Taking on investors in a startup: timing, risks and legal framework

Sooner or later, almost every growth-oriented company comes to the point where substantial external financing is required – be it to accelerate growth, to enable expansion into new markets or simply to keep pace with technological competition. Particularly in innovative sectors such as artificial intelligence (AI), software-as-a-service (SaaS), Web3, games and eSports, the question of taking on investors then arises. The decision as to when and under what conditions external investors are brought on board is of crucial importance for start-ups and founders. This is not only about the financial side, but also about far-reaching legal and strategic consequences.

The right time for investor participation can determine the future course of a start-up. A premature entry of venture capital or other investors can, for example, lead to a loss of control for the founders or severely dilute their shares if the company raises capital at a very early stage with a low valuation. On the other hand, looking for investors too late can inhibit growth and lead to scaling delays – for example, if the company runs out of funds in a critical growth phase while competitors are already gaining momentum through financial injections. In the worst case scenario, the wrong timing could lead to the loss of the original entrepreneurial spirit if external investors take over or the start-up loses its innovation leadership due to a lack of funding.

This specialist article takes a comprehensive look at the legal challenges and entrepreneurial considerations when taking on investors in young technology companies. It first addresses the questions of when is the right time to invest and how to recognize the wrong time. It then discusses the key risks associated with the very early or very late involvement of investors – from the risk of influence and misappropriation of the company’s vision to structural problems in later financing rounds.

In the following, various forms of participation and financing instruments are presented, which are particularly common under German law: from silent partnerships, profit-participating loans and subordinated loans to capital investments requiring a prospectus and modern tokenized investments via blockchain. For founders, it is essential to understand the legal framework and requirements associated with each of these options – for example with regard to the structure of contracts, information and control rights of investors or compliance with regulatory obligations (keyword BaFin prospectus obligation).

In addition, the differences between German and international investor law will be worked out. Both regulatory aspects (BaFin vs. SEC in the USA) and corporate law considerations (participation of a GmbH or AG versus the typical US corporation structure) play a role here. International growth ambitions often require adapted strategies, as a startup that scales globally comes into contact with investors from different jurisdictions and may have to adapt its corporate structure to these requirements.

We also pay particular attention to the challenges of raising capital for start-ups with high research and development costs (e.g. in the field of AI or life sciences) and for companies that are internationally oriented from the outset. These companies often have to raise substantial sums early on without generating revenue in the short term – which requires special financing strategies and entails legal stumbling blocks (e.g. when protecting intellectual property vis-à-vis investors).

Finally, the specifics of the games and eSports industry in Germany are analyzed. These sectors in particular often have their own rules: The availability of business angels and private investors is limited in this country, the investment climate is considered difficult and there are industry-specific legislative hurdles. Financing models such as publisher deals, sponsoring or community funding play a greater role than traditional venture capital. We look at the special legal and economic framework conditions that founders in the games and eSports industry have to take into account – from state funding and regulatory aspects to the question of how these industries position themselves in an international comparison.

This article is aimed at founders and startup teams with an interest in law who are looking for sound guidance in the strategic planning of their financing. The article is intended to show what needs to be taken into account when choosing and structuring investor involvement and to provide expertise from the perspective of a specialized IT lawyer and startup consultant. The presentation is factual and practical, with references to relevant legal norms and an economic classification of the various options. The aim is to enable founders to make informed decisions in order to finance the growth of their company in a legally secure yet flexible manner.

The right and wrong time to take on investors

There is no general answer to the question of when is the best time to bring investors into a company – it depends on many individual factors, such as the business model, the market situation and the development of the startup to date. However, there are typical constellations in which investors may enter too early or too late, causing problems. Founders should be aware of these scenarios in order to make an informed decision about timing.

Investors involved too early

In the very early phase of a start-up – for example, before or immediately after market entry – it can seem tempting to take on external investors. A high capital requirement for product development or market development often leads to founders selling shares to venture capitalists or business angels at the seed stage. Although such an early investment brings fresh money and sometimes also valuable know-how into the company, it involves considerable risks.

Risks of premature investor entry:

• Loss of control by the founders: If investors join at a time when the company valuation is still low, founders have to give up a large proportion of their shares for comparatively little capital. This can greatly reduce the founders’ voting power. External investors often secure veto rights or seats on the advisory board/board of directors, which restricts the decision-making freedom of the original entrepreneurs. In extreme cases, founders may lose control over the strategic direction because investors set different priorities (e.g. rapid growth at all costs or an early exit) than the entrepreneurs themselves.
• Severe dilution: The early issue of shares leads to a dilution of the existing shareholders’ shareholding. The percentage share of the founders can shrink rapidly, especially in the case of several financing rounds at short intervals. This not only has a psychological impact (you may suddenly only own a minority share of your “own” company), but can also affect the motivation and long-term loyalty of the founders – especially if they feel they have to cede most of the increase in value to the investors later on.
• Loss of the entrepreneurial spirit: In the initial phase, start-ups are often characterized by a strong entrepreneurial spirit, flexibility and quick decision-making processes. If investors are brought on board very early on, there is a risk that the agile startup culture will be slowed down by formalized reporting obligations, approval requirements and the influence of external investors. The founders could be forced to spend more time on investor relations and administrative tasks than on product development and customer acquisition. In the worst case scenario, the young company changes so much due to investor requirements that the original vision is diluted and entrepreneurial freedom is significantly restricted.
• Immature business models under external pressure: Another risk of very early financing is that the business model is not yet validated or market-tested. However, external investors often expect scalable growth strategies and measurable success in a short period of time. This pressure can lead to founders expanding prematurely or launching an immature product just to meet the expectations of investors. This increases the risk of failure. Without an investor, the founders might have more time to adapt the product or pivot the concept before embarking on a growth course.

Despite these risks, there are also opportunities with an early investor entry. Experienced business angels or venture capital managers with industry experience can provide the startup with decisive impetus. They bring networks, mentoring and credibility. A prominent early-stage investor can, for example, signal to other market players (other investors, potential customers or partners) that the business model has substance. Financial backing from the outset can also make it possible to build on a technological lead or secure market share early on before competitors enter the field.

The “right” time in the early stages is therefore a fine line: on the one hand, founders should not hesitate too long to accept external support if this is necessary, but on the other hand, they should first have created a viable foundation – such as a functioning prototype, first paying customers or at least valid market data. This ensures that the company valuation is not unnecessarily low and that investors are approached from a position of strength and conviction.

Late admission of investors

The other extreme – waiting too long to raise capital – can also be problematic. Some founders are reluctant to give up shares and finance their growth for as long as possible from their own funds, current sales or small amounts of public funding. Although this bootstrapping mentality initially preserves independence, it quickly reaches its limits in capital-intensive sectors or rapidly growing markets.

Risks of a late investor take-up:

• Delay in scaling: The most obvious risk is that valuable time is lost during which the company could actually grow faster. If there is a lack of external capital, important investments – e.g. in personnel, marketing, international expansion or research and development projects – cannot be made. Growth is then slower than possible. In dynamic markets (e.g. in the AI or platform sector), this can mean that competitors with better financing pass by. A market opportunity could pass by unused because your own start-up simply lacks the funds to scale aggressively enough.
• Financial bottlenecks and unfavorable conditions: If going to investors is put off for too long, it often comes at a time when the company is already under financial pressure. If the liquidity reserves are almost exhausted and capital is needed quickly, the startup is in a poor negotiating position (“fire sale scenario“). Investors who get involved at this late stage will be aware of the urgent need for capital and may dictate tougher conditions – such as a significantly higher share for the same investment amount or particularly strict contractual conditions. In the worst case scenario, no investor can be found in time, which increases the risk of insolvency.
• Lost synergies and know-how: capital from outside means not only money, but often also strategic support. If you operate without investors for a long time, you miss out on potential external expertise, industry contacts and mentoring. Taking on investors at a later stage can then reveal that certain strateg# Taking on investors in a start-up: timing, risks and legal framework

Sooner or later, almost every growth-oriented company comes to the point where substantial external financing is required – be it to accelerate growth, to enable expansion into new markets or simply to keep up with technological competition. Particularly in innovative sectors such as artificial intelligence (AI), software-as-a-service (SaaS), Web3, games and eSports, the question of taking on investors then arises. The decision as to when and under what conditions external investors are brought on board is of crucial importance for start-ups and founders. This is not only about the financial side, but also about far-reaching legal and strategic consequences.

The right time for investor participation can determine the future course of a start-up. A premature entry of venture capital or other investors can, for example, lead to a loss of control for the founders or severely dilute their shares if the company raises capital at a very early stage with a low valuation. On the other hand, looking for investors too late can inhibit growth and lead to scaling delays – for example, if the company runs out of funds in a critical growth phase while competitors are already gaining momentum through financial injections. In the worst-case scenario, the wrong timing could lead to the loss of the original entrepreneurial spirit if external investors take over or the startup loses its innovation leadership due to a lack of funding.

This specialist article takes a comprehensive look at the legal challenges and entrepreneurial considerations when taking on investors in young technology companies. It first addresses the questions of when is the right time to invest and how to recognize the wrong time. The central risks associated with the very early or very late involvement of investors are then discussed – from the risk of influence and misappropriation of the corporate vision to structural problems in later financing rounds.

