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Formation of a German start-upCompany - GmbH and UG
Dr. Joachim Homeister 7 Feb 13Monday, February 11, 13
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Agenda
1. Available Types of Companies
2. Timing for Incorporation
3. UG and GmbH4. Articles of Association
5. Shareholder Agreements
6. Wrap-up
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IncorporationTypes of Companies available for Start-ups
Incorporated: private limited company (GmbH/UG)
stock corporation (AG)
Non-incorporated: trade partnership (oHG)
limited liability partnership (KG)
civil law partnership (GbR)
Hybrid
GmbH & Co. KG
Foreign companies
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IncorporationPros and Cons - corporations
Pros no personal liability of founders
easily transferable
preferable for fundraising
Cons more complicated foundation process and costs (notary
needed)
minimum capital requirements (GmbH: 25k, AG: 50k) but: UG does require only 1 per shareholder
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IncorporationPros and Cons non-incorporated company
Pros easy foundation (foundation agreement can be in simple
written form or is not required at all)
no capital required
Cons personal liability of founders (except for limited partners in
KG)
tax aspects (founders are subject to personal income taxwith personal tax rate of up to 45%, complicated accounting)
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IncorporationPros and Cons GmbH & Co. KG
What is this? A limited partnership whose only general partner is a GmbH
(or other incorporated company), with the founders beinglimited partners
Pros combines advantages of incorporated and non-incorporated
companies
may have tax advantages as long as company generateslosses (unlikely for founders who concentrate on one core
business)
Cons complicated (GmbH must be founded in addition to
partnership)
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IncorporationPros and Cons Foreign Companies
Pros no capital requirements (e.g. UK Limited)
may have tax advantages but be careful! If a foreigncompany has no substance German tax authorities may
treat the company as non-existing and tax the founders as ifthey were acting without incorporation (= personal tax rate ofup to 45%)
Cons administration complicated (need to obtain PoAs, corporate
and other documents from local service provider and inforeign language; often legalization is required)
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Agenda
1. Available Types of Companies
2. Timing for Incorporation
3. UG and GmbH4. Articles of Association
5. Shareholder Agreements
6. Wrap-up
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Timing for IncorporationWhy?
Limit your liability
Consolidation of assets
For investment
Accounting Treatment Tax Treatment
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Timing for IncorporationWhen?
Sooner, rather than later: Limit liability
Protect & consolidate IP
Establish cap table
Late foundation may make foundation more complicated!
Speed of incorporation: Incorporation usually should take not more than 2-3 weeks
after notarization (unless there are complications, e.g.reorganization of a pre-existing company)
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Timing for IncorporationWhen?
But not too quick: Founders must determine initial shareholder structure at
incorporation
What if co-founders join at a much later date?
What if co-founders leave soon after incorporation?
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Timing of IncorporationWhere?
Legal Issues: German corporate law is advanced and sophisticated
Legislation is continually amended to meet changingbusiness needs
German courts have experience in sophisticated corporateissues
English language is easily available and can be used fordocumentation, if international founders and or investors areinvolved (except for documents that need to be filed with
public registers)
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Timing of IncorporationWhere?
Commercial Issues: Where are your customers located?
Where are your likely investors located?
Where might your likely acquiror be located?
Will your company go public? If so, where?
Will your company require an acquisition currency?
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Timing of Incorporation and finally
All is not lost if you incorporate in Germany: can always flip to a foreign company at a later date, if
required
Same is true with foreign companies
But then have two companies: Parent
Subsidiary
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Agenda
1. Available Types of Companies
2. Timing for Incorporation
3. UG and GmbH4. Articles of Association
5. Shareholder Agreements
6. Wrap-up
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UG and GmbHGmbH
Gesellschaft mit beschrnkter Haftung =Limited Liability Company
Standard company form for small and mid-sized
business in Germany since 1892 (!) Was created by the legislator, inter alia, in order to create asimple form for company foundation, after the stockcorporation law (enacted in earlier 1870-ies) had becometoo complicated
Minimum capital requirement: 25,000 Capital shall ensure a minimum of security for
company creditors, since founders exclude theirpersonal liability
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UG and GmbHGmbH
Corporate Governance General meeting of participants
(Gesellschafterversammlung)
At least 1 (one) managing director (Geschftsfhrer)
Facultative: supervisory board (Aufsichtsrat) or advisoryboard (Beirat)
Foundation requires notarization andregistration in the trade register
Foundation costs: approx. 530 (notarizationand registration in the trade register)
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UG and GmbHGmbH: Notarization
The Public Notary A lawyer who is empowered by the state to certify certain
documents (e.g. company foundation deeds, sale-purchaseagreements for real estate, testament)
Form requirement shall ensure accuracy andcorrectness of the documents which aresubject to notarization
Simplifies the process with the trade register(notary is familiar with and is responsible forall procedures)
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UG and GmbHUG
Foundation costs: approx. 530 for standardcase with personalized articles of association
same as GmbH!
