The romanticization of the “fail fast” principle in startups – When does failure become deception towards stakeholders?

“Fail fast, fail often” – hardly any other motto characterizes the start-up culture as much as the idea of trying things out quickly and failing just as quickly if necessary. In the tech industry, failure is often seen as part of the path to success and is almost romanticized. In fact, the fail-fast principle promotes agile experimentation and rapid learning in order to adapt business models iteratively. Failure thus becomes an accepted learning step on the path to potential growth.

However, this mindset is on thin ice as soon as outside capital and employees are involved. What is sold as a courageous willingness to take risks from the founder’s perspective can appear to be a careless handling of entrusted trust and assets from the perspective of investors or employees. At the latest when founders knowingly accept a risky failure, the question arises: when does “fail fast” turn into deception?

This paper takes a detailed look at the legal limits of risk culture in start-ups. The focus is on the responsibility of founders towards business angels, early-stage investors and employees, especially when deliberately pursuing unstable or high-risk business models. We look at the civil and criminal law standards – from the duty of disclosure to fraud – and discuss when calculated risk is no longer covered by the founders’ mantra, but is to be regarded as deception or immoral behavior towards stakeholders. Special constellations such as foreign investors (USA) and typical contractual arrangements (term sheets, employee participation, convertible loans, SAFE agreements, etc.) are also analyzed in a practical manner.

The aim is to provide a legally sound but practical guide for founders, investors and company lawyers to master the balancing act between innovative risk-taking and legal responsibility.

Founder’s responsibility towards investors and employees

Start-up founders not only bear vision and risk, but also responsibility towards their stakeholders. Even in the early stages, there are certain duties of care and loyalty towards investors and employees. Even if start-ups are naturally uncertain ventures, this does not exempt founders from dealing honestly and fairly with the legitimate expectations of their partners.

Basis of trust with investors

Early-stage investors (such as business angels or seed investors) trust the information provided by the founders, as the presentation of the business model, the market and the planning are particularly important in the absence of reliable figures. Here, the founders have an implicit duty of loyalty not to make any unrealistic promises or conceal any significant risks. Although a venture investor bears the risk of total loss – and experienced investors know that only a fraction of start-ups are successful – founders must not abuse this trust by exploiting information asymmetrically to their advantage. Information asymmetries characterize all startup financing: the founders usually know the product and the real challenges better than the investors. This asymmetry creates an obligation to inform the backers truthfully about all key circumstances so that they can make an informed decision.

A breach of this duty cannot be justified with the argument that the investor could have checked more carefully. Even if an investor is negligently optimistic or inexperienced, this does not relieve the founder of his responsibility: According to supreme court rulings, even gross credulity on the part of the investor does not change the assessment of deceptive behavior as fraud. In other words, even a reckless investor is legally entitled to truthful information. Founders must therefore be aware from the outset that active deception or concealment of critical facts is not covered by the “usual start-up risk”, but can give rise to liability claims and even criminal liability.

Responsibility towards employees

The same applies to employees in young companies: They rely on the founders to offer realistic prospects and not knowingly make impossible promises. Employees recruited at an early stage in particular often forego secure alternatives because they believe in the start-up’s vision – often lured by employee shares or stock options that are supposed to be lucrative in the event of success. Here, founders have a duty of care, at least morally if not legally, not to let their employees run into the open knife.

Legally, this responsibility manifests itself in pre-contractual duties of disclosure when hiring personnel. If an employer conceals the true financial situation or the foreseeable failure of the company from new recruits, this can trigger liability for breach of pre-contractual obligations (Sections 280 (1), 311 (2) BGB). For example, a labor court ruled that a managing director breached the employer’s duty when he concealed the actual poor order situation from an applicant and instead feigned a healthy impression of the company. In this case, the employee was able to prove that he had only given up his previous job, which had not been terminated, due to the misrepresentation. Although the claim ultimately failed due to a lack of demonstrable damage (the employee was able to continue working under the old conditions in the short term), the court made it clear that the managing director had deliberately conveyed a false impression in this case. The message is clear: founders must not fraudulently lure applicants onto a sinking ship. Anyone who hires new employees even though it is already foreseeable that the startup will soon fail or have to drastically cut jobs is violating the legitimate expectations of those affected for honest communication. In serious cases, claims for damages for so-called “recruitment fraud” can arise – e.g. compensation for loss of earnings if the employee has given up their old job.