In the following, various forms of participation and financing instruments are presented, which are particularly common under German law: from silent partnerships, profit-participating loans and subordinated loans to capital investments requiring a prospectus and modern tokenized investments via blockchain. For founders, it is essential to understand the legal framework and requirements associated with each of these options – for example with regard to the structure of contracts, information and control rights of investors or compliance with regulatory obligations (keyword BaFin prospectus obligation).

In addition, the differences between German and international investor law will be worked out. Both regulatory aspects (BaFin vs. SEC in the USA) and corporate law considerations (participation of a GmbH or AG versus the typical US corporate structure) play a role here. International growth ambitions often require adapted strategies, as a startup that scales globally comes into contact with investors from different jurisdictions and may have to adapt its corporate structure to these requirements.

We also pay particular attention to the challenges of raising capital for start-ups with high research and development costs (e.g. in the field of AI, biotechnology) and for companies that have an international focus from the outset. These companies often have to raise substantial sums early on without generating revenue in the short term – which requires special financing strategies and entails legal stumbling blocks (e.g. when protecting intellectual property vis-à-vis investors).

Finally, the specifics of the games and eSports industry in Germany are analyzed. These sectors in particular often have their own rules: The availability of business angels and private investors is limited in this country, the investment climate is considered difficult and there are industry-specific legislative hurdles. Financing models such as publisher deals, sponsoring or community funding play a greater role than traditional venture capital. We look at the special legal and economic framework conditions that founders in the games and eSports industry have to take into account – from state funding and regulatory aspects to the question of how these industries position themselves in an international comparison.

This article is aimed at founders and start-up teams with an interest in law who are looking for sound guidance in the strategic planning of their financing. The article shows what to look out for when choosing and structuring investor involvement, bringing in the expertise from the perspective of a specialized IT lawyer and startup consultant. The presentation is highly professional and factual, with references to relevant legal norms and an economic classification of the various options. The aim is to enable founders to make informed decisions in order to finance the growth of their company in a legally secure yet flexible manner.

The right and wrong time to take on investors

There is no general answer to the question of when is the best time to bring investors into a company – it depends on many individual factors, such as the business model, the market situation and the development of the startup to date. However, there are typical constellations in which investors may enter too early or too late, causing problems. Founders should be aware of these scenarios in order to make an informed decision about timing.

Investors involved too early

In the very early phase of a start-up – for example, before or immediately after market entry – it can seem tempting to take on external investors. A high capital requirement for product development or market development often leads to founders selling shares to venture capital providers or business angels at the seed stage. Although such an early investment brings fresh money and sometimes also valuable know-how into the company, it involves considerable risks.

Risks of premature investor entry:

• Loss of control by the founders: If investors join at a time when the company valuation is still low, founders have to give up a large proportion of their shares for comparatively little capital. This can greatly reduce the founders’ voting power. External investors often secure veto rights or seats on the advisory board/board of directors, which restricts the decision-making freedom of the original entrepreneurs. In extreme cases, founders may lose control over the strategic direction because investors set different priorities (e.g. rapid growth at all costs or an early exit) than the entrepreneurs themselves.
• Severe dilution: The early issue of shares leads to a dilution of the existing shareholders’ shareholding. The percentage share of the founders can shrink rapidly, especially if several financing rounds are carried out at short intervals. This not only has a psychological impact (you may suddenly only own a small part of your own company), but can also affect the motivation and long-term loyalty of the founders – especially if they feel they have to cede most of the increase in value to the investors later on.
• Loss of the entrepreneurial spirit: In the initial phase, start-ups are often characterized by a strong entrepreneurial spirit, flexibility and quick decision-making processes. If investors are brought on board very early on, there is a risk that the agile startup culture will be slowed down by formalized reporting obligations, approval requirements and the influence of external investors. The founders could be forced to spend more time on investor relations and administrative tasks than on product development and customer acquisition. In the worst case scenario, the young company changes so much due to investor requirements that the original vision is diluted and entrepreneurial freedom is significantly restricted.
• Immature business models under external pressure: Another risk of very early financing is that the business model is not yet validated or market-tested. However, external investors often expect scalable growth strategies and measurable success in a short period of time. This pressure can lead to founders expanding prematurely or launching an immature product on the market just to meet the expectations of investors. This increases the risk of failure. Without an investor, the founders might have more time to adapt the product or pivot the concept before embarking on a growth course.

Despite these risks, there are also opportunities with an early investor entry. Experienced business angels or venture capital managers with industry experience can provide the startup with decisive impetus. They bring networks, mentoring and credibility. A prominent early-stage investor can, for example, signal to other market players (other investors, potential customers or partners) that the business model has substance. Financial backing from the outset can also make it possible to build on a technological lead or secure market share early on before competitors enter the field.

The “right” time in the early stages is therefore a fine line: on the one hand, founders should not hesitate too long to accept external support if this is necessary, but on the other hand, they should first have created a viable foundation – such as a functioning prototype, first paying customers or at least valid market data. This ensures that the company valuation is not unnecessarily low and that investors are approached from a position of strength and conviction.

Late admission of investors

The other extreme – waiting too long to raise capital – can also be problematic. Some founders are reluctant to give up shares and finance their growth for as long as possible from their own funds, current sales or small amounts of public funding. Although this bootstrapping mentality initially preserves independence, it quickly reaches its limits in capital-intensive sectors or rapidly growing markets.

Risks of a late investor take-up:

• Delay in scaling: The most obvious risk is that valuable time is lost during which the company could actually grow faster. If there is a lack of external capital, important investments – e.g. in personnel, marketing, international expansion or research and development projects – cannot be made. Growth is then slower than possible. In dynamic markets (such as in the AI or platform sector), this can mean that competitors with better financing pass by. A market opportunity could pass by unused because your own start-up simply lacks the funds to scale up aggressively enough.
• Financial bottlenecks and unfavorable conditions: If going to investors is postponed for too long, it often comes at a time when the company is already under financial pressure. If the liquidity reserves are almost exhausted and capital is needed quickly, the startup is in a poor negotiating position (this is referred to as a “fire sale scenario“). Investors who get involved at this late stage will be aware of the urgent need for capital and may dictate tougher conditions – such as a significantly higher share for the same investment amount or particularly strict contractual conditions. In the worst case scenario, no investor can be found in time, which increases the risk of insolvency.
• Lost synergies and know-how: capital from outside means not only money, but often also strategic support. Companies that operate for a long time without investors miss out on potential external know-how, industry contacts and mentoring. Taking on investors at a later date can reveal that certain strategic or structural mistakes could have been avoided in the past. For example, an experienced investor might have urged the optimization of the business model or the professionalization of certain processes at an early stage. Without this input, inefficient structures can become entrenched, which are only corrected at a late stage and at great expense.
• Limited competitiveness: In global tech industries, large financing rounds often create publicity and trust among customers. A start-up that remains without well-known investors for a long time is sometimes viewed more critically by outsiders: Potential major customers or business partners may wonder why no investor has recognized the potential. This can affect reputation. In addition, competitors with strong financing have funds for aggressive marketing, better conditions for customers or faster product development. Your own company risks being less visible on the market despite having a good product.

However, there are also advantages to bringing investors into the company at a later stage. Probably the most important argument is the preservation of independence in the early phase: the founders can build up their product and brand without external influence and allow the company to grow organically. If they succeed in doing this on their own, the company value usually increases – which leads to a higher valuation (higher pre-money valuation) when investors come in later. As a result, fewer shares have to be sold and the dilution is limited. In addition, founders who have already proven their business model (e.g. through their first paying customers or a functioning technology) can negotiate with investors on an equal footing and do not need to agree to as many compromising clauses.

Nevertheless, the timing of the first major financing should not be delayed indefinitely. A proven approach is the concept of the“window of opportunity“: founders identify when their company is at a turning point at which additional capital can trigger a maximum growth spurt – for example, after the successful completion of a development phase or shortly before the international roll-out of a product. It is precisely this window of opportunity that needs to be exploited. If it is missed, later financing may still be useful, but some of the market potential or competitive advantage may already have been lost.

Interim conclusion: Neither a dogmatic early entry of investors nor a fundamental delay in raising capital is optimal per se. The decisive factor is an honest assessment of the current situation: Does the startup already have a minimum viable product and reliable key figures that justify a reasonable valuation? Or is there a risk of a capital shortfall within the next few months without fresh capital? The answers to such questions provide clues for the right timing.

Intermediate forms such as convertible loans or SAFE agreements(Simple Agreement for Future Equity) can also be used to bridge the gap: They enable financing even before an official valuation round, whereby the exact participation quota is only determined later – usually in the next equity round. Such instruments can help to make the timing more flexible and better manage the balancing act between “too early” and “too late”.

Ultimately, the aim is to bring investors on board at the right time – namely when the benefits of the additional capital available clearly outweigh the associated sacrifices (share transfer, investors’ co-determination rights, etc.).