Foundation with template articles(Musterprotokoll) is less expensive
approx. 170 (notarization and registration)
But: template articles in most cases do not
suit the founders needs possible exception: sole founder wishes to
incorporate a company
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Agenda
1. Available Types of Companies
2. Timing for Incorporation
3. UG and GmbH4. Articles of Association
5. Shareholder Agreements
6. Wrap-up
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Articles of AssociationContents (Mandatory)
Company name / legal form
Company Seat
Company Objective
Statutory Capital / Participatory Interests
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Articles of AssociationContents (Facultative)
Share Transfer Restrictions Right of First Refusal
Drag-along Right / Tag-along Right
Corporate Governance Shareholder Reserved Matters
Management and Representation
Supervisory Board / Advisory Board
Redemption
Dividends
Non-Compete Clauses
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Articles of AssociationCompany Name / Legal Form
GmbH: Company name must containdesignation Gesellschaft mit beschrnkterHaftung or an abbreviation thereof
UG: Company Name must containdesignation Unternehmergesellschaft(haftungsbeschrnkt) or UG(haftungsbeschrnkt)
Other than this, the company name can befreely chosen, if it is not yet used in the traderegister
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Articles of AssociationCompany Seat
Any municipality in Germany
not necessarily the factual place where thebusiness is carried out
is relevant for the competence of the trade register
Business address to be indicated separately
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Articles of AssociationStatutory Capital / Participatory Interests
Minimum amount: 25k (GmbH) or 1 perfounder (UG)
Each participatory interest must be multiple of
1 Participatory Interest describes the
participation in the company (e.g. 5,000participatory interest grants 20% participation
in a company with 25k capital) Participants can make additional contributions
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Articles of AssociationCompany Objective
Must describe the intended business of thecompany as objectively as possible
In case of later changes of the business
objective, articles of association should beamended
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Articles of AssociationShare Transfer Restrictions
Consent requirement (Vinkulierung)
Right of First Refusal (Vorkaufsrecht)
Drag-Along Right / Tag-Along Right
is not a restriction in the sense of the word butobliges a shareholder to sell its participatoryinterest in certain situations
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Right of First RefusalWhat is it?
Basic definition: Investors get first dibs on transfers of shares
Legal definition: a right to acquire shares being sold by existing
shareholders to third parties.
Why is it important? allows investors to increase their percentage ownership of
the company going forward
bargaining tool for the Investor: complementary (or flip side) to Co-Sale Right
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Right of First RefusalTips & Tricks
Tips: ensure broad range of carve-outs (including tax planning)
may not want offer round if numerous small shareholders
Company may not always be able to purchase
Tricks: class by class RoFR
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Right of First RefusalTraps
Traps: VC investor only
timings
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Drag-along RightWhat is it?
Basic definition: Investors can force other shareholders into a joint sale
Legal definition: if a certain threshold percentage of a companys
shareholders agree to sell their shares, then all othershareholders are obliged to sell their shares in connectionwith such transaction.
Why is it important? insure that a sale of the company will not be blocked by
other shareholders
Tag-along Right / Co-Sale Right?
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Drag-along RightTips & Tricks
Tips: avoid low majority requirements
Tricks: ensure participation by all shareholder groups in decision
list carve-outs (e.g. below market sale, sale to affiliate)
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Drag-along RightTraps
Traps: VC investor only?
if right can be triggered by only a few shareholders (nochecks and balances)
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Articles of AssociationCorporate Governance
Determination of Corporate Bodies General Meeting (mandatory)
Managing Directors (mandatory)
Supervisory Board (facultative) Advisory Board (facultative)
Procedures for Summoning and Decision-making
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Shareholder Reserved MattersWhat is it?
Basic definition: Certain management decisions require approval of the
general meeting of participants
Legal definition:
an obligation of the managing directors to obtain adecision of the general meeting of participants prior tomaking certain management decisions.