In summary, there is a basis of trust between founders, investors and employees that must be protected through openness and honesty. “Fail fast” does not exempt from fairness: neither investors nor employees should be degraded to mere figures in a high-risk experiment without being aware of the risks.

Legal limits: From duty of disclosure to fraud

Although the German legal system allows entrepreneurs a great deal of leeway to take risks, it draws clear boundaries in the case of deception and fraud. Both civil law claims by disappointed stakeholders and criminal law consequences in the event of serious deception are relevant here. The following is an overview of the most important standards and legal principles that define when risky business conduct becomes illegal.

Civil law duties of disclosure and liability

In civil law, the principle of good faith (Section 242 BGB) and the duty to act in good faith already apply when a contract is initiated. In concrete terms, this means Anyone who concludes a contract (for example with an investor or employee) must inform the other party of circumstances that are material to the decision, provided that the other party could reasonably expect this information. If he fails to do so or deliberately misrepresents facts, the contract can later be contested or result in claims for damages based on culpa in contrahendo (fault in contract negotiations).

§ Section 123 BGB (rescission due to fraudulent misrepresentation) allows a contract to be rescinded if it was concluded by deception. A deceived investor could therefore contest his investment agreement if the founder has fraudulently lured him into the investment. The challenge must be made within one year of discovering the deception. If it is successful, the contract is treated as void from the outset – the investor would be entitled to repayment of his investment, but in return would have to transfer back any shares received (which may be effectively worthless in the event of the startup’s insolvency). Important: Not only the deliberate lie is fraudulent, but also the deliberate concealment of facts that you were obliged to disclose. Silence only does not constitute deception if there is no duty of disclosure. In the case of capital investments, however, there is a regular obligation to provide accurate information about all circumstances that are of material importance for the investment decision. For example, the BGH has emphasized that the investment prospectus must clearly indicate the maximum risk of loss (up to total loss). If such information is missing or is misleading, this constitutes a misrepresentation relevant to information.

In these cases, claims for damages pursuant to § 280 para. 1 BGB in conjunction with § 311 para. § Section 311 (2) BGB come into consideration. The deceived party is to be placed in the same position as if he had never concluded the contract (so-called negative interest). In the case of an investment, this usually means: repayment of the invested amount concurrently with the return of the shares, less any interim benefits. If the investors had not invested at all if they had been informed truthfully, they can demand their money back – even if the startup is insolvent in the meantime, there would then be an insolvency claim. The same applies to employees: If an employee would not have concluded the contract without deception, the employer must put them in the same position as if the contract had not been concluded (e.g. compensation for loss of earnings if the employee has given up their previous position). However, causality is often difficult to prove – in the aforementioned judgment, the plaintiff did not receive any money as he was able to return to work with his old employer for a short time and therefore did not suffer any damage

In addition to rescission and c.i.c. liability, capital market law also includes the special concept of prospectus liability. This applies in particular to capital investments if a formal prospectus or information memorandum was incorrect. Although special laws with strict liability rules apply to public offers (e.g. stock exchange prospectuses), founders can also be liable outside of formal prospectuses: Case law recognizes prospectus liability in the broader sense, according to which founders or initiators are liable to investors if they are responsible for the preparation or distribution of information documents that contain false or misleading information. For example, founders of a start-up GmbH can be personally liable if they provide investors with an information document about the company that is incorrect or incomplete in material respects, even if there was no legal obligation to publish a prospectus. Anyone who publishes documents such as pitch decks, business plans or investment memoranda should therefore exercise the utmost care. In particular, risks must not be minimized or concealed – a lack of or embellished risk disclosure gives rise to liability.

