When and How Should an Investor Enter Your Startup? Key Legal Considerations

When and How Should an Investor Enter Your Startup? Key Legal Considerations

The entry of an investor into a startup is usually seen as a positive milestone. And it is. But from a legal standpoint, it is also one of the stages where the most mistakes are made, often due to rushing the process or assuming that “it will be sorted out in the next round.”

The reality is different: what is agreed at the outset will heavily shape everything that follows.

When does it make sense to open up the capital?

There is no fixed rule, but from a corporate law perspective, there are fairly clear guidelines.

At very early stages, when there are no solid metrics or the product is not yet validated, forcing a direct equity investment usually results in a low valuation and, consequently, inefficient dilution for the founder. At that point, it is both common and sensible to use instruments that allow the valuation to be deferred.

Once there is some traction, revenue, or at least market validation, the logic changes. That is when it starts to make sense to structure the investment through a capital increase with a defined valuation.

From the standpoint of the Spanish Companies Act (Ley de Sociedades de Capital), this is not a minor issue. The entry of an investor necessarily involves the issuance of new shares or quotas, the resulting dilution, the application of pre-emption rights, and, where applicable, their exclusion, all subject to specific formal requirements.

In other words, this is not just a strategic decision; it is a corporate transaction with direct legal implications.

Structuring the investment: commonly used instruments

This is where market practice has evolved the most in recent years.

A capital increase remains the most orthodox mechanism. The investor enters directly into the share capital, a valuation is set, and the transaction is formalised in a public deed and registered with the Commercial Registry. It provides full legal certainty, albeit with less flexibility.

Convertible notes, on the other hand, have become a very useful tool at early stages. Legally, they are what they are — a loan under civil law — but with the key feature that repayment is replaced by conversion into equity in a future round. When properly structured, they allow time to be gained and avoid premature valuation discussions. Poorly drafted, however, they can lead to significant disputes, particularly if the conversion mechanics are not clearly defined.

SAFEs deserve a separate mention. They are increasingly used, but it is important to bear in mind that they are imported instruments with no specific regulation under Spanish law. In practice, they are structured as contractual agreements subject to certain conditions, whose execution will necessarily require a subsequent capital increase. The main risk lies not in the concept itself, but in its implementation: if not properly adapted to the framework of the Companies Act, issues may arise when the time comes to convert.

The shareholders’ agreement: where things really matter

Beyond the investment instrument, what truly defines the relationship between founders and investors is the shareholders’ agreement.

It is quite common to focus on valuation and overlook everything else. However, many future tensions have little to do with price and much more to do with control.

There are several points that deserve close attention.

Founder vesting, for instance. When properly designed, it aligns incentives and protects the project. When misunderstood, it can become a pressure mechanism.

Drag-along and tag-along rights are standard, but their specific wording matters far more than it may initially seem.

Enhanced majorities and veto rights are where real decision-making power is defined. From a legal standpoint, they are perfectly valid, but it is essential to properly align the shareholders’ agreement with the company’s bylaws if they are to be enforceable against the company itself.

And, of course, anti-dilution provisions. They are common, but not all are equal. Some, in practice, shift almost all the downside risk onto the founder.

The term sheet: not as harmless as it seems

There is a tendency to downplay the importance of the term sheet on the basis that it is “non-binding.” This is a fairly widespread mistake.

Even if many of its provisions are not legally binding, in practice it sets the rules of the game. And what is agreed at this stage is very difficult to renegotiate later.

Some warning signs are fairly clear.

• Excessive liquidation preferences, for example, which may result in founders receiving little to no return in an exit, even if the company performs well.
• Disproportionate control rights, effectively turning the investor into a de facto co-manager.
• Full ratchet anti-dilution clauses, particularly aggressive in down-round scenarios.
• Or, in the case of convertibles and SAFEs, a lack of clarity around key elements such as valuation caps, discounts, or conversion events.

It is also worth being cautious with long exclusivity periods without a real commitment from the investor. These can block the company at a time when it should remain open to alternative opportunities.

Final thoughts

An investor’s entry is not just a capital injection. It is, fundamentally, a reconfiguration of the company’s legal structure.

And, as is often the case in corporate law, problems do not arise when everything is going well, but when things become more complex or when new funding rounds take place.

For that reason, rather than focusing exclusively on valuation, it is worth investing time in properly structuring the transaction from the outset. Because what is agreed in that first round rarely stays there.