Why is it important? allows co-founders and investors to controlimportant
management decisions
provides management with security with respect to criticaldecisions (fiduciary duties, liability towards shareholders)
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Shareholder Reserved MattersTips & Tricks
Tips: ensure sufficient flexibility (provide for sufficient thresholds
allowing day-to-day management without resort to generalmeeting of participants)
provide for general approval (e.g. annual budget)
Tricks: adjust majority requirements to shareholder structure
(founders, investors)
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Shareholder Reserved MattersTraps
Traps: Low thresholds paralyze day-to-day management
timings
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Management and Representation
Managing Directors carry out day-to-daymanagement
Towards shareholders they are obliged to observerestrictions (Shareholder Reserved Matters)
Restrictions generally are, however, not bindingupon third parties
Be aware of liability issues!
General rule: Several managing directorshave joint representation power
Articles may provide for variations
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Supervisory Board / Advisory Board
Facultative management bodies Supervisory board may be mandatory in
companies with more than 500 / 2000 employees
Supervisory board is similar to supervisoryboard in stock corporations
preeminently control function for the management
certain decisions of the management can be
subjected to approval of the supervisory board Advisory board can be designed according to
the needs of the founders and investors
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R d ti
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RedemptionWhat is it?
Basic definition: Investors get another kind of exit
Legal definition: an investors right to require the company to repurchase
shares that the investor has purchased (often at a price thatis greater than what the investor paid).
Why is it important? another form of downside protection (or even insurance
policy), but investor may exercise this right if they realise
that the company has no real prospect of an exit (the cashcow scenario)
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R d ti
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RedemptionTips & Tricks
Tips: resist, as not all VCs or investors require it
should be justified by the VC
Tricks:
stagger the redemption ( / / ) ensure carve-out for legal ability to do so
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Redemption
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RedemptionTraps
Traps: full redemption at a single date
multiple return (pseudo liquidation preference)
we have never exercised our right of redemption
long term debt on the balance sheet (increasing if dividendas well)
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Dividends
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DividendsWhat is it?
Basic definition: Investors get additional return on their money
Legal definition: distributions to shareholders from the companys profits,
usually on an annual basis at a specified rate. Why is it important?
Investors sometimes want a guaranteed rate of return ontheir investment
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Dividends
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DividendsTips & Tricks
Tips: resist, as not all VCs or investors require it
if have multiple liquidation preferences, may not be justified
Tricks:
non-cumulative delay commencement of earning / accruing dividends
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Dividends
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DividendsTraps
Traps: cumulative (accumulate at a specified rate)
multiple rounds + liq. pref. + dividends = mountain
effect on redemption
accounting treatment
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Non-Compete Clauses
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Non-Compete ClausesWhat is it?
Basic definition: Shareholders are prohibited from carrying out the same or a
materially similar business outside the company
Legal definition:
a shareholder shall not compete with the business of thecompany while being a shareholder (and within a certainperiod after an exit).
Why is it important? Co-founders and investors have an interest that the founder
concentrates his business in one company
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Non-Compete Clauses
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Non Compete ClausesTips & Tricks
Tips: make sure that subject of the non-compete clause is
sufficiently described
Tricks:
court practice limits validity of non-compete provisions afterexit. If its too long, it may be invalid.
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Agenda
1. Available Types of Companies
2. Timing for Incorporation
3. UG and GmbH4. Articles of Association
5. Shareholder Agreements
6. Wrap-up
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Shareholder Agreements
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Shareholder AgreementsWhat is it?
Gesellschaftervertrag Are facultative but often used when investors become
involved
No need to be registered in the trade register (i.e. not knownto the public)
Generally no notarization requirement (can be concludedpost-foundation)
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Shareholder Agreements
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Shareholder AgreementsContents
Founders Stock (Vesting) Share Transfer Restrictions
Right of First Refusal
Drag-along Right / Tag-along Right
Special rights for investors
Anti-dilution protection Liquidation preference
Information rights
Non-Compete Clauses
IP
Obligations with respect to marital status (ehelicherGterstand)
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Founders Stock (Vesting)
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( g)What is it?
Basic definition: Founder no longer really owns his/her shares
Legal definition: the shares held by a founder, typically issued at
incorporation, that are subject to reverse vesting granting acall option to the Company to acquire certain number ofthese shares in case of a leaver event.