In extreme cases, Section 826 BGB (intentional immoral damage) may also be relevant. This general offense applies if someone causes damage to another person in a reprehensible manner. For example, a founder who knowingly promotes a hopeless business model and “burns” money could be accused of causing immoral damage to investors – especially if no specific fraud can be proven, but the overall conduct can be classified as grossly dishonest. However, the hurdles for this are high: immorality requires objectively particularly reprehensible conduct and intent, especially with regard to the damage. In practice, claims by injured investors therefore tend to be based on specific breaches of the duty of disclosure (c.i.c) or breaches of protective legislation (such as Section 263 StGB via Section 823 (2) BGB, see below).

Criminal law limits: Fraud and investment fraud

While civil law focuses on compensation for damages, criminal law draws a clear red line: deception for the purpose of raising capital can be prosecuted as a criminal offense. Two core provisions come into consideration in the startup context:

• § Section 263 StGB – fraud: This offense is fulfilled if someone causes another person to make a mistake by deception (by pretending false or concealing true facts) and thereby obtains a pecuniary benefit from the deceived person with the intention of obtaining an unlawful pecuniary advantage for themselves or a third party. Translated to the start-up situation: founders are liable to prosecution if, for example, they knowingly mislead an investor with false figures or prospects of success in order to obtain their investment. Classic examples would be an embellished business plan, fictitious sales figures or concealing the fact that the supposedly groundbreaking technology does not yet work. Even receiving the investment under false pretenses constitutes fraud, even if the failure or loss only occurs later. The decisive factor is the intent behind the act of deception. Case law in Poland, for example – which is transferable to similar German cases – has made it clear that obtaining financing based on a falsified business plan or unrealistic forecasts is to be regarded as fraud. It is also fraud if founders massively underestimate the costs and at the same time know that the project can never be profitable. In short: “Fake it till you make it” can be punishable if it is based on deliberately misleading investors.
• § Section 264a StGB – investment fraud: This special offense complements general fraud and is aimed at attracting a larger group of investors. § Section 264a StGB makes it a criminal offense to make false, advantageous statements about material circumstances or to conceal disadvantageous facts in connection with the sale of securities or company shares to a larger group of people. The “wider circle” is important here: The standard typically applies to public offerings, crowdinvesting or when many small investors are targeted. For example, a startup founder could be prosecuted under Section 264a StGB if he makes false statements in a widely distributed investment memorandum or on a crowdfunding platform in order to persuade as many small investors as possible to invest. The difference to fraud is that Section 264a StGB already sanctions the abstract endangering offense – it does not depend on whether someone actually invests or whether damage occurs. Even the dissemination of false information to the public is punishable. The threat of punishment (up to 3 years imprisonment or a fine) makes it clear that the legislator wants to protect the general public’s trust in the capital market. For startup founders, this means that anyone who promises “blue skies” in their public statements to potential investors runs the risk of being prosecuted for investment fraud. Even euphemistic advertising or the omission of significant risks is sufficient, provided it is done in prospectuses, presentations or online platforms that are addressed to a large number of people.

In addition to fraud and investment fraud, the German Criminal Code also includes other relevant offenses in the corporate context, e.g. Section 266 of the German Criminal Code (breach of trust), which criminalizes the violation of asset management obligations. For example, if a managing director uses capital entrusted to him for an improper purpose – such as using investor funds for private expenses or for completely unrelated purposes – this could be considered a breach of trust. Similarly, delaying an insolvency (failure to file for insolvency in good time despite insolvency, Section 15a InsO, punishable under Section 15a (4) InsO) can have criminal consequences. Although these criminal offenses relate more to the phase after the crisis has occurred, they underline the fact that founders can become personally liable and punishable if they overstep boundaries and violate obligations.

Conclusion of the legal analysis: The fail-fast philosophy does not have carte blanche under German law. As soon as a founder persuades investors or employees to participate by making false promises or concealing risks, there is a risk of rescission, damages and criminal sanctions. The legal guard rails – from the duty to provide information to fraud – are intended to ensure that high entrepreneurial risk does not turn into irresponsible use of the trust of third parties.

Delimitation: When is failure covered by entrepreneurial risk?

The central question remains: Where is the line between legitimate failure in the context of general startup risk and failure based on deception or impermissible recklessness? In other words, at what point can the founder be legally accused of failure?