Legal framework and requirements of various forms of participation

There are various forms of investment available to startups when taking on investors, each of which is subject to specific legal regulations and economic effects. The most important models are presented below and their key legal points are explained:

• Silent partnership – the investor does not appear openly, but receives a share of the profits.
• Profit-participating loan – a form of loan with profit-related interest, possibly combined with subordination.
• Subordinated loan – a loan that is subordinated in the event of insolvency and can have an equity-like character.
• Capital investments requiring a prospectus – traditional public investment offers that fall under asset investment or securities prospectus law.
• Tokenized investments via blockchain – new models in which shares or rights are issued in the form of digital tokens.

Each of these forms has advantages and disadvantages as well as certain legal requirements. It is important that founders choose the right instrument for their situation and are aware of the associated obligations.

Silent partnership

The silent partnership (Sections 230 et seq. of the German Commercial Code, HGB) is a traditional form of corporate financing in which an investor – the silent partner – provides capital to an existing company without appearing externally as a shareholder. In legal terms, the silent partner participates in the commercial business of another party (the business owner or the main company) with an asset contribution and in return receives a contractually agreed share of the company’s profits.

The main features of the silent partnership are

• Internal participation, no status under company law: The silent partner does not become a shareholder under company law (e.g. does not hold shares in a GmbH). His position is based solely on the participation agreement. The investor remains anonymous to the outside world; the share capital of the company does not change. The silent partner’s contribution becomes part of the company’s assets, similar to an injection of outside capital.
• Profit (and loss) participation: Typically, the silent partner participates in the profits of the company. He only participates in losses up to the amount of his contribution (i.e. his contribution can be used up by losses, but he is not liable beyond this amount). This structure is known as a typical silent partnership. A more extensive loss participation or participation in the hidden reserves/assets can also be contractually agreed – in such cases, this is referred to as an atypical silent partnership, which can establish the status of a co-entrepreneur for tax purposes (with corresponding consequences for taxation).
• No management authority: The silent investor has no say in the management and is not involved in day-to-day business. However, he has a statutory right of control (§ 233 HGB), which allows him to inspect the books and papers as well as the annual financial statements in order to be able to check the correctness of the profit participation. Depending on the negotiating power, extended information rights and reservations of consent can be agreed in the participation agreement, but in principle the silent partner remains passive. This means for the startup: It does not have to relinquish any voting rights or company shares – a clear advantage over an open participation.
• Contractual flexibility: The silent partnership offers a great deal of flexibility. The term, termination rights, profit distribution key and other rights/obligations can be freely agreed. For example, minimum terms can be defined so that the silent partner does not withdraw at short notice. Arrangements for withdrawal (including compensation for the silent partner) and succession planning can also be agreed individually. It is crucial to balance the interests of both sides – the investor wants an attractive investment and security for his capital, the company wants as much freedom as possible and long-term use of the capital.
• Accounting classification: In the company’s commercial balance sheet, the contribution of a typical silent partner is recognized as debt capital (liability). In economic terms, this is so-called mezzanine capital(a hybrid between equity and debt capital). However, under certain conditions – long-term capital transfer, loss participation, subordination – the silent partnership contribution can be treated as equity in the over-indebtedness test (keyword: qualified subordinated capital, see Section 19 InsO). A silent participation can therefore improve the startup’s creditworthiness without increasing the formal equity ratio (in the narrower sense).
• No direct dilution of voting rights: As the silent partner does not formally become a shareholder, the existing shareholders retain their voting and control rights unchanged. However, the silent partner’s profit share naturally reduces the share of the profit that remains with the other shareholders. In the event of success, the founders therefore “share” the profits with the silent investor, but they do not share the power in the company.

Silent partnerships are interesting for investors if they want to participate in the economic success of the company but do not want any operational involvement or official say. Silent partners can be wealthy private individuals, for example, who have confidence in the founding team and are looking for returns without becoming entrepreneurially active themselves. Institutional investors also use silent partnerships, for example for balance sheet structuring, as they are considered debt capital (and no co-shareholders have to be excluded, for example).

From a legal perspective, it is important to ensure that all key points are clearly regulated in the contract when setting up a silent partnership: Determination and distribution of profits, information rights, duration and termination options, dealing with losses, and exit scenarios (e.g. what happens to the silent partnership contribution if the company is sold or goes public). In addition, the regulations must not lead to the silent partner acting like a real shareholder after all – otherwise there could be a different legal classification in the external relationship (e.g. risk of a sham company). A well-drafted silent partnership agreement prevents such ambiguities.

Important: If a silent partnership is not offered as an individual solution for one investor, but on a larger scale (to a large number of investors), capital market law applies. A publicly offered silent partnership is considered an investment and may require a prospectus (see section “Investments requiring a prospectus”). However, most startup financings use silent partnerships in the form of individual contracts with a few selected investors, so that this issue remains manageable.

Profit-participating loan

An alternative or a middle ground between equity and a traditional loan is the profit-participating loan. “Partiar” means that the interest rate is variable, namely dependent on the success of the business (Latin partiar = to share, meaning a share in the profit). In legal terms, a profit-participating loan is initially a normal loan agreement in accordance with Section 488 of the German Civil Code (BGB): The investor (lender) gives the startup (borrower) a sum of money that must generally be repaid. The special feature, however, is that no fixed interest rate is agreed as remuneration, but rather a profit share.

Characteristics of a profit-participating loan:

• Performance-related interest: In return for his capital, the lender typically receives a percentage of the company’s profit or turnover instead of a fixed interest rate. Example: “The lender receives 10% of the annual profit before tax as interest.” In years without profit, he may receive nothing (no fixed minimum interest rate). This agreement binds the investor and entrepreneur together – the investor benefits from success, but also bears some of the risk of failure, at least as far as the return is concerned.
• Repayment obligation: In contrast to a silent partnership, where the capital can remain in the company for an indefinite period, the repayment of the loan amount is generally fixed (usually at the end of the term or after termination). The startup therefore undertakes to pay out the capital received at a later date. This can be after a fixed term of X years, for example, or linked to an event (e.g. repayment when certain financing rounds are reached or when the company becomes profitable).
• No corporate rights: The lender does not become a shareholder and therefore has neither voting rights nor ownership rights in the company. Its influence is limited to contractually agreed commitments. However, it is customary to grant the lender certain information rights so that it can follow developments (similar to a silent partner or shareholder). Sometimes clauses are also included that oblige the company not to make any risky changes without the consent of the lender (so-called negative covenants), e.g. no further loans of the same ranking, no distribution of profits to shareholders before the loan has been serviced, etc. These are intended to protect the investment, but do not actually occur. These are intended to protect the investment, but are less common in smaller start-up constellations than with bank loans.
• Subordination and qualified subordination: Profit-participating loans are often structured as subordinated loans. This means that in the event of insolvency or liquidation, the lender subordinates its repayment claims to all other (non-subordinated) creditors. This agreement – which must be clearly recorded in writing – means that the loan becomes similar to equity for accounting and insolvency law purposes. In the case of qualified subordination, the lender also declares that it will not demand repayment as long as this would cause the company to become insolvent (over-indebtedness or insolvency). Such a qualified subordination is important in order to be classified as equity substituting under insolvency law. For the investor, this means that he cannot assert his claim if this would cause the company to slide into insolvency – in effect, he waives his money until the company recovers.
• Exit clauses (bonus interest): Start-up loan agreements often contain special agreements for the event of an exit. If the company is sold during the term of the loan (trade sale) or goes public or another valuation jump transaction takes place, the lender receives a one-off bonus (also known as a “kicker”) in addition to its profit share. For example: “If the company is sold before the loan is repaid in full, the lender receives an additional 2% of the proceeds from the sale.” In this way, the lender participates in the increase in value in a similar way to an equity investor, which supplements the repayment claim that is fixed per se. This motivates the investor and can serve as compensation for not holding shares that would increase in value in the event of an exit.

Advantages for the startup: The profit-participating loan offers an injection of capital without the transfer of voting rights. Interest payments are only due if the company is successful (which protects liquidity in the initial period). Due to subordination clauses, it counts economically as so-called economic equity, which can increase the creditworthiness from the perspective of other creditors. It can be agreed flexibly and quickly (no notary, no entry in the register). It can also be attractive from a tax perspective: Interest payments (in this case profit sharing) are operating expenses, whereas dividends to shareholders would not be deductible.

Risks/disadvantages: The startup has an obligation to repay the loan – so at some point there must be sufficient liquidity to pay off the loan amount. This can be a burden during the growth phase if new equity investments or profits are not generated in time. In addition, if the company is very successful, the total amount of profit-related interest payments over the years can be higher than a fixed interest rate would have been (but this is not usually a problem, as there was sufficient profit – although from the founders’ perspective, this is “dearly bought” capital).

For investors, the default risk is high: in case of doubt, they are at the back of the queue, have to bear entrepreneurial risk, but formally do not receive an ownership share. For this reason, profit-participating loans are often used by investors who either trust the founder but do not (yet) want shares, or as an interim solution before a planned later equity round (e.g. to bridge time or wait for a certain development before the valuation is determined).

