Participatory financial instruments are a quick and easy way to receive lenders while retaining full ownership of the company. They are atypical financial instruments, for which there is no specific regulation and ample autonomy is left to the issuing company to define the rights to which holders are entitled. SFPs have existed since 2012 (Decree Law 179/2012) but have recently been made available not only to start-ups but also to innovative SMEs.
What are the most popular participatory financial instruments?
In general, this category includes the means by which a start-up or innovative SME can raise funding and other resources from investors, who are granted a number of rights. The contribution may consist of:
· Pure funding, with an obligation to repay.
· Equity, the repayment of which depends on the company's economic performance.
· Works or services, non-returnable.
One of the most common participatory financial instruments is work for equity, which consists of remunerating employees and collaborators by means of financial instruments. However, this type is reserved exclusively for persons who perform services or works for the company.
Two PFS which are aimed at the market outside the company are stock options and warrants. Stock options grant the right to subscribe for shares for a predetermined price (these are option rights generally offered to directors and managers of the company). Warrants grant the right to subscribe to or purchase or sell shares by a maturity date against payment of a predetermined amount, or an amount to be predetermined, in accordance with a specific issue regulation.
The rationale behind the introduction of financial instruments into company law is simple: the legislator wanted to expand the possibilities of corporate financing through flexible instruments for easier access to financial resources not only by shareholders but also by third parties outside the company structure, creating new and alternative financing channels to the traditional banking system.
SFPs vs. shares
The first distinguishing feature of participatory financial instruments, as opposed to shares, is the different form of participation attributable to the subscriber, who does not have the status of shareholder. The latter, in fact, may be a creditor of a participation in profits, or in losses within the limits of the contribution made), or only a creditor of a participation in profits, with a claim to repayment of the contribution, or a creditor of the provision of certain services of the company. In general, the PFS holder has no voting rights in the general meeting of shareholders.
In addition, FPSs, unlike shares, do not realise a new contribution that increases the share capital, but a contribution that cannot be charged to capital. Since they are not new contributions, there is no complex procedure for FPIs as there is for shares and bonds.
Participatory financial instruments, therefore, on the one hand allow the startup to access and benefit from the resources contributed by investors without affecting the decision-making capacity of the existing shareholder structure: the exclusion of voting rights, in particular, prevents the reduction of the shares of existing shareholders; on the other hand, it allows investors who want to bet on the business project to limit their risk to the investment and contribution made.
Ownership of such instruments represents a risk investment since they can be issued without a redemption obligation.
The main advantages of SFPs
We have seen how, for the issuing company, SFPs are a quick form of financing without giving up shares and maintaining control of the company. The rights that the investor acquires through FFS, on the other hand, are of two types:
· capital rights, i.e. forms of remuneration linked to the ownership of the instrument;
· administrative rights, which include the right to vote on specifically designated matters and the right to appoint a member of the board of directors or supervisory board or an auditor. This excludes the right to intervene and vote in the general meeting.
These instruments, therefore, allow for a minor and well-circumscribed involvement in the life of the company, whereby the investor is exempted from playing a necessarily active role in the company, thus allowing ownership to maintain control.
Taxation of FPSs
The tax treatment of FPSs depends on their specific characteristics. In particular, different treatments are distinguished depending on whether the instrument is assimilated to a share, is granted free of charge to employees or to managers/employees against a contribution in cash or in kind.
In the first case, i.e. where the participatory financial instrument can be assimilated to a share, the profits received, which must depend exclusively on the economic performance of the company, will be taxed as capital income.
A final consideration is that the possibility of issuing participatory financial instruments must be provided for in the articles of association of the issuing company. The shareholders must regulate its content, the conditions of issue (and possibly circulation), as well as possible sanctions in the event of non-compliance. All this must be formalised by means of an appropriate regulation, directly in the articles of association.