In principle, case law recognizes that start-ups operate in an environment of extreme uncertainty. It is often assumed that the success of a start-up is statistically only 10% likely. Investors are aware of this and factor in high failure rates – after all, disproportionately high profits await in the event of success. This ex ante low risk/reward ratio is part of the nature of venture capital. Risk-taking alone is therefore not reprehensible, but an integral part of innovative business models.

However, not every failure can be excused with a blanket “bad luck”. From a legal perspective, a gradation is emerging:

• Normal entrepreneurial failure: Despite proper management and honest information from all parties involved, the business model does not succeed – e.g. because the market does not accept the product after all or a competitor is faster. Such cases are covered by the general risk of life. In principle, an investor cannot make any accusations here as long as he was correctly informed. The failure is then the realization of the jointly recognized risk. The principle of entrepreneurial freedom of decision and the business judgment rule (for managing directors of a GmbH or AG) apply here: as long as the decisions were justifiable and not grossly negligent, there is no liability for the failure.
• Failure due to common mistakes/mismanagement: More difficult are cases in which there is no deception, but the founders make serious management mistakes or the growth concept proves to be completely misguided. Example: The founding team stubbornly pursues a strategy even though there are early signs that the market does not want it. At some point, the money is gone. Was this still an acceptable risk – or was it already a neglect of duty of care? Here, founders often argue that they acted within the scope of acceptable risk, after all, they were trying out the unknown. Investors could argue that the limits of reasonable business activity have been exceeded. The legal situation here is fluid: a merely unsuccessful business model does not justify a liability claim. However, if there was an objective lack of economic rationality or it was apparent at an early stage that the concept was not viable, it is possible to speak of risk limits being exceeded. In some legal systems, there is even a criminal offense for gross mismanagement (e.g. in Poland the criminal offense of negligent economic damage similar to grossly negligent breach of trust. In Germany, there is no explicit criminal provision for “bad management” – however, serious misallocations could possibly be covered by Section 266 of the German Criminal Code (Untreue) if a duty to look after the company’s assets has been breached. Under civil law, liability of the managing director towards the company (internal liability) could at best be considered, not directly towards the investor, provided that no special guarantees have been breached. In such cases, the investor would usually only be left with frustration – unless one constructs an intentional immoral damage (§ 826 BGB), which, however, has high requirements.
• Failure as a result of deliberate deception or unjustifiable risks: Here the founder clearly crosses the line. This includes cases in which no serious success was expected from the outset, but external money was nevertheless raised. Example: A founder knows that his product is technically still years away from being ready for the market, but presents investors with an unrealistic time-to-market of 6 months in order to obtain financing. He is “gambling” that either a miracle will happen or that he can finance salaries and marketing for at least a few months to give it a try. This approach would be difficult to qualify as a normal risk – rather, there is a suspicion that deception is involved here in order to acquire money, although failure is inevitable. The legal system reacts strictly here: as explained above, such a founder may be liable to prosecution for fraudulent inducement and liable for damages under civil law. The moral assessment is also clear: this is an abuse of the fail-fast concept, a kind of gambling with other people’s money. The line between courageous visionary and irresponsible hasard has clearly been crossed here.

In summary, it can be said that as long as founders act within the framework of recognized business risks, provide transparent information about these risks and make decisions to the best of their knowledge, they cannot be blamed for failure. Stakeholders share the entrepreneurial risk. However, if the situation tips over into a situation where founders act against their better judgment or run into disaster with their eyes open and others follow suit, the protection afforded by the general risk of life ends. The courts then speak of “exceeding the permitted risk”. In such cases, failure is no longer bad luck, but the result of a deceptive or at least grossly reckless handling of entrusted capital.

Special features for foreign investors (especially USA)

The start-up world is international – many German founders attract investors from abroad, especially from the USA. This raises the question: When dealing with foreign stakeholders, do German startups also have to take their legal system into account? US investors in particular are known for rigorously enforcing their rights, and terms such as disclosure and fiduciary duty carry great weight there.

