Staged financing beyond the venture record: Equity rounds in the accounts of Italian SMEs
By analyzing share-premium reserves in Italian innovative SMEs rather than relying on professional investor records, this study reveals that equity rounds are driven by growth rather than profitability and often precede a decline in firm performance, challenging the selection bias inherent in intermediary-based samples.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
Most of what we know about how young companies get their first big injections of money comes from the records of professional investors. When a venture capitalist or a business angel writes a check, that deal is usually logged in a database. But this view is incomplete. It misses the companies that raise money from their own founders, from family members, or from private investors who never file a report with a regulator. It is like trying to understand how people get married by only reading the announcements in the newspaper; you see the big, public weddings, but you miss the quiet ceremonies in living rooms and courthouses that happen every day. For decades, researchers have assumed that outside money flows to companies that are growing fast and running out of cash, or perhaps to those that are struggling and need a rescue. The question has been whether capital is a reward for success or a lifeline for the failing.
A team of researchers in Italy has found a way to look past the professional investors and see the whole picture. They turned to a specific line in the official financial accounts of thousands of small Italian companies. In Italy, when a company issues new shares at a price higher than their face value, it must record the extra money in a special, restricted account called a share-premium reserve. This is a mandatory entry that cannot be faked or created by simply revaluing assets. By scanning these records for 3,225 innovative small businesses over a ten-year period, the researchers could see exactly when a company received new outside money, regardless of who sent it. They found nearly 3,000 distinct rounds of funding. This method allowed them to ask a simple but previously unanswerable question: what is actually happening inside a company right before it gets a new round of cash?
The answer challenges a common belief about how startups survive. The researchers discovered that outside money does not arrive because a company is running out of cash. In fact, the amount of cash a company holds right before it raises money is exactly the same as it was in years when it did not raise money. The capital does not come to rescue a drowning firm. Instead, the money arrives at companies that are growing their sales at a rapid pace. However, there is a twist that changes the story completely. These fast-growing companies are often losing money. In fact, six out of ten of the companies that raised new equity had closed their previous year with a loss. The data shows that profitability and growth are not the same thing in this world; a company can be expanding its business aggressively while simultaneously burning cash.
The timing of these losses is the most revealing part of the story. Before the money arrives, the companies are not in a state of financial collapse; their cash levels are stable, and their losses are not getting worse. The losses actually deepen only after the new money comes in. At the same time, the companies start buying more intangible assets, such as software, patents, or brand value, which cannot be used as collateral for a bank loan. This sequence suggests that the new capital is being used to fund a choice to invest and grow, not to fix a broken balance sheet. The money allows the company to take on more risk and build a future that requires spending before it earns. The researchers found that this pattern holds true whether the company is young or older, whether it is in a high-tech sector or a more traditional one, and whether it is losing a little money or a lot.
The study also looked at what happens after the first round of funding. It turns out that getting a second round of money depends entirely on what the company did with the first one. If the company continued to grow its sales, it was likely to get more money. If it stopped growing, the money stopped coming. The size of the first check did not matter; only the results mattered. This confirms that the financing process is a series of steps, where investors watch the company's performance before deciding to commit more funds. The researchers used advanced statistical tools to ensure that this pattern was real and not just a fluke of the data. They tested their findings against different types of mathematical models and found that a simple, straight-line relationship explained the data just as well as complex, twisting curves. This gives them high confidence that their description of the phenomenon is accurate.
The implications of this discovery are significant for how we understand business growth. It suggests that the companies most likely to attract outside investment are not necessarily the ones that are "doing well" in the traditional sense of making a profit. They are the ones that are growing fast, even if they are losing money in the process. This means that policies or rules designed to support startups should not focus solely on profitability. If a government or a bank only gives money to companies that are already profitable, they will miss the very companies that the market is willing to fund. The study shows that the market selects for growth, not for immediate earnings. By looking at the mandatory financial records of every company, rather than just the ones that made headlines with professional investors, the researchers have revealed a hidden layer of the economy where growth and loss happen together, and where new money fuels that combination.
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