Legally, it is important to clearly regulate how the profit share is calculated (so that there are no later discussions about which balance sheet items are to be included), and how and when the lender can inspect the books. The subordination clause must be clearly formulated in order to be recognized in the event of insolvency. In addition, such a loan must not be considered a hidden contribution – it must be clear that there is a repayment claim (even if subordinated), otherwise you could end up in the area of investments requiring a prospectus.

As with silent partnerships, if such a profit-participating loan is publicly collected from many investors (e.g. via crowdfunding), the German Investment Act applies. In fact, in the early days of crowdinvesting in Germany, subordinated profit-participating loans were very often granted to the crowd in order to avoid the obligation to publish a prospectus and to avoid creating corporate investment chaos. Small investors received, for example, 1% of the profit per €100 loan plus a bonus interest rate on exit. Due to the crowdfunding rules (§ 2a VermAnlG), this is now permitted within certain limits (up to €6 million), but certain formalities (VIB, investment limits) must be observed.

Summary: The profit-participating loan is a flexible mezzanine instrument that is suitable in certain situations, such as when capital is needed in the short term but a regular investment is not (yet) desired. It bridges the interests of investors and companies, but cannot be a long-term substitute for real equity if the startup wants to grow extremely fast (loans are usually redeemed and converted into equity at the latest in large VC rounds in order to clean up the capital structure).

Subordinated loan (mezzanine capital)

The concept of the subordinated loan has already been mentioned. In principle, any type of loan (profit-participating or fixed-interest) can be subordinated. Subordination means that in the event of insolvency or liquidation, the claim is only serviced after all other creditor claims. Qualified subordination – often agreed in the case of start-ups – also means that the creditor waives the right to assert its claim for as long as it would cause insolvency (over-indebtedness or inability to pay).

Subordinated loans are particularly interesting for start-ups for two reasons:

1. Equity substitution in insolvency law: Under German insolvency law (Section 19 InsO), a qualified subordinated loan can be treated as equity-like in the over-indebtedness test. This means that the company is not considered to be overindebted despite being overindebted on the balance sheet if sufficient qualified subordinated capital is available because these debts are not enforced in the event of an emergency. This gives companies in crisis more time to act without having to file for insolvency. This can be important for young, as yet unprofitable start-ups in order to avoid getting into difficulties due to accounting losses (e.g. research expenses).
2. No deposit business: If a startup were to collect money from many people and promise them a fixed repayment, this would constitute a prohibited banking transaction (deposit business), as only banks are permitted to accept such funds (investor protection). Due to the subordination and the entrepreneurial character (e.g. profit-participating interest), such loans are excluded from the concept of a “deposit”. This is why subordinated loans were popular in the crowdfunding scene: they made it possible to borrow money from the crowd without a banking license, as every investor bears the total risk of loss in the worst case (similar to an equity investment).

A start-up that wants to pre-finance a new product line, for example, could offer a subordinated loan at 8% fixed interest via a platform. The investors know that if it goes wrong, they will only see their money after all the other creditors (probably not at all). Such constructs are risky, which is why, as mentioned, the legislator has limited the sums and requires information sheets.

From a balance sheet perspective, subordinated loans are of course reported as a liability. However, they are often counted as economic equity in ratings or creditworthiness assessments. It can therefore be a positive signal for other investors if founders themselves or related parties provide the company with subordinated funds – it shows trust and cushions the company somewhat against insolvency.

Contract design: A subordinated loan agreement explicitly contains a subordination clause. It often states that the lender’s repayment and interest claim is subordinated “to all current and future non-subordinated claims of other creditors”. The qualified subordination adds: “and as long as and insofar as the repayment/yield payment would give rise to a reason to open insolvency proceedings, there is no claim.” It should also be regulated whether interest accrues during the subordination (usually not, it expires or is deferred) and whether the subordination ceases as soon as the company is restructured.

Practice: Subordinated loans are often provided by existing shareholders or funding institutions. For example, business angels sometimes convert open shareholder loans into subordinated loans in order to give the startup the opportunity to raise new debt capital (banks often require shareholder loans to be subordinated before they grant loans themselves). Alternatively, a founder can transfer his profit claims from a previous company to the new startup as a subordinated loan. Public development loans (e.g. from state development banks) also sometimes have a subordinated character in order to facilitate house bank loans.

For traditional VC investors, subordinated loans are rarely a final solution – they prefer real shares (with all rights). But until a large round comes about, subordinated loans can be a bridging or supplementary instrument.

Differentiation between silent partnership vs. profit-participating loan vs. subordinated loan: These terms overlap, therefore a clarification here:

• A silent partner can participate in profits and losses, but has no guarantee of repayment of his capital (he depends on success and may get nothing back in the event of a loss).
• A profit-participating lender is entitled to repayment of his sum, but the interest is not fixed but dependent on profits.
• A subordinated loan (qualified) can have both silent features (no repayment in the event of a loss) and profit-participating elements (variable remuneration). However, it is primarily characterized by subordination, regardless of whether the interest rate is fixed or variable.

In modern financing terminology, all three are often grouped together under mezzanine capital. What you choose depends on subtleties: There can be differences in terms of tax (profit shares vs. interest), liability (the silent partner bears the risk of loss, the lender doesn’t really except in the event of insolvency), and the motivation of the financier (does he want to get out safely at some point or stay involved for longer?).

Investments requiring a prospectus

As soon as start-ups go beyond the scope of individual negotiations and want to make public offers to potentially numerous investors, they come up against the limits of capital market law. In Germany, the Asset Investment Act (VermAnlG) and the Securities Prospectus Act/EU Prospectus Regulation are particularly relevant here.

Typical cases in which this is affected:

• Crowdinvesting campaigns in which, for example, 500 small investors are asked to invest € 1,000 each.
• Publicly advertised participation rights, silent partnerships or bonds.
• Token sales (ICOs/STOs) to the general public.

The Asset Investment Act considers investments to be, among other things Shares in partnerships (KG, GbR), silent partnerships, profit-participating loans, subordinated loans, profit participation rights, registered bonds and other forms of investment that promise interest and repayment (unless they are securities or investment funds).

Principle of the prospectus requirement: Anyone offering such an investment to the public must first publish a prospectus that has been approved by BaFin (Section 6 VermAnlG). Public means that the offer or corresponding advertising is aimed at a non-individually limited group of people. A notice on a website or a press release on an investment offer is therefore public. A personal conversation or an email only to known investors, on the other hand, would not be public.

A prospectus is a detailed document (often 50-150 pages) that contains all the information about the provider, the investment, business model, risks, financial data, etc. It is intended to protect investors by providing full transparency. It is intended to protect investors by providing full transparency. BaFin primarily checks completeness and consistency, but not the quality of the content of the investment.

Creating a prospectus is expensive (a mid-five-figure sum at least, plus a few months’ time). This is rarely worthwhile for a typical early-stage startup. This is why the legislator has provided for various exemptions to help start-ups and SMEs in particular:

• Private placement exception: Offers that are not public do not require a prospectus. You can therefore address selected investors up to a certain limit. Specifically, the VermAnlG states that it is not a public offer if, for example, you only approach people with an investment amount of at least €100,000 or a total of less than 20 investors (see Section 2 VermAnlG). In practice, this means that a startup can, for example, get 15 business angels on board for every €50,000 invested without a prospectus, provided it approaches them individually (and does not advertise via an advertising campaign).
• Minor limits (Section 2 (1) No. 3 VermAnlG): No prospectus required if fewer than 20 units are offered or the total amount of all units offered does not exceed €100,000 in 12 months or each investor invests at least €200,000. These conditions are alternatives – it is sufficient to comply with one of them. For startups, the €100,000 limit is usually too small, but the “under 20 investors” rule is often useful (this covers many business angel rounds). The €200,000 per investor rule is aimed at professional investors who do not require a prospectus.
• Crowdfunding (Section 2a VermAnlG): There is a special exception to enable crowd investing: in the case of profit-participating loans, subordinated loans, profit participation rights and certain other investments, the obligation to publish a prospectus does not apply up to a total amount of € 6 million per issuer within 12 months, provided that the offer is made via a corresponding internet platform and certain conditions are met. These requirements include in particular Preparation of an investment information sheet (VIB), which comprises a maximum of 3 DIN A4 pages and describes the investment in a comprehensible form; submission of this VIB to BaFin (which only “permits” it without approval); compliance with investment amount limits per retail investor (normally €1.000 per investor, higher only if the investor proves certain income/asset ratios or provides self-disclosure, maximum €25,000 for wealthy investors); prohibition of combined offers (no simultaneous crowdfunding and other prospectus-free offer for the same project). Thanks to this regulation, start-ups can now use legally compliant crowdinvesting without a prospectus as long as they remain under €6 million and go through a registered platform.
• EU Prospectus Regulation and securities: If a startup offers a security instead of an asset investment (e.g. real shares, bonds, or certain tokenized rights that are considered securities), the EU Prospectus Regulation applies. This has its own thresholds: Across the EU, public offerings under €1 million are prospectus-free, and member states are allowed to create national exemptions between €1 million and €8 million. Germany has introduced an option similar to the VIB in the form of the securities information sheet (WIB): Under €8 million, you can use a 10-page information sheet (with BaFin approval) instead of a giant prospectus. This is relevant for share or bond issues by small start-ups. However, startups rarely issue shares publicly before they are big. The WIB was used more for SME bonds.