Firstly, it should be noted that the main legal relationship typically depends on the chosen contractual statute. If a US venture capital fund invests in a German GmbH, the investment agreement will often be governed by German law (unless Delaware law is expressly chosen, for example). In such cases, the German rules described above primarily apply. However, this does not mean that typical US expectations are irrelevant: Many US investors require certain contractual assurances and compliance with their home law standards before investing. For example, US standards for due diligence and disclosure are indirectly incorporated into the contract – e.g. comprehensive guarantee catalogs, regular reporting obligations, clauses on compliance with anti-corruption and sanctions regulations, etc.

If, on the other hand, a German start-up is brought into a US legal form (a common way is to establish a Delaware corporation as a holding company), then the founders are subject to the corresponding US regulations. In the USA, for example, directors have fiduciary duties towards the shareholders, which include duties of loyalty and due diligence. A founder as a board member of a Delaware C-Corp must act in the interests of all shareholders. If he only aims at his own “fail fast” without regard to investor protection, he could violate the duty of care if his actions are classified as gross negligence (the business judgment rule only protects to a certain extent; it does not apply to gross negligence ). The duty of loyalty also prohibits seeking personal advantages at the expense of the company or the other shareholders – a serial founder who transfers know-how or customers from a near-fail company to his next project, for example, could quickly run into conflicts of interest and liability in the USA.

Particular attention must be paid to the federal securities laws in the USA. Classic VC or angel investments are usually private placements that are exempt from registration (e.g. under Regulation D, Rule 506). However, Rule 10b-5 (from the Securities Exchange Act 1934) also applies in the Reg D context, which prohibits, mutatis mutandis, any untrue statement or concealment of material facts in connection with the purchase or sale of securities. This provision is the basis of numerous fraud lawsuits and SEC proceedings – it is similar to the German fraud offense, but has enormous enforcement power under civil law (keyword: class actions). A German startup that offers shares to US investors can be liable under Rule 10b-5 if it makes false statements in its offering documents. It does not matter whether the company itself is based in Germany – the decisive factor is that US investors are involved and US courts assume jurisdiction (which is quickly affirmed in the case of transactions denominated in US dollars or via US investment vehicles).

One practical aspect: US investors expect comprehensive disclosure, i.e. disclosure of all risks and weaknesses. While German investors sometimes act more informally in the early stages, angels/VCs from the USA are usually very documentation-driven. Founders should be prepared to provide complete and written documentation and not conceal anything important. Failure to do so could be interpreted negatively in the future, not only contractually but also in US courts.

In addition, the USA has stricter rules on certain specific points – such as export control regulations or the handling of certain technologies – which can be incorporated into investment agreements. Special disclosure obligations may arise if, for example, a US VC manages funds from public bodies; the VC must ensure that the investment in a foreign startup is carried out properly. Although a German startup does not have to apply US law across the board, it must bear in mind that the legal and regulatory culture of the investor plays a role.

Practical tip: When negotiating with US investors, it should be clarified at an early stage which law applies and which compliance requirements must be met. US investors often demand that the startup establish a US Inc. for the investment round, which means that US law (Delaware Law) automatically applies. In such cases, US legal advice should be sought urgently in order to avoid breaching obligations. Otherwise, there is a risk of US as well as German legal consequences – just think of the drastic penalties for securities fraud in the USA, which are significantly higher than German sanctions. Under civil law, claims for damages (with punitive damages) are also a serious risk in the USA.

To summarize: A German startup with foreign (especially US) investors should not be lulled into a false sense of security. Although the agreed law primarily applies, the expectations and legal enforcement methods of the foreign partners may be stricter. It is therefore advisable to proceed according to the highest common standard, i.e. maximum transparency, clean contracts and compliance with all relevant regulations on both sides. In case of doubt, US law must also be taken into account, especially with regard to honest disclosure and avoidance of misleading information.

Moral and legal assessment of high-risk business models

“Move fast and break things”,“growth at all costs“, “fake it till you make it” – these Silicon Valley maxims have a common premise: Fast growth justifies extreme risks, and success justifies the means to a certain extent. But how should business models that deliberately focus on rapid growth with high risk and possible failure be assessed?

