The Participatory Financial Instruments (PFS) are an alternative capital raising tool to classic capital increases, bank loans and even crowdfunding. Still little known in Italy, they are based on the S.A.F.E. model, a type of investment contract of U.S. origin, and offer operational flexibility and attractive opportunities for both companies and investors. We discussed them in our general article on SFPs: today we delve into Who can issue Participatory Financial Instruments based on the current regulatory environment and when it is useful to consider them to raise capital.

What are Participatory Financial Instruments and how they work

To make the topic of this article easier to understand, let us start with a brief summary of what SFPs are and how they work.

PFS are hybrid financial instruments first introduced into the Italian legal system with the 2003 company law reform. This reform aimed, among other things, to provide corporations with more flexible financing instruments and able to attract investment, overcoming the rigidity of traditional forms of collection.

Article 2346, paragraph 6 of the Civil Code introduced by that reform provided that: "this is without prejudice to the possibility that the company, as a result of the contribution by shareholders or third parties including work or services, may issue financial instruments provided with equity rights or even administrative rights, excluding voting in the general meeting of shareholders."

This is an excellent definition of what SFPs are and their hybrid nature, because it highlights the possibility of To raise capital as well as goods, services or professional services, provided they are susceptible to economic valuation, in exchange for securities that constitute neither equity shares nor obligations in the strict sense. These contributions are not considered share capital, but rather equity in the company.

An SFP can recognize various types of property and/or administrative rights which bring it closer to a stock or bond, but it does not have a standard content, because it is determined by the individual bylaws and the individual issue regulations drawn up by the company:

• can grant property rights (profit sharing, liquidation, dividends, periodic remuneration);
• may provide limited administrative rights (e.g., right to information, right to veto certain extraordinary transactions, the right to vote on specific matters in special meetings, but never the right to vote in the general meeting of shareholders);
• may be convertible later into units or actual shares.

It is precisely because of this flexibility that PFSs are often referred to as "tailor-made tools," adaptable to the goals of the enterprise and the type of relationship you want to establish with lenders, but also to the stage of development you are in.

A company, therefore, can include in its articles of incorporation the option of issuing Participatory Financial Instruments and use it to construct customized investment or service contracts in which are offered to selected and strategic investors and/or collaborators specific and diversified administrative and/or equity rights, more unbalanced toward equity or debt as needed.

If the remuneration is wholly or predominantly linked to the company's performance and there is no unconditional obligation to repay the contribution, SFPs take on the characteristics of equity instruments. Conversely, if they include a fixed remuneration and a clear obligation to repay at maturity, they are assimilated to debt instruments. In between, there are many intermediate configurations that companies can explore.

Who can issue Participatory Financial Instruments: the regulatory framework

From a regulatory point of view, PFS are regulated mainly by the Civil Code, in which they were introduced as of 2003, as we have already mentioned. Initially, the opportunity was reserved for S.p.A., then it was also recognized by analogy for S.r.l., provided that they are innovative startups or SMEs (Growth Decree 2.0 of 2012 and Investment Compact of 2015).

Even young companies with limited initial liquidity can thus attract capital, expertise and services by offering in return a stake in future results without burdening the financial structure with debt or immediately diluting the shareholder base.

To date, then, Participatory Financial Instruments may be issued in Italy by S.p.A. and S.r.l., but also cooperative societies with some specific limitations.

In contrast, partnerships and self-employed professionals are excluded, as the regulation of PFS is closely related to the company law of corporations.

In order for companies to issue SFPs, they must meet additional conditions:

• Have a corporate charter that allows it
• Resolve the issue at the shareholders' meeting
• Specify in statute the rights incorporated in the instruments.

With the ECSP Regulations, in addition, Participatory Financial Instruments can also be issued on crowdfunding platforms authorized, simplifying the process and placement. Previously, however, they could only be placed through private, direct negotiations with investors.