All in all, this means that If a startup wants to approach many investors (e.g. via an online campaign), it should either use crowdinvesting or strictly observe the limits. If it exceeds these, it must have a prospectus drawn up in good time. Raising money illegally without a prospectus can have serious consequences: BaFin can prohibit the offer, impose a penalty payment, and the contracts with investors would be contestable (keyword: risk of rescission under civil law). In addition, you may be liable (prospectus liability if information was made public and investors trust it without a prospectus).

In practical terms, this means that founders are better off limiting themselves to private financing rounds in the early phase. Public appeals such as “Everyone invest in our startup!” are taboo without a prospectus. For crowdfunding projects, you should use established platforms (which are familiar with the process and ensure that the legal requirements are met). And if the business model requires a broad public to become an investor at some point (e.g. in the case of a large financing round with many participants or if you want to enable customers to participate), you have to factor in the expense of a prospectus and consult the relevant experts (capital market lawyers).

In recent years, some start-ups have used workarounds, such as issuing profit participation rights in excess of €8 million via a securities information sheet, or have looked abroad (for example, by passporting a vehicle prospectus in Luxembourg or Liechtenstein). However, such approaches are complex and are usually only worthwhile for larger sums.

To summarize: Capital market law somewhat restricts the free choice of financing forms when small investors come into play. Those who focus on professional investors practically do not have this hurdle. However, anyone who wants to use the crowd or the free market as a source of capital must fulfill transparency obligations. With appropriate preparation, however, this can also be an opportunity – for example, to attract attention and customer loyalty (often a side effect of crowdfunding) in addition to capital. A prospectus can also emphasize seriousness, as it is certified; the downside is the costs and liability risks in the event of incorrect information.

Tokenized investments via blockchain

A modern phenomenon in recent years is the tokenization of company shares or forms of investment. Investors’ rights (e.g. profit entitlements, voting rights or bonds) are represented in the form of digital tokens on a blockchain. The best-known example is the initial coin offering (ICO), in which a company sells its own digital tokens to raise capital. Depending on their design, such tokens can be structured as pure usage rights (utility tokens) or as an investment (security tokens).

From a legal perspective, it is crucial that although a token is technically new, economically it usually corresponds to an already known financial instrument. This means that – depending on the classification – the same regulations may apply as for conventional investment products.

Security token (security token)

If a token securitizes membership rights (similar to shares), bonds (repayment claim and interest) or profit participation rights, BaFin treats it like the respective traditional instrument. This means the following in particular:

• Prospectus requirement: If the security token is a publicly offered security or an asset investment, the requirements of the prospectus laws (Securities Prospectus Act/EU Prospectus Regulation or Asset Investment Act) apply. A comprehensive prospectus is required unless one of the statutory exceptions (e.g. private placement, small investor exception) applies.
• Licensing requirements: If tokens are classified as financial instruments, there may be licensing requirements for certain activities – such as custody, trading or brokerage – for example, a crypto custody license or permission to operate a multilateral trading facility (MTF).
• Classification as an asset investment: BaFin clarified early on that a token that guarantees holders a share in the profits of a company can legally constitute an asset investment (e.g. in the form of a profit-participating loan or a silent partnership). In the case of public placement, a sales prospectus must be approved for this.

Utility Token

If a token merely grants its buyer the right to use a product or platform (e.g. as a voucher or means of payment for a future service) without the expectation of a return as with a traditional security, it may fall outside the strict financial market regulation. However, caution is required here:

• Actual use vs. investment character: As soon as a “utility token” is purchased primarily for speculative reasons or strongly resembles an investment in its economic structure (e.g. through expected value appreciation or distributions), the supervisory authority is more likely to classify it as a security token.
• Clear presentation in the whitepaper and contract: In order for a utility token to be legally valid as such, it should be clearly documented that it provides the buyer with a concrete utility value and that no profit sharing or comparable property rights are linked to it.

Legal development: eWpG and MiCA

In Germany, the legislator has taken a first step with the Electronic Securities Act (eWpG) to enable the tokenized issuance of bonds (and, in the future, other securities) without the usual creation of certificates. At EU level, the new Markets in Crypto-Assets Regulation (MiCA) is intended to ensure uniform regulation and create legal clarity.

MiCA and other reforms (e.g. extension of the eWpG) are also expected to better regulate tokenized shares. This increases the chance that founders and investors will be able to implement security token offerings (STOs) with legal certainty in future – albeit in compliance with all regulatory requirements (prospectus obligation, transparency requirements, etc.).

Opportunities and risks

The advantages of tokenized participation lie in the potentially fast and global approach to investors, the possible tradability of tokens on corresponding secondary markets and the innovative community involvement (e.g. direct co-determination by token holders).

On the other hand, there are risks and hurdles:

• Regulatory uncertainty: The classification of a token may change if its functions or marketing practices change.
• Licensing requirements and prospectus liability: Violations of prospectus or licensing requirements can lead to prohibitions, fines and claims for damages.
• International compliance: A global token offering triggers its own regulatory requirements in many countries (e.g. SEC in the USA, BaFin in Germany). This increases the coordination effort and the costs for legal advice.
• Technological risks: Smart contract errors, security gaps or market volatility can lead to significant losses in value and damage investor confidence.

Conclusion

Blockchain technology opens up new ways for innovative companies to raise capital. However, tokenization is by no means a substitute for thorough legal protection and careful structuring of the financing. For founders planning an ICO or STO, it is highly recommended to obtain specialized legal advice and to check the prospectus obligation as well as any licensing requirements at an early stage. Close coordination with the supervisory authorities and a transparent structure (e.g. in a white paper) are essential in order to avoid legal violations and subsequent liability risks.

Despite all the challenges, tokenized financing can be a complementary option to traditional venture capital or private placement rounds – provided it is designed in a legally compliant manner and embedded in the overall concept in a meaningful way. This is the only way to exploit the potential of blockchain technology without putting the company at risk.

Excursus: Differentiation and combination of forms of participation

In practice, start-ups sometimes combine several financing instruments in order to meet the respective needs. For example, a convertible note can combine elements of a loan with the option of later equity participation – this enables investors to initially act as lenders and later exchange them for shares if successful. Such hybrid forms are particularly popular in an international context (e.g. SAFE agreements in Silicon Valley), as they allow quick deals without an immediate company valuation.

From a legal perspective, it is important to clearly define when and how the change in legal nature takes place in the case of hybrid agreements (e.g. automatic conversion of the loan into shares at the next capital round on defined terms). In Germany, for example, GmbHs must be careful to structure SAFEs or convertible loans in such a way that the subscription rights of existing shareholders are preserved or effectively excluded (in order to be able to carry out capital increases that are contestable). Similarly, an ESOP (employee stock ownership plan) – often implemented as a virtual stock ownership plan (VSOP) – must not unintentionally overlap with the rights of investors. These cross-cutting issues show: The architecture of the financing needs to be planned holistically. Each additional instrument (be it a subordinated loan, a token or an option program) should be integrated with a view to the big picture, so that in the end no component contradicts the other.

Now that the common models and their legal cornerstones have been explained, we turn to the differences between German and international investor law, as well as the specific challenges of certain industries and business models.

Differences between German and international investor law

Startups with international ambitions or investors quickly come up against different legal cultures and regulations. Two key areas should be highlighted here: Firstly, the differences in the regulatory treatment of financing (such as BaFin vs. US SEC requirements) and secondly, the differences in corporate law (German legal forms vs. international corporate structures). These aspects influence how financing rounds are structured and contracts are drafted.

Regulatory law: BaFin vs. SEC and Co.

Germany (BaFin): As stated above, BaFin places importance on prospectus requirements for public offerings and licensing requirements for certain financial services. In principle, start-ups in Germany can negotiate freely with professional investors as long as there is no public advertising. The prospectus requirement is primarily intended to protect small investors. BaFin is relatively strict in this regard and can take severe measures (fines, prohibitions) in the event of violations. Nevertheless, with the exemption rules (20 investors, crowdfunding up to €6 million), Germany has created mechanisms to enable startup financing without excessive bureaucracy.

USA (SEC): In the USA, the legal situation is structured somewhat differently: Under the Securities Act of 1933, any offering of securities must be registered (i.e., filed with the SEC with a prospectus) unless an exemption applies. The most commonly used exemption is Regulation D Rule 506(b), which allows unlimited amounts to be raised from accredited investors (e.g. high net worth individuals, professional investment firms) without a prospectus as long as no public solicitation is made. Up to 35 non-accredited investors would also be permitted, but in practice this is usually waived. A variant, Rule 506(c), even permits public advertising, but then requires verification of the accreditation of each investor. There is also a crowdfunding rule in the USA (Reg CF), which serves similar purposes to Section 2a VermAnlG, but is also limited in terms of amount (currently approx. $5 million per year).