Why is it important? Investor ensures that Founder is incentivised to remain with
the company (golden handcuffs) overcomes the free rider problem with Founder who has
left
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Founders Stock (Vesting)
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( g)Tips & Tricks
Tips: know what youre getting into
define good leaver / bad leaver
define the compensation for unvested shares
Tricks: use bad leaver as the benchmark
bad leaver = fraud, join competitor or moral turpitude
credit for time served
acceleration -> single & double trigger
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Founders Stock (Vesting)
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( g)Traps
Traps: standard good leaver / bad leaver
use good leaver as benchmark = out the door feet first
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Liquidation Preference
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What is it?
Basic definition: Investors get their money back before anyone else
Legal definition: a right given to holders of a preferred class of shares
whereby such holders, in the event of a liquidation event, areentitled to receive their investment back (plus accrueddividends) before the holders of ordinary shares receiveanything.
Why is it important?
gives investors downside protection guarantees the investor that they will see the first money
out in a liquidation scenario
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Liquidation Preference
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Tips & Tricks
Tips: run the exit model (a VC has already done so)
multiple liq. pref. & participation reflect state of economy
Tricks:
horizon / time based inflection point cap / participation removed above $$ value
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Liquidation Preference
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Traps
Traps: high pre-money valuation with multiple / participating liq.
pref.
liquidation preference on IPO
participation = double dip
accrued cumulative dividends
liq. pref. stack from multiple rounds can be oppressive
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Anti-dilution Protection?
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What is it?
Basic definition: Investors get price protection
Legal definition: a mechanism which insures that an investors equity
stake in a company will not be reduced through subsequentinvestments in the company at reduced valuations.
Why is it important? gives investors downside protection
guarantees the investor that they will benefit from favourable
terms of subsequent investment round
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Anti-dilution ProtectionTi & T i k
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Tips & Tricks
Tips: full ratchet vs. weighted average
ensure carve-outs are listed
do the math
Tricks: time-based conversion from full ratchet to weighted average
pay to play
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Anti-dilution ProtectionT
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Traps
Traps: high pre-money valuation with full ratchet
when weighted average weighted average
miscalculating the liquidation preference (money in vs. pershare)
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Agenda
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Agenda
1. Available Types of Companies2. Timing for Incorporation
3. UG and GmbH4. Articles of Association
5. Shareholder Agreements
6. Wrap-up
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Helpful Resources(English)
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(English)
The Funded www.thefunded.com
Venture Hacks www.venturehacks.com
Brad Feld & Jason Mendelson: Venture Deals: Be Smarter than your Lawyer and Venture
Capitalist
Katharine Campbell:
Smarter Ventures: A Survivors Guide to Venture Capitalthrough the New Cycle
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Helpful Resources(German)
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(German)
Vogelsang / Fink / Baumann: Existenzgrndung und Businessplan:
Ein Leitfaden fr erfolgreiche Start-ups Bonnemeier:
Praxisratgeber Existenzgrndung: Erfolg- reich starten und auf Kurs bleiben Grnderlexikon
www.gruenderlexikon.de
SelbstndigImNetz Forum sin-forum.de
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Questions & Answers
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About OrrickQuick Overview
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One of the worlds largest and best-regarded law firms
More than 1,100 lawyers in 23 locations in 8 countries
Named to Law 360s "Global 20 list of the world's
leading global law firms
Focus on emerging companies More than 1,000 emerging company clients
More than 100 lawyers in the Silicon Valley office,
including founding members of Venture Law Group
Lawyers on the ground in all global hot spots for
emerging technology companies
Relationships with more than 100 venture capital funds
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Quick Overview
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About OrrickEmerging Companies Practice
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Emerging Companies Practice
Recognized by Legal500as one of the top firms in the U.S. for our venturecapital and emerging companies practice
Clients include 5 ofThe Momentum Indexs Top 50 Technology Companies, 8
companies listed in GreenTech Media's Top 50 Greentech Startups, and
companies listed among The Wall Street Journal's Top 50 Venture-Backed
Companies, BusinessWeek's 50 Best Tech Start-Ups, and VentureWires 50
Most Innovative Technology Startups
As one measure of our market presence, we have acted as either company
counsel or investor counsel in venture capital financings for 9 ofThe Momentum
Indexs Top 20 Technology Companies
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Dr. Joachim Homeisterjhomeister@orrick.com
+49 30 88574 2-55
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Thanks
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Dr. Joachim Homeisterjhomeister@orrick.com
+49 30 88574 2-55
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