Morally, it can be argued that great progress is hardly possible without considerable risk. Many revolutionary companies (from biotech to aerospace) would never have been created if people had not willingly accepted failure. A culture of failure that does not stigmatize failure can fuel innovation. From this perspective, the “fail fast” paradigm seems positive: it is better to fail early and learn from it than to ride a dead horse forever. Founders who boldly take calculated risks drive progress – and investors and employees alike voluntarily participate in this culture in the hope of above-average opportunities.

On the other hand, it must be asked whether the romanticization of failure does not also serve to whitewash dangerous tendencies. When failure is glorified, there is a risk that diligence and responsibility will suffer. It makes a difference whether a founder has tried everything imaginable and still fails – or whether he cultivates a “hop or skip” mentality from the outset, where the company is treated almost like a disposable item. Critics complain that some serial founders virtually plan for failure: if success does not come immediately, the project is dropped and the next one is started. What remains is burnt investor money and disappointed employees, while the founder moves on to the next start-up undaunted. This pattern can be described as strategic failure – it is almost part of the business model of such founders.

Legally, a business model that relies on rapid growth at all costs is not illegal per se. Aggressive expansion, high burn rates, accepting years of losses – all of this can be economically sensible as long as there is a prospect of either becoming the market leader or at least having a chance of making profits later on. The law does not stipulate a success rate. However, a “growth-at-all-costs” approach collides with the obligations described above if the costs are not openly communicated. High risks of loss must be honestly stated. A startup that deliberately pursues a “flash scaling” model (i.e. extremely rapid scaling with the acceptance of losses) should explain this to its investors from the outset: We are focusing on market share, not short-term profit; there is a significant possibility that the capital will come to nothing if there is no follow-on investment. Employees also need to know, for example through transparent communication, that the company’s survival depends on aggressive targets.

Such a model becomes morally questionable when deception comes into play, i.e. when founders have long been aware of the shakiness of their construct internally, but pretend to be a perfect world externally in order to gain time or more money. Examples from the start-up world show just how thin the line is: “Fake it till you make it ” – the principle of initially maintaining the appearance of success in order to actually achieve success – has led to serious fraud and scandals in cases such as Theranos (biotech) or FTX (crypto exchange). In these cases, rapid growth was placed above all else, even when it was clear that the promises could not be kept. These extreme cases are, of course, outliers, but they illustrate the danger that excessive pressure to succeed combined with a culture that does not properly acknowledge failure can lead to systematic deception.

In the German context, the socio-ethical component must also be considered: a business model that relies from the outset on being able to burn the invested money in a controlled manner in case of doubt touches on questions of immorality. It almost sounds like gambling or betting with other people’s assets. While the law does not prohibit betting and speculation, it does require fairness and transparency. Founders should ask themselves whether they themselves would invest under the same conditions that they offer their backers. If the honest answer is that the model is actually only attractive if certain truths are not spoken, then something is wrong – morally and legally.

Interim conclusion: Fail fast as a culture can be positive as long as it is practiced with discipline and integrity. A study in Harvard Business Review advises founders, for example: Set ambitious but realistic goals and keep your stakeholders informed of the risks; see “fail fast” as a call for quick learning cycles, not a license to take ill-conceived risks; and stay honest about prototypes and results instead of sugarcoating them. This shows that the startup community itself recognizes the balance that is needed. Failing quickly should not be an end in itself and certainly not an excuse for keeping stakeholders in the dark. Failure can be constructive – but only if it happens in a culture of openness, not deception.

Serial start-ups and “fail fast” as a strategy – information asymmetries

Let’s look specifically at the phenomenon of serial entrepreneurs – i.e. founders who set up one startup after another. For such people, the fail-fast principle can become a deliberate business strategy: Try it out quickly, close it down quickly if it fails and start the next idea. From a founder’s perspective, this may seem efficient; from an investor’s point of view, however, it can be problematic.