For a German startup with US investors, this means that if it wants to involve US investors (such as business angels from Silicon Valley), it must ensure that it does not appear as an unregistered offering in the US. In practice, such investors will also be involved via a Reg D-compliant private placement – in other words, you limit yourself to accredited US investors and ensure that there is no general advertising in the USA. Many startup financing rounds include appropriate clauses in the subscription agreement in which the investors confirm that they are accredited and that there is no public offering.

Another difference: The SEC (unlike BaFin) does not recognize a concept such as the investment information sheet. Either you prepare a complete Offering Prospectus or you operate under the exceptions mentioned above. However, US prospectuses are particularly relevant for IPOs and SPAC deals; private placement exemptions are almost always used in the pure startup VC area.

Europe and other jurisdictions: Many countries have their own peculiarities – e.g. the UK Financial Conduct Authority (FCA) approach is similar to the European one, but has higher thresholds for prospectus exemptions post-Brexit, for example. Switzerland also has a prospectus requirement with exceptions (which largely correspond to the EU rules). For internationally active start-ups, it is worthwhile to carry out a jurisdiction-by-jurisdiction analysis of where potential investors are located and how to approach them in a compliant manner.

Licensing requirements: In addition to prospectuses, there is the issue of licensing: Anyone who brokers financial investments as a platform, for example, needs a license in Germany (financial investment broker in accordance with Section 34f GewO or as a securities institution). Broker-dealer registrations are required in the USA. A self-directed startup rarely becomes a financial service provider itself, but if it distributes its own tokens internationally, for example, it can get into gray areas (is this considered securities trading?). The legal systems differ here too. The USA considers some tokens to be securities, the SEC takes aggressive action against unregistered crypto exchanges and issuers. Germany has specifically regulated crypto (crypto custody as a financial service, etc.). Overall, international financing projects must be multi-compliant, i.e. comply with the strictest requirements or exclude the respective market.

To summarize: In Germany, the legal framework for startup financing is well balanced, with clear – albeit strict – lines between private rounds and public offerings. Internationally, founders need to know these lines for each country. Especially for larger rounds with international funds, this is usually done with professional support (every larger VC fund knows the SEC rules, etc.). The challenge lies more with innovative models (such as cross-border crowdinvesting or token sales), where you are entering uncharted territory. Here, startups should not try to fly “under the radar”, but should consciously decide which legal system should apply and, if necessary, limit offers geographically (e.g. consistently exclude US persons in order to avoid risking trouble with the SEC).

Company law: German legal forms vs. international structures

In addition to supervisory law, the legal form of the company plays an enormous role in how investors can be involved. A German founder typically starts with a GmbH or Unternehmergesellschaft (UG). In the USA, on the other hand, the standard for scalable start-ups is the Delaware C-Corporation. British Ltd. or the French SAS are also examples of foreign corporations with their own rules. These differences have the following practical effects:

• Minimum capital and formation costs: A GmbH requires €25,000 share capital (UG only €1, but then without the full rights of a GmbH). An AG even € 50,000 and complex formation formalities. A Delaware corp can be founded with very little capital (e.g. 1,000 authorized shares with a par value of $0.0001) and is registered within one day. The lower initial capital makes US start-ups easier and faster – which is why some German founders move their incubator/growth vehicle to Delaware to make it easier for investors to get started. However, the GmbH enjoys a high level of trust among German investors and is standard in this country.
• Share transfers and capital increases: In the case of a GmbH, shares are not freely transferable without further ado – every sale requires notarization and every new shareholder must be entered in the list of shareholders. Capital increases require shareholder resolutions (75% majority) and also a notarized process with registration in the commercial register. This makes frequent financing rounds time-consuming. In contrast, a Delaware corp can issue new shares relatively flexibly: as long as it is within the scope of the authorized capital, the Board of Directors decides on the issue and updates the cap table. No notary or state registration is required for each change (only annual franchise tax filings, etc.).

  Transferability also differs: GmbH shares can only be transferred contractually with consent (restriction on transferability) or pre-emption rights apply under the articles of association; in an AG/Corp, shares are generally freely tradable (unless there are separate lock-up agreements). For startups looking to exit through share sales or employee ownership, a share-like structure may be more advantageous. Therefore, growing startups often consider the change of legal form (GmbH -> AG) or the so-called Delaware Flip (the formation of a US holding company over the GmbH).

• Preferential rights and share classes: German GmbHs have no share classes in law. It is possible to grant different shares with different rights, but this requires very detailed regulations in the articles of association and leads to a confusing structure. In practice, German start-ups make do by keeping all shares the same and granting investor-specific rights via a shareholders’ agreement. In a US corp, it is common for investors to receive preferred stocks that enjoy special rights under the articles of association (liquidation preference, anti-dilution, voting majorities in certain decisions, dividend preferences, etc.). These rights are firmly anchored in company law and form part of the security. In a GmbH, on the other hand, the rights given in the ancillary agreement only apply under the law of obligations between the parties. In the event of a conflict, it can be more difficult to enforce such rights (e.g. a veto right in the contract does not formally prevent a capital increase from being entered in the commercial register – but it does give rise to damages if unjustified). This increases complexity as the number of investors increases.
• Corporate governance: A GmbH has one or more managing directors and the shareholders’ meeting as the decision-making body. There is no mandatory supervisory board in small GmbHs. This means that investors who do not become managing directors often remain dependent on indirect control (reservations of consent in the shareholders’ agreement for certain management measures). In an AG or Corp, there is a board of directors/supervisory board on which investors can take seats to participate directly in monitoring. Many international investors prefer these clear structures as they give them a formal say. In response to this, some larger German start-ups have voluntarily installed advisory boards or have even become a stock corporation (AG) in order to be able to set up a management/supervisory board, for example, which is made up of investor representatives. Legally, the AG also offers the possibility of issuing preference shares without voting rights, for example, or of placing new shares more easily – which is why the AG form is often chosen shortly before an IPO or a larger VC round. However, the administrative costs of an AG are higher (general meeting obligations, auditing, etc.).
• Minority protection: In Germany, even a stake of 25% + 1 share in a GmbH or AG confers a blocking minority for resolutions to amend the articles of association (because 75% is required for this). This means that a large investor with more than 25% can block important decisions. In US corps, there is typically no statutory blocking minority; instead, protective provisions are defined in the investment agreements, which actions are only permitted with the approval of the majority of preferred shareholders (e.g. amendment of the articles of association, issue of new shares, sale of the company, etc.). In fact, both amount to similar protection, but the German system grants certain rights automatically, whereas the US system is more contractually differentiated (e.g. different veto rights may apply between different investor rounds – Series A vs Series B). For founders, this means that in Germany they must ensure that they clearly agree with a major investor (25%+) when they will use their blocking minority. In the US case, they have to negotiate which vetoes he explicitly receives.
• Employee share ownership (ESOP/VSOP): As already briefly mentioned, the implementation of employee share ownership in a GmbH is difficult. In the USA, a corporation can issue stock options to employees relatively easily, which – if exercised – simply extend the cap table. In a German GmbH, every new employee would be accepted as a co-partner, which is impractical. This is why German start-ups resort to virtual shareholdings (VSOPs): employees receive a bonus under the law of obligations as if they held X% of the shares in the event of an exit. This structure does not dilute the real shares and does not require any changes to the register. Disadvantage: Employees have no real shareholder rights in the meantime and only a promise of payment. International investors usually accept VSOPs, but require that these pools are clearly defined (e.g. 10% virtual pool) and are taken into account in the event of an exit before the purchase price is distributed. In US settings, it is common to set up the ESOP before a round so that investors are not affected by subsequent dilution. In Germany, the VSOP is also often factored in pre-money, but the mechanics are different. This can be a hurdle for globally active teams: they have to manage two systems in parallel (VSOP for German employees, real options via a subsidiary or similar for any US employees). Foresight is required here – you might consider setting up a parent company abroad in due course, through which a uniform stock option program runs.
• Tax aspects and exitability: Investors also consider how tax-efficient an investment is. Germany, for example, has the “partial income method” of taxation for capital gains from GmbH shares (60% taxable) and certain add-backs for free float dividends, etc. The US has different rules. Different rules apply in the USA. For foreign investors, it can sometimes make sense for a German startup to have a foreign holding company, e.g. to avoid double taxation on dividends or to have a clear jurisdictional affiliation in the exit (many VCs have clauses that portfolio companies must be in Delaware for a US IPO). This explains why some of the biggest German successes ended up as US entities (example: many Berlin startups set up a Delaware Inc. early on to raise money in Silicon Valley). The so-called “Delaware flip” is now a well-known procedure: The shares of the German GmbH are transferred to a newly founded US corp, the investors join the corp, and the GmbH remains as an operating subsidiary in Germany. This can be tax-neutral for the founders if structured correctly, but requires competent tax and legal advice. It should also be borne in mind that reciprocal foreign relationships (US parent, DE sub) increase compliance costs (two sets of accounts, consolidated financial statements, legal coordination, different employee rights for employees in different countries, etc.).

