Legal preparation for the first investment round

As a lawyer who has accompanied numerous start-ups through their first financing rounds, I can say that legal preparation is often the key to success. Careful legal structuring can make the difference between a successful deal and a stumbling block to further growth. In this blog post, I would like to highlight the most important legal aspects that startups should consider before their first investment round.

The right legal form as a foundation

Choosing the right legal form is of fundamental importance for start-ups planning an investment round. In practice, the GmbH has emerged as the preferred legal form. It offers a clear structure, limited liability and is known and accepted by investors. Alternatively, the UG (haftungsbeschränkt) can also be considered for very young start-ups, which requires less share capital.

The articles of association should be thoroughly reviewed before an investment round and amended if necessary. Particular attention should be paid to the following points:

– Clear rules on profit distribution and loss participation
– Provisions on the transfer of shares
– Rules on the withdrawal or death of a shareholder
– Non-competition clauses and confidentiality obligations
– Rules on management and representation

Term sheet: setting the course for negotiations

The term sheet is the first formal step towards the investment. It sets out the main features of the transaction and serves as the basis for subsequent contract negotiations. Typical contents of a term sheet are

– Valuation of the startup (pre-money valuation)
– Amount of the investment and resulting participation quota
– Liquidation preferences
– Anti-dilution protection
– Information and control rights of the investor
– Vesting regulations for founder shares

Although the term sheet is generally not legally binding, it should be negotiated with great care. The agreements made here form the basis for the subsequent contracts and are often difficult to revise.

Due diligence: preparation is everything

Once the term sheet has been signed, the investor will usually carry out due diligence. All relevant aspects of the start-up are examined – from finances and legal structures to technical details. Good preparation can speed up this process considerably and strengthen investor confidence.

Typical audit areas in due diligence are

– Corporate structure and documentation
– Intellectual property and industrial property rights
– Employment and service contracts
– Customer contracts and general terms and conditions
– Financial situation and forecasts
– Compliance and regulatory aspects

It is advisable to set up a virtual data room in which all relevant documents are made available in a structured manner.

The investment documentation: the heart of the transaction

The actual investment documentation usually consists of several contracts:

Investment agreement

This contract regulates the specific conditions of the investment, in particular:

– Amount and timing of the capital contribution
– Issue of new shares
– Guarantees and warranties of the founders
– Conditions for the closing of the transaction

Shareholders’ Agreement

This governs the rights and obligations of the shareholders among themselves, including

– Voting and veto rights
– Rules for future financing rounds
– Exit scenarios (drag-along and tag-along rights)
– Non-compete covenants and confidentiality obligations

Amendment to the Articles of Association

The articles of association of the GmbH must be adapted to the new shareholder structure and the agreements with the investor.

Rules of procedure for the management

Rules of procedure are often agreed that specify the tasks and powers of the management.

5 Typical clauses and their meaning

Investment contracts often contain clauses that may seem complex for founders at first glance, but are of great importance:

Liquidation preference

This clause gives investors priority in the distribution of proceeds in the event of an exit. There are various forms, from a single (1x) to a multiple liquidation preference.

Anti-dilution protection

This clause protects investors from dilution in subsequent financing rounds at lower valuations. Common methods are the “full ratchet” and the “weighted average” adjustment.

Vesting

Vesting clauses stipulate that the founders’ shares must be “earned” over a certain period of time. This is intended to ensure that the founders remain on board in the long term.

Drag-Along and Tag-Along Rights

These clauses regulate the rights and obligations of the shareholders in the event of an exit. Drag-along obliges minority shareholders to co-sell, tag-along gives them the right to do so.

Conclusion

The legal preparation for an investment round is complex, but crucial for success. Careful structuring and negotiation of contracts can not only facilitate the process, but also set the course for future financing rounds and a successful exit.

As an experienced lawyer in the field of startup investments, I advise founders to obtain legal expertise at an early stage. Investing in good legal advice usually pays off several times over – be it through better conditions, avoided pitfalls or a smoother transaction process.

Remember: every clause you negotiate today can have far-reaching effects on the future of your startup. A solid legal basis is not only important for the upcoming investment round, but also forms the foundation for the long-term growth and success of your company.

Author: Marian Härtel

Marian Härtel ist Rechtsanwalt und Fachanwalt für IT-Recht mit einer über 25-jährigen Erfahrung als Unternehmer und Berater in den Bereichen Games, E-Sport, Blockchain, SaaS und Künstliche Intelligenz. Seine Beratungsschwerpunkte umfassen neben dem IT-Recht insbesondere das Urheberrecht, Medienrecht sowie Wettbewerbsrecht. Er betreut schwerpunktmäßig Start-ups, Agenturen und Influencer, die er in strategischen Fragen, komplexen Vertragsangelegenheiten sowie bei Investitionsprojekten begleitet. Dabei zeichnet sich seine Beratung durch einen interdisziplinären Ansatz aus, der juristische Expertise und langjährige unternehmerische Erfahrung miteinander verbindet. Ziel seiner Tätigkeit ist stets, Mandanten praxisorientierte Lösungen anzubieten und rechtlich fundierte Unterstützung bei der Umsetzung innovativer Geschäftsmodelle zu gewährleisten.