When it pays to issue PFS and for what types of enterprises

The issuance of Participatory Financial Instruments can be strategic in different scenarios and for different objectives.

Diversification of funding sources and capital strengthening

PFS can be used to diversify funding sources and raise capital from a wider range of investors, including business angel, venture capital funds, employees, and strategic partners, without necessarily facing an immediate increase in nominal share capital that would result in direct dilution of existing shareholders' holdings.

Contributions from the subscription of SFPs, since they are not charged to share capital, generally flow into special reserves in equity. This mechanism leads to a strengthening of the company's capital structure, potentially improving its balance sheet ratios (e.g., the ratio of equity to debt) and its ability to attracting additional funding, both debt and risk. 

Work for Equity and Incentive Tool.

SFPs are an effective means of implementing mechanisms of work for equity and to incentivize several key figures for enterprise development. The ability to issue SFPs against the contribution of works, services, know-how or other professional services is explicitly provided for in the regulations.

This feature is of paramount importance especially For startups and SMEs in the growth phase, which often have limited liquidity but need specialized skills (technology development, marketing, management) to get off the ground. Offering SFPs (often convertible into shares/equities) in exchange for such services allows them to Attract and retain talent, consultants or strategic partners, aligning their interests with those of society.

Finally, awarding SFPs to employees as a form of variable and participatory compensation can contribute to stronger employee commitment, turning them into true partners and positively influencing corporate culture.

Postponement of assessment

One aspect of particular importance, especially for the early-stage enterprises, is the ability to use SFPs to raise capital without having to immediately define a pre-money valuation of the company. The determination of the actual value of the investor's stake (and thus the number of shares/units he or she will receive) can be postponed to a future time, typically coinciding with a subsequent round of financing conducted by institutional investors, or upon the occurrence of other significant events (e.g., the achievement of certain development or turnover targets).

It is a mechanism that can more effectively align the interests of founders and early-stage investors in contexts of high uncertainty, reducing the risk of litigation or penalizing valuations for one of the parties that could jeopardize the future growth of the company.

Because of their versatility, SFPs can also find application in sophisticated financial contexts, for example: 

• The institutional investors in venture capital, such as the funds of venture capital and business angels, can use SFPs, especially in the form with equity conversion rights to finance innovative startups and SMEs. This allows them to enter capital at a later stage, at a more defined valuation, while benefiting from any equity rights or forms of light control.
• In situations of crisis or debt restructuring, SFPs can be a valuable tool for engaging new lenders or for converting existing loans (e.g., from banks) into semi-equity instruments. FFS underwriters can be offered capital rights linked to the success of the restructuring and specific powers to influence or monitor management, aimed at protecting their investment and ensuring the implementation of the recovery plan.

Let us now look at some examples of typical scenarios for the use of Participatory Financial Instruments that may involve different types of enterprises.

For seed and early-stage innovative startups.

Validation of the business idea: raising capital from early investors to complete development and start commercialization without immediately relinquishing control shares.

Attraction of strategic investors: business angels or advisors can participate in the company without acquiring governance powers, obtaining a discount on the company's future valuation.

For SMEs in the growth phase

Capital raising: financing expansion projects without burdening bank debt.

Rewards on performance: Tying remuneration to the achievement of results, retaining investors and managers.

For established companies

Incentive plans: allow managers and employees to be involved in venture capital with flexible formulas.

Spin-off projects: you can issue SFPs related to specific projects or new business units, isolating risk and remunerating investors in a manner correlated with the performance of the individual project.

Particularly in cases where it is not necessary to offer FFS only to targeted strategic investors, it may be useful for any type of company to place these instruments through crowdfunding campaigns on authorized platforms, to meet a wider range of investors and have operational support, but also more flexibility in the configuration of the instrument than a normal equity or lending campaign.

As we explained in theArticle on the differences between Participatory Financial Instruments and equity crowdfunding, moreover, these two ways of raising capital can also be combined.