To summarize: German company law offers reliability and strong creditor protection (through share capital, notarial control), but can be somewhat inflexible for very fast-growing, internationally financed start-ups. International investors are more familiar with their domestic structures, which is why they often insist that a startup adapts to them – be it by choosing a standard international legal form or a corresponding contractual simulation in the GmbH. Founders should be aware of these differences and weigh them up early on: If primarily German capital is coming in, you can work well with the GmbH. However, if you are aiming to reach well-known US investors or an IPO overseas, it may be worth setting up an appropriate structure in good time. The costs and benefits must be weighed up; not every ten-person startup needs to implement a dual holding structure immediately. An experienced legal advisor can often show you how far you can get with the existing setup and at what point (e.g. Series B financing with the participation of a US fund) a change is advisable.

Challenges in raising capital for research-intensive and internationally scaling start-ups

Not all start-ups are the same: business models with a high need for research and development and those that are conceived globally from the outset face special financing problems. Here, legal and economic strategies need to be adapted in order to find suitable investors and achieve the company’s goals.

Early-stage, research-intensive start-ups (deep tech, AI, SaaS)

Start-ups in the fields of artificial intelligence, biotechnology, hardware development, cleantech or deep tech in general often have long lead times before their product is ready for the market and profitable. This means that

• High capital requirements before market entry: considerable sums often have to be invested in development, prototypes, laboratories, tests or certifications before sales can even be generated. A classic example: an AI startup develops a new machine learning architecture – it needs expensive specialists, computing capacity and perhaps data partnerships, all costs, but the paying customer only comes into play much later. Start-ups like this are dependent on early investors who believe in the vision and are prepared to provide financing for years. In Germany, publicly co-financed investors often step in here (e.g. High-Tech Gründerfonds, which works with state funds, or strategic investors from industry). Funding programs such as EXIST (start-up grant) or the research allowance (R&D tax subsidy) also play a role. Founders should systematically exhaust all funding opportunities: from state start-up grants to EU funding projects (Horizon Europe) and sector-specific grants (e.g. from the BMBF for biotech). From a legal perspective, it must be ensured that the acceptance of such funding does not lead to conflicts with later investors – for example, funding conditions (earmarked use, publication obligations, etc.) must be disclosed and should not be so restrictive that they hinder commercialization.
• IP rights and patents: In high-tech start-ups, the question of patent protection and intellectual property arises immediately. On the one hand, patents are attractive to investors because they create barriers to entry for competitors and make the company more valuable (studies show that start-ups with strong patents receive capital more easily). On the other hand, patents cost time and money, which can be a burden for the young company. This is where an IP strategy needs to be developed: Which inventions do we register? Where (only national, European, international)? How do we finance patenting (is there WIPANO patent funding, for example)? And most importantly: Who owns the rights? – Deep-tech start-ups often cooperate with universities or use results from previous research projects. Founders must ensure that all essential IP rights belong to the company: Through inventor transfer agreements, clarity in cooperation agreements with universities (keyword: university inventions), and agreements with employees/freelancers (every line of code, every prototype created for the startup must legally belong to the startup). Failures here can later become deal-breakers in due diligence reviews.
• Investors’ staying power: A VC fund typically has an investment horizon of 5-10 years. Deep-tech projects can go beyond this time frame. This is why specialized investors often come into play here, such as corporate venture arms (large corporations that invest strategically and can wait longer) or family offices that are not tied to fund terms. Public investment companies (such as the European Innovation Council EIC Fund) are also involved. For founders, this means that the search for investors must be even more targeted: Not every classic VC is suitable, but perhaps new financing paths (a combination of subsidies, angels, strategic partners and individual VC investments). Contract design can be more flexible here: strategic investors may want exclusive licenses or pre-emptive rights to results – you need to prepare for this and weigh up whether to grant such rights or prefer to seek pure financial capital.
• Cooperation instead of exit: In research-intensive areas, the exit is often a sale to a large corporation (trade sale) because an IPO is unrealistic at an early stage. This influences the financing: investors know that an industrial group will probably buy in the end, possibly even a strategic partner that is already involved. This can lead to conflicts if an investor wants maximum valuation but the partner wants to take over at a favorable price. Transparent governance can help here: for example, disclosing if there are already non-binding expressions of interest, or clearly regulating whether a strategic investor may later increase its commitment (rights of first refusal for existing investors vs. drag-along for a sale to a third party, etc.). Legally, such scenarios must be addressed in the investment agreements so that there is no stalemate between different investor interests in an emergency.
• Regulatory uncertainty: Research often also means uncharted territory in a legal sense. A medtech startup faces medical device laws, while an AI startup may have to keep an eye on data protection and future AI regulation (EU AI Act). These uncertainties make investors nervous. Founders should show that they take compliance seriously: for example, obtain clinical advice early on, draw up a regulatory roadmap and address ethics and data protection issues with experts in the case of AI. In this way, you can signal to investors that the legal risks are manageable.

Internationally scaling startups

For companies whose product or service is designed for global scaling from the outset (e.g. a social media app, a SaaS tool with a global target market, or an eCommerce marketplace with an international community), financing is doubly challenging: you need money not only for product development, but also to conquer several markets in parallel.

Challenges and solutions:

• Early expansion vs. focus: Investors are often ambivalent: On the one hand, a startup should grow quickly internationally, but on the other hand, too early an expansion drive is also viewed critically (“Focus on your core market first!”). Founders need to present a convincing roll-out plan. For example: first validate the DACH region and generate sales, then expand to the UK and France with Series A financing, later the USA with a strategic US investor in Series B. These phases should be taken into account in the financial models. The timing of the capital rounds must match the market entry costs. Legally relevant: With every market entry, license agreements, establishment of branches and local compliance must be considered. This not only costs money, but also requires foresighted planning (e.g. registering trademarks in the target markets in good time, securing domains, understanding local labor law, adapting terms of service to the respective law if necessary).
• International fundraising: A globally oriented startup will also try to attract international capital. This means pitch decks in English, presence in startup hubs (San Francisco, London, Singapore depending on the industry), participation in accelerators abroad, etc. Legally, the startup must then be “investor-ready” according to international standards be. This includes, for example, that the cap table is understandable and clean (no complicated silent partnerships that a foreign investor cannot classify), the IP is clarified (otherwise US investors in particular will quickly shy away), and the company structure may already be designed in such a way that a foreign investor can easily invest in it (see above, possibly a holding company in an investor-friendly country). Often Convertible instruments used to synchronize different investors: e.g. a German angel invests in euros via a convertible loan, a US angel invests in dollars via a SAFE – both then convert into the respective shares at the same conditions in the next equity round. In this case, the documents must be drawn up in such a way that they fit together and can be synchronized at the next round there is no chaos.
• Currency risks and financial flows: An internationally operating startup can generate income in different currencies and have expenses in different countries. This requires financial planning that takes exchange rate fluctuations into account. For investors who invest in a specific currency (e.g. euro), it is interesting to know how the company manages currency risks. Although this is more of a business management task, it can also be contractually taken into account, for example by defining certain milestones in EUR or by adjusting exchange rates when recalculating an investment tranche. In addition, a startup must ensure that capital flows between different national companies are structured correctly for tax purposes (transfer pricing, license fees, etc.), which is particularly relevant when investors are located in the holding company and sales are generated in the operating subsidiaries.
• Legal fragmentation: Each country has its own legal rules: Consumer protection, tax law, reporting obligations where applicable (e.g. register for foreign direct investments). For example, if a startup operates an online platform in the USA, it may be subject to the CCPA (California Consumer Privacy Act) in California if it has X number of users; in Europe, of course, it would be subject to the GDPR; in Brazil, there would be the LGPD, etc. In terms of financing, this means you may have to budget money for legal advice in several jurisdictions. Investors will ask: “Do you have everything under control legally when you launch in country Y?” – a smart answer would be that you already have an international law firm on board or an internal compliance structure in place.
• Company structure: For international activities, start-ups often establish subsidiaries in important markets (e.g. Inc. in the USA as a sales unit, Ltd. in the UK for customers there). Alternatively, they work with local distributors or partners. Depending on the model, this can have an impact on financing: Investors usually invest in the parent company; it should be ensured that this parent company holds all rights to the foreign activities (e.g. via 100% subsidiaries or contractual arrangements with partners). If local co-investors are included in a market (e.g. a joint venture in Asia with a local investor), coordinated shareholder agreements are required so that control over the entire group is not lost. Such structures are highly complex and require intensive legal support. Some start-ups avoid this by operating internationally centrally from one country (e.g. everything via the German GmbH, without local units). This is simple in terms of structure, but can be limited in business terms (hiring employees abroad is difficult, local customers may want a local contractual partner). Investors generally prefer a clear, stringent group structure where they know that their money will flow into the holding company: Their money flows into the holding company and from there into all markets in a controlled manner, without outside influences.
• Cultural differences and investor relations: The expectations of investors can also vary internationally. A US investor might expect more aggressive growth (“Go big or go home”), while a German investor might pay more attention to efficiency and an early break-even. If both sit at the cap table, the founding team must be very skilled communicators in order to create a common understanding. In the shareholders’ agreement, different ideas about e.g. liquidation preferences or exit timing can clash – a compromise is required here (perhaps a graduated liquidation preference that meets both US and EU standards). Good stakeholder management and transparent communication help to prevent conflicts from arising in the first place.

