Formation of a Germany Startup Company

7/30/2019 Formation of a Germany Startup Company

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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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Monday, February 11, 13


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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





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





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





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





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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( 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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( 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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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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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



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

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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 [email protected]

+49 30 88574 2-55

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Thanks


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Dr. Joachim [email protected]

+49 30 88574 2-55

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Formation of a Germany Startup Company

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