Information asymmetry plays a major role here: a new investor may not know the founder’s past in detail. A serial founder who has already had several failed projects may have experience – but may also have developed a tendency to abandon projects very quickly as soon as difficulties arise. If this is not communicated openly, a mismatch of expectations arises: The investor may believe in staying power, while the founder is already mentally planning the next company. This can lead to considerable conflict. For example, a serial founder could realize after receiving the investment that the concept is not working after all and instead of pivoting hard or saving the company at all costs, he decides to liquidate the company and move on to something new. The investor is faced with a fait accompli – his capital is gone, perhaps the project could have been saved with a little more effort or a different approach, but the founder did not have enough motivation to continue. From a purely legal point of view, it is difficult to blame the founder as long as no specific contractual obligations were breached. After all, entrepreneurial discretion also includes the decision to end a hopeless battle. But from an investor’s point of view, it feels like a breach of trust, especially if the founder is perhaps already working on the next financing for the new start-up at the same time.

Conflicts of interest can come to a head when a serial founder juggles several projects in parallel. If he abandons one of them, but the business model lives on in a slightly different form in a new vehicle – possibly with different investors – he could be accused of having “taken” assets or opportunities that actually belonged to the first start-up and its investors. In legal terms, this could constitute a breach of the duty of loyalty or even a transfer of assets. For example, if the founder has transferred intellectual property (code, inventions) from the old company to the new one, this would be a clear breach of the law (breach of corporate duties, possibly theft of trade secrets). Even if it is only a matter of ideas or knowledge, you are ethically in a gray area: the first investors ultimately financed the founder’s learning, but others reap the rewards.

It is therefore particularly important to maintain transparency and fairness in the context of serial founders. An experienced founder should disclose how they intend to proceed in the event of failure. Some investors specifically ask about the resilience of the founding team: will it immediately throw in the towel when faced with headwinds or does it have a plan B/C? Two philosophies often clash here – the Silicon Valley logic (“fail fast, move on”) and the more medium-sized German logic (“hang in there and work your way to success”). Neither is right or wrong per se, but a mismatch in philosophy must be clarified in advance. Otherwise there is a risk of disappointment or even legal disputes: For example, an investor could argue that the founder has breached his duties by giving up prematurely – which is difficult to enforce, however, as long as no specific contractual clauses have been broken.

Such conflicts can be prevented somewhat contractually: vesting clauses (reversion of shares if the founder leaves the company early) ensure that a serial founder does not simply take the money and move on without having “skin in the game”. Non-compete clauses can prevent him from immediately starting a competing follow-up project. Investor rights in the articles of association, e.g. veto rights on the dissolution of the company or the sale of significant assets, can make an unplanned total closure more difficult – the founder cannot then decide alone to turn out the lights if there is still money in the coffers. All of this serves to compensate somewhat for the asymmetry in the information and power position. Although the founder has operational control, the investors are given mechanisms to at least have a say in important steps.

Ultimately, dealing with “fail fast” in serial start-ups requires trust – and trust is built through open communication. A serial founder would do well not to make a secret of his previous failures, but on the contrary to emphasize the lessons learned and make it clear how he will approach things differently this time. However, if it is clear that they are taking an experimental approach, investors should be selected carefully: Some investors, especially from the US, support a portfolio strategy (broad diversification, quick pivot/termination decisions), while others expect more commitment. Information asymmetry can be reduced here by ensuring that both sides have the same expectations of what should happen in the worst-case scenario.

Interim conclusion: Fail fast as a strategic pattern for serial founders is a double-edged sword. It can be used to efficiently weed out bad ideas, but it harbors considerable potential for conflict due to differing expectations. Legally, a quick termination is permitted, but only as long as no fiduciary duties or assets are breached. The best way to prevent disputes is for founders and investors to clearly communicate in advance how a potential failure will be dealt with and, if possible, to reflect this in contracts (e.g. exit strategies, liquidation preferences, decision-making powers in the event of a pivot or shutdown).

