US/ German Startup Differences – Legal Differences during Founding Phase

Having started and operated a startup in the US and assisted (and invested) in multiple startups in Germany, I recognize that there are some important differences in the two countries.   Most of these differences are a consequence of the variations in legal structures, but there are also some important cultural differences which need to be understood.  I’ll be splitting these topics into multiple posts.  (These posts are principally applicable only to GmbHs, AGs have some differences).

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Some of the biggest differences are simply in getting a corporate entity founded and up and running.  In the US this is rather easy, after deciding on a name, you have your attorney draft the Articles of Incorporation (assuming a C Corp), Bylaws, etc, and file with the Secretary of State and receive a Tax ID Numbers.  Total costs can be as low as $1,000 and takes a few days or weeks.

Formally organizing a startup (or any company) in Germany is very different.  Deciding on the corporate form involves the same concerns as a US company (limiting liability, ownership structure, etc), but also involve some regulatory hurdles which must be overcome.  Assuming a GmbH (more or less like a LLC), which is the most common form for a startup, then the following must be kept in mind:

  • A GmbH has a minimum capital cash reserve requirement (“Stammkapital”) of 25T€.  This must always be kept in a bank account somewhere untouched, and the company cannot formally organize without at least this amount being paid in. So if you are thinking of creating a GmbH entity, remember you must have at least 25T€ cash on hand just to get started.  (In recent years there was an attempt to lower the barrier to 10T€, but that failed.  However another corporate form, and called the “UG” is an exception and can be founded under more strict controls with only 1€).

 

  • Just like in the US, the company must draft and accept Bylaws, incorporation agreements, shareholders agreements, etc, along with deciding on the corporate officers.  But another big difference is reporting requirements to the government. In Germany, a company is not officially a legal entity until it is recognized as such by the “handelsregister” (basically registry of commerce).  These are operating at the state or city level and must be informed of details on the company, including: names and birthdays of officers, corporate address, number of outstanding shares (“stammkapital”), list of shareholders, and the bylaws.  If any of these changes, the company must inform the handelsregister.  Also, this information is public!  So if you close a financing round, all it takes is for someone to look at the change in the number of outstanding shares or a new addition to the shareholder list, for them to see that you just received an investment.

The time it takes for the handelsregister to officially recognize a change and publish the results can vary widely depending on the city or state. Some only take a few days; others can take up to two months. This is important to understand because many investors will only initiate the final wire transfer for the paid in capital after they have officially the handelsregister publishes that they are listed as a shareholder.  This is for the protection of the investors, since it is possible the handelsregister finds a problem in the documents which prevents an investment.  In that nightmare scenario, the investor would have wired the money without having received any shares.

  • Shares of a German company are also very different than in the US.  Although in both countries there exists the concept of the par value and premium of a stock share, the par value number in US startups are most often set just above zero, while in Germany they are a minimum of 1€.  In both countries, the legally required amount they must keep in reserve (depending on the state) is:

Number Outstanding Shares multiplied by the Par Value.

So if a US company sells 10T shares (assuming a $0.01 par value as required by some states), the legally required amount they must keep on hand is 10T X .01 = $1,000 (which basically any company has).  If you are based in the US and this is news to you, don’t worry, the par value requirements are so low I think most US entrepreneurs don’t ever even know about it.

Where it gets interesting, however, is in Germany where the par value requirement is set by law at a minimum of 1€ (and the number of issued shares must be an integer).  That means in the example above, the 10T outstanding shares corresponds to 10T€ capital reserves which the company must always have on hand somewhere.  Given that all GmbH’s have a minimum paid in capital amount (see above) of 25T€, that means all GmbH’s have at least 25T outstanding shares and must always maintain a minimum cash on hand of 25T€.

This has the side effect that in Germany there is no distinction between outstanding and issued shares.  While in the US a company may authorize 1 Mio. Shares, with perhaps only 100T issued, such a construction is impossible with a German GmbH.  (That also has a HUGE impact on subjects such as Vesting and Stock Pools, which I’ll write about another time).

