Internal vs. external funding rounds: pros, cons and timelines

Internal vs. external funding rounds: pros, cons and timelines

In corporate financing it is common to distinguish between internal and external funding rounds, not only by who contributes the capital, but also by the legal transaction cost and the realistic timeline to close the deal. Simply put, an internal round is one in which the money comes from shareholders already on the cap table (or from financiers who already have an established contractual relationship with the company). An external round, by contrast, brings in a new investor, which typically triggers higher information requirements, negotiation of rights, and more formal closing steps.

Operation of internal rounds

Internal rounds tend to be faster because they reduce the friction associated with trust and familiarity with the business. From a legal standpoint, they can be structured through capital increases, shareholder contributions, participating loans, convertible notes, or other hybrid instruments. Their main advantage is speed: due diligence is usually lighter, valuation tends to be less contested because there is a prior history, and if the shareholders’ agreement is already reasonably well organized, corporate resolutions and standard company documentation are often sufficient.

They also allow the company to cover short-term cash needs until certain operational milestones are reached, gain time to execute the plan, and avoid conducting an external negotiation under pressure.

However, the main risk lies in governance: when the same shareholders recapitalize the company, the conversation around dilution, veto rights, and economic preferences is reopened. If the internal round is structured with privileges (for example, liquidation preference or enhanced rights), it can create asymmetries among shareholders and strain the corporate relationship, particularly if some do not participate and become diluted.

In terms of timing, an internal round can be closed within a matter of weeks, but that “potential for speed” depends on two variables:

• The first is how well the company’s documentation is in order: updated corporate books, valid powers of attorney, coherent bylaws, a clear cap table, and basic compliance with corporate and tax obligations.
• The second is shareholder alignment: if management and the key shareholders agree on the instrument, amount, and valuation, the closing becomes largely mechanical.

In Spain, one must also consider notarial and Commercial Registry formalities in the case of a capital increase, as well as proper handling of pre-emptive subscription rights unless they are waived or limited in accordance with the law and the bylaws. When there are disagreements, an internal round can become surprisingly slow because the company lacks the “anchor” of a third party that forces a balance, and negotiations drift into control disputes.

What are external funding rounds like?

External rounds, on the other hand, provide distinctive value: new capital, market validation, and often access to commercial networks, talent, and credibility with customers and institutions. Legally, they are more complex because the incoming investor needs to build a protective perimeter against risks that are not yet fully known. This translates into a more intensive due diligence process (corporate, contractual, tax, labor, intellectual property, data protection, and, where applicable, regulatory).

It also entails negotiating key terms: valuation, the class of shares/participations, liquidation preference, anti-dilution, information rights, board seats, vetoes or reserved matters, founder vesting/lock-up obligations, non-compete clauses, and exit rules (tag-along and drag-along). Each of these elements affects future governance and requires careful drafting to avoid deadlock or ambiguity.

The practical cost of an external round is not only financial; it also involves time and management attention. For a founding team, preparing a data room, answering Q&A, and negotiating documentation can consume several weeks. In addition, closing is often conditional, meaning the investor may require certain issues to be regularized beforehand (for example, assigning intellectual property to the company vehicle, cleaning up key contracts, updating corporate books, or resolving contingencies).

From a formal standpoint, deals involving direct equity entry will require notary and registration steps; in convertibles or loans with a conversion option, the initial closing may be faster, but complexity is deferred to the conversion stage.

Difference between internal and external rounds

Comparing pros and cons, internal rounds stand out for potential speed, lower exposure of sensitive information, and lower transaction costs, but with the risk of reopening internal tensions and concentrating even more power in a subset of shareholders. External rounds stand out for their ability to scale the project, professionalize governance, and “set a market price” for the company, but they require heavier documentation, more surrender of control, and less predictable timelines. In both cases, the key to controlling timing is preparation: a clean cap table, updated bylaws and shareholders’ agreement.

In conclusion, the choice between an internal and an external round is not only financial, but also legal and strategic. If the priority is to buy time and execute milestones, an internal round or a bridge round can be appropriate, provided shareholder fairness and contractual clarity are protected. If the priority is to accelerate growth with capital and strategic allies, an external round is the natural path, assuming the process requires documentary discipline and governance negotiation.

In practice, many companies combine both: an internal round to cover immediate needs and prepare an external round under better conditions, minimizing friction and maximizing negotiating leverage.