Conclusion in this area: A start-up with a global focus needs a capital strategy that is as international as its business model. This means that financing rounds should fit in with the internationalization roadmap, the contracts must be internationally compatible and the corporate structure must allow for growth in several countries. From a legal perspective, it is advisable to draw up standard contracts early on that can be used flexibly – e.g. a master participation agreement with modular clauses for different types of investors, or standard contracts for sales partners that can be adapted for each new market. This avoids having to start from scratch every time and creates trust among investors, who see that professionalism and scalability are anchored in the company.

Specifics of the games and eSports industry in Germany

Finally, we will take a closer look at two closely related sectors that are part of the digital economy but have some unique characteristics: the computer games industry (games) and eSports. Both are characterized by rapid growth and a high level of public attention – but in Germany in particular, specific challenges have emerged in terms of financing and the legal framework.

Investor climate and financing in the games industry

Germany is a large market for the consumption of video games, but for a long time it was not an easy place for developer studios and games start-ups. Private venture capital held back. Reasons for this included:

• Reputation as a hit-or-miss industry: Game development was considered volatile – a game could be a million-dollar hit or a flop. Many investors shied away from this risk, especially as they often had little understanding of games as a product (the necessary industry expertise was lacking). The situation is different in countries such as the USA, Japan, South Korea and Canada, where there are a number of investors specializing in games.
• Small scene of business angels: In Germany, there were only a few well-known investors who invested in games start-ups. Some exceptions, such as Förderbank-invest### Investor climate in the games sector (continued)

Development bank-financed funds and individual family offices stepped in in individual cases, but the overall volume of venture capital remained low. Many studios therefore resorted to publisher models: instead of selling shares, a publisher finances the development in return for later revenue shares and assigned exploitation rights (IP rights to the game). In legal terms, license and production agreements dominate, but not a classic participation agreement. As a result, the studio receives money without giving up shares, but in some circumstances relinquishes control over the project. This can be a serious restriction for founders – especially if the publisher influences creative decisions or takes control of sequels to a game series. It is therefore important to consider whether this form of financing is preferable to giving up company shares.

In order to improve the situation, the German government introduced federal computer games funding in 2019, which has since supported numerous projects with grants (around 50 million euros are now available annually). This non-dilutive funding helps to ensure that more prototypes and games “Made in Germany” can be realized. However, the demand was so great that the funds were exhausted at times (there was a temporary application freeze in 2023). The funding is not a substitute for private capital, but increases the attractiveness of studios for investors, as the financial risk per project is reduced and a proof of concept already exists.

Despite such progress, the investor climate in Germany remains cautious. Industry experts note that German developers are often reluctant to seek funding with a mere idea, while international competitors are more courageous in “selling” their vision and receiving capital in return. A change is slowly taking place here: Successful exits (sales of German games start-ups abroad) are giving rise to a generation of financially strong industry insiders who are investing back as business angels. The scene is also becoming more networked – initiatives by the game association or special investor meetings (e.g. Gamesweek in Berlin) are creating visibility.

For a games startup in Germany, all of this means that a clever financing strategy combines various building blocks – public funding, crowdfunding/community support, publishing deals and, where possible, private equity. From a legal perspective, care must be taken to coordinate the various contracts: For example, funding conditions (e.g. earmarking of funds) must not conflict with the rights of a publisher. Similarly, profit or revenue shares of a publisher must be compatible with any claims of crowd investors or silent partners. Careful contract drafting and coordination between the parties involved are essential here in order to avoid conflicts.

Special challenges in the eSports sector

The eSports sector faces similar financing problems in some cases. Professional eSports teams and leagues require capital for player salaries, infrastructure and tournament participation. Traditional income (sponsorship, media rights, prize money, merchandising) is often not enough to finance steady growth. However, many investors are hesitant because eSports companies are difficult to value: Their most important “assets” are the players and the fan community; there are hardly any intangible assets as in games development (e.g. own IP). In addition, the legal recognition of eSports is still in flux – eSports is not (yet) recognized as a sport in the sense of an association in Germany. As a result, there is a lack of non-profit structures for popular sports, for example, which makes public funding more difficult and denies tax benefits (such as those enjoyed by traditional sports clubs).

Although well-known investors and celebrities have joined eSports teams in recent years (for example, Bundesliga soccer clubs have been involved in eSports for a while, or tech companies have invested in eSports start-ups), the scene remains heavily reliant on sponsorship and strategic partnerships. The structure of many eSports organizations is more similar to media companies or event organizers than classic startups. Accordingly, financing often comes from the media and entertainment industry or through cross-financing of existing companies, rather than from independent venture capital funds.

Legal innovations, such as the eSports visa introduced in 2020 (which facilitates the immigration of foreign professional players) or the gradual integration of eSports into existing sports funding mechanisms, show that the framework is slowly improving. However, there are still uncertainties, e.g. regarding the labor law classification of players (they are often hired as freelancers, which can be tricky in terms of social security law) or in the area of compliance (topics such as doping controls, match-fixing prevention, youth protection for young eSports players).

For investors, such unresolved issues are risk factors. At the same time, the rapid global popularity of eSports offers enormous potential – the number of spectators and sponsorship funds is continuously increasing worldwide. Some investment funds specifically focused on eSports/gaming (such as the globally active BITKRAFT Ventures, founded by a German industry pioneer) are already investing in start-ups along the value chain: from analytics platforms and coaching apps to tournament organizers. This development also benefits local founders, provided they have internationally oriented business models.

An eSports founder in Germany should carefully examine which financing method suits their concept. Strategic alliances with established sports or media companies can often make more sense than an early hunt for VC money. If venture capital is sought, it is advisable to approach specialized funds or foreign investors who understand the eSports economy. The legal foundation must be solid in any case: contracts with players should regulate both commitment and exit clauses (for transfers to other teams), licenses with game publishers (for league operations) must be secured, and trademark rights (team name, logos) must be protected. This homework creates trust and professionalism – essential prerequisites for improving the initially skeptical investor climate.

Conclusion

This article has made it clear that legal pitfalls and strategic considerations go hand in hand when it comes to startup financing. Forward-looking legal planning enables the founding team to retain their entrepreneurial freedom and at the same time provide investors with the necessary framework for their involvement. There is no one-size-fits-all solution that applies equally to all start-ups – industries, business models and growth plans are too different. Nevertheless, one thing is clear: The best time to take on investors is when the startup has developed its potential on its own strength to such an extent that there is a realistic valuation and negotiating position, but still in good time before bottlenecks occur so that fresh capital can be used effectively for the next growth spurt.

Founders would do well to familiarize themselves with the various forms of investment at an early stage and critically weigh up which structure suits their objectives. Whether a flexible silent partnership, a performance-based loan, a classic equity round or an innovative token model – each option has specific legal consequences for control, liability, regulation and tax burden. A deeper understanding of these mechanisms makes it possible to act at eye level in dialog with investors. For example, anti-dilution clauses or veto rights can be designed proactively and fairly instead of experiencing unpleasant surprises later on.

Especially when jumping into international waters – be it through foreign investors or the development of global markets – start-ups should consider the different legal systems. The requirements of BaFin and the SEC, the differences between a German GmbH and a Delaware corp or the variety of local regulations in target markets determine how smoothly a company can scale. Here it pays to choose legal structures that facilitate growth and further financing rounds in the future. A forward-looking conversion to a suitable holding company or early implementation of international compliance standards can save costly detours later on.

Last but not least, a look at specialist sectors such as games and eSports shows that sector-specific factors always play a role alongside the general rules. Successful founders know their ecosystem inside out: they know where there are funding opportunities, what customs investors expect in this area and how to counter any reservations. They combine this knowledge with solid legal protection – with contracts that protect intellectual property, financing agreements that allow creative leeway and structures that also endure in the event of later exits or restructuring.

In conclusion, it can be said that law is not an annoying obstacle in the start-up context, but a tool for shaping sustainable growth. Those who understand the legal framework and use it skillfully will give their company a head start in the competition for capital. The trick is to reconcile entrepreneurial vision and legal reality. This requires the courage to negotiate and shape – for example, to develop new forms of financing or contractual constructs – as well as the wisdom to seek specialized advice on complex issues. The support of an experienced IT lawyer and start-up consultant can make a decisive contribution to avoiding mistakes and implementing solutions that are sustainable in the long term.

Prepared in this way, founders can confidently enter into discussions with investors in the knowledge that they are presenting their company as both commercially attractive and legally robust. For their part, investors appreciate it when start-ups have professional structures and the common rules of the game are clearly defined – this creates trust and lays the foundation for a successful partnership.

All in all, taking on investors is not a single event, but a process that requires planning, adaptation and a willingness to compromise. Startups that approach this process in a strategic and legally sound manner increase their chances of not only obtaining capital, but also effectively converting it into sustainable growth. With the right timing, the right form of investment and a clear understanding of the legal framework, the challenge of finding investors becomes a great opportunity – namely to take your own company to the next level without losing your own identity and control.