US/ German Startup differences– Legal Differences in Startup Contracts and Agreements

As part of the ongoing series on in US and German Startup/VC processes, laws, and culture, I’ll be addressing some of the most glaring differences I’ve observed regarding shareholders’ agreements, startup contracts, etc.  It should be noted that most of these observations are relevant only to GmbHs.  While many of the same differences apply to German AGs, I’m limiting this post to GmbHs, where I have more experience.

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Under German law, any contracts which deal with the transfer or sale of shares must be notarized.  This is not as in the US, where the process can take only a few minutes and most law firms’ secretaries are also state certified notaries.  The situation in Germany is quite different.

For one, there is a set number of notaries in the country (“Notar”) who are allowed to notarize documents, so it’s not a question of just asking a secretary or paralegal to do it.  Notary positions are highly sought after in Germany, with only the most highly qualified legal specialists allowed to become one.

Notaries assume personal liability for the documents they are certifying.  For example, in a 100T€ transaction, the notary can be liable for the 100T€ if he fails to verify that the details of the transaction are all permitted.  For example, if someone signs a contract for someone else without having a proxy or power of attorney, the notary is liable for any damages that arise from this.  This leads to a situation where the notaries are basically paid to go thru every detail of what is permissible in a transaction with the parties, verifying everything, and only then will he notarize the transaction.

The process can be very long.  For a typical seed investment, for example, there is a shareholders agreement, new bylaws, IP and Software assignments, etc.  To verify the agreement of all the parties, the Notary will ask everyone to come together, and then he will read EVERY SINGLE WORD of all of the contracts.  After finishing that (which can take many hours) everyone agrees to them and prepares to sign the contracts.  Now the Notary must verify that everyone present is actually able to sign the contracts.  If someone is representing the startup, or the VC firm, or someone else, then the Powers of Attorney must be checked.  This becomes even more complicated with the Powers of Attorney documents are also linked to entities which also are given by Powers of Attorney.  The Notary must verify all the parts of the chain, make sure they are correctly done, and then check the identities of the people present (passports, etc).  Then and only then can he notarize the contracts.

Since the Notary is personally liable for any problem he may have missed, he is of course very thorough.  His costs are also representative of his liability (and standardized across the country, so don’t bother trying to shop around).  A 500T€ Seed Investment notarization can be many tens of thousands of Euros, a signification portion of the attorneys and transaction costs.

I’ll leave the relative advantages and disadvantages of this system to another post; for now any US-based VCs or Entrepreneurs who are participating in a financing round based in Germany should be made aware that the transaction itself can be more complicated and formal and expensive than simply getting together around a conference table and signing.

US/ German Startup differences – Legal Differences on Founder Liability

Similar to in the US, officers and directors of a German GmbH can also be held personally liable for their actions or for the liquidity of the company.  The penalties, however, can be very different from those to which a US entrepreneur is accustomed. As before, I offer this information informally and I strongly recommend checking with a German attorney on the finer points.

The Managing Director of a GmbH can in some situation be personally liable for his or the company’s actions.  D&O insurance and the corporate shield are of little protection in many of these situations.  A CEO taking on a leadership role (and officially becoming Geschäftfuhrer) in a German Start Up needs to inform himself of the liabilities to which he is exposed.  The issue of bankruptcy is course likely the most relevant for entrepreneurs, though there are a few others (including fraudulent activity and not respecting the minimum capital requirements for a GmbH).  For example, when the cash on hand drops below half of the minimum required capital reserves (“stammkapital”), the CEO is required to inform all the shareholders.

At the most extreme, founders can be held criminally liable.  Even if criminal activity hasn’t been committed, in some situations the officers may be officially barred from participating in management of a company for a period of time.

The German Law Journal has a great treatise on the subject which can be found here.