring revenue.

Simple agreements for future equity (SAFEs)

The panel then turned to SAFEs and other convertible instruments. Toomas Prangli set the scene with an anecdote about a client who raised money quickly using SAFEs and a family loan, only to find 18 months later that he had given away far more than intended. Investing based on a SAFE without discussing valuation, he said, is like ‘marrying without discussing who does the dishes’. The panellists agreed that SAFEs are quick but can give rise to certain complexities. Inconsistent terms across several instruments create difficulties on conversion. Alastair Peet described one £24m raise that required six separate conversion prices. Several panellists agreed that an early priced round often imposes useful discipline.

Debt

On debt, the panel considered private credit and non-bank lending. Such credit providers were seen as more flexible, more familiar with intellectual property (IP)-heavy businesses and less restrictive on security, consents and covenants, but the panel stressed that the debt must ultimately be repaid from the cash flow. Family financing raises distinct issues. The panel insisted that family loans must be documented, with the amount, repayment and purpose agreed, and that family lenders understand that a later lender’s security will rank ahead of them. Outside capital, whether debt or equity, also alters succession, transfer, pre-emption and consent rights, may require personal guarantees and places outside funders ahead of the family on an exit. Arina Shulga cited survival rates of about 30, 12 and three per cent into the second, third and fourth generations, and Alastair Peet described a brewer founded around 1740 with about 1,200 family shareholders, for which an internal share market was created to allow exits.

Venture capital

Corporate venture capital was recognised as bringing more than money, including access to markets, customers, suppliers and technology. The panel nonetheless identified risks for investee companies: rights of first refusal or first negotiation that deter other buyers, observer rights and corporate opportunity waivers that limit the investor’s duties, IP leakage, customer dependency and shifting corporate priorities. The panel recommended keeping investment and commercial agreements separate, negotiated by different teams, with clear terms for when the commercial relationship ends. Martin Viciano Gofferje offered a more positive view from Germany, where corporate investors have matured into professional and reliable partners.

Conclusion

Where a company has several funders, the panel stressed that equity and debt providers should communicate and agree ranking early, and that management’s position should not be overlooked. On covenants, the panel advised testing them against the business plan, including planned capital expenditure, dividends, acquisitions and disposals; matching reporting to what the company can deliver, starting with less frequent reporting and increasing it as the company matures; keeping consent rights away from day-to-day operations; and checking change-of-control clauses in existing contracts, including subleases. Annalise Papa observed that something as mundane as late audited accounts can trigger a technical default.

As final remarks, the panel urged advisers to help clients think long-term, watch for unintended consequences in control, develop exit and preference terms and involve lawyers before making financing decisions.