Legally compliant contract design: protective clauses for risk and failure

In view of the many pitfalls, founders, investors and employees should pay attention to legally secure contractual clauses at an early stage in order to both enable legitimate failure and prevent abuse or disappointment. The following are some of the important contractual arrangements and clauses in term sheets, participation agreements, convertible loans, SAFE agreements, etc. that are particularly relevant in the context of high risks:

Term sheets and participation agreements

• Transparent communication of assumptions: The term sheet (letter of intent) can already state that both parties are aware of certain risks. For example, the founders can include the following: “The company is in an early experimental phase; both parties are aware of the considerable risk that the business model may have to be fundamentally adjusted or discontinued if the assumptions prove to be incorrect.” Although a term sheet is usually non-binding, such formulations create a common understanding.
• Do not give any unfulfillable guarantees: In the investment agreement (e.g. investment and shareholder agreement), founders will typically have to make a number of guarantees (e.g. that the books are correct, no liabilities have been concealed, all patents belong to the startup, etc.). Founders should be honest here and not promise anything they cannot keep. It is also important to classify any forward-looking statements correctly: It is better not to give a guarantee that a certain level of turnover will be achieved, but at most to state that you have drawn up the plans to the best of your knowledge without being liable for them. As a rule, investors do not demand any assurance of success anyway, but rather guarantees about the status quo (e.g. “not ready for insolvency”, “all major contracts disclosed”). These must be fully and truthfully disclosed in order to avoid subsequent liability.
• Material Adverse Change (MAC) clauses: In some contracts – especially in tranche models – conditions are agreed under which the investor can withdraw from the investment if serious deterioration occurs before completion. Although MAC clauses are rare in the early stages, investors may insist on them in high-risk models, e.g: “Should a material adverse event occur prior to closing (such as loss of a key customer or patent dispute), the investment obligation shall lapse.” This is initially unpleasant for founders, but ultimately fair, as it ensures that the investor only gets involved if the initial situation is intact – which also protects the founder from later accusations.
• Co-determination rights in the event of a pivot or business closure: Investors often secure contractual veto rights for fundamental decisions (set out in the articles of association). This can include Changing the object of the business, selling the entire company, filing for insolvency or liquidation. In this way, the investor ensures that a founder does not completely change the business model on their own authority or throw in the towel without at least consulting the investor. Founders should grudgingly accept such rights, as they help to find a solution together in an emergency (e.g. another attempt at financing, sale instead of liquidation). This protects both sides: the investor from premature termination and the founder from being accused of having destroyed capital on his own authority.
• Liquidation preference: A liquidation preference in the investment agreement determines the order and amount in which investors receive money back in the event of an exit or insolvency before the founders/shareholders receive anything. In the case of risky models, it is customary to guarantee investors at least the original investment (1x liquidation preference) as a priority in the event that something can be realized. Although this does not help in the event of total insolvency (as there is nothing there), investors at least get something back in the event of a partial success or sale below cost value. This is manageable for founders as long as the preference is not exorbitant. It softens the impression that the founders could still enrich themselves with a small exit, while investors lose out.
• Claw-back or earn-out clauses: In some cases, it can be agreed that founders will make additional contributions or waive future profits if certain promises turn out to be false. This is more common in M&A, but is conceivable in startup contracts if, for example, founders have made very specific promises. For example: “The founders promise to reach at least 1000 paying users within 12 months. Otherwise, their share will be reduced by X% in favor of the investors.” Such hard clauses are rare and also legally tricky (as they act as a contractual penalty), but such mechanisms could asymmetrically shift the risk back to the founders. You have to weigh things up in negotiations: Terms that are too rigid can demotivate or signal mistrust. Softer methods such as milestone financing are more common (see below).
• Tranching and milestones: Instead of investing the full amount at once, financing rounds can be paid out in tranches, depending on the achievement of certain milestones. This works well for “high-risk growth” – the investor only gives further money if, for example, a prototype works or certain KPIs have been achieved. In this way, the willingness to take risks is linked to measurable success. For founders, this means discipline, but also that they cannot expect any further money if they fail to achieve certain milestones (which is better than having to rely on them for better or worse). It is important to define milestones realistically so as not to fall behind schedule.

Convertible loans (convertible notes)

Convertible loans are a popular instrument in Germany for making early-stage investments flexible. The investor initially grants a loan, which is typically later converted into shares (often in the next financing round). From a legal perspective, it is a loan agreement combined with a conversion right (or obligation) and often an agreed discount or cap for the later valuation.

In the case of high-risk start-ups, convertible loans should be carefully structured in order to create clarity in the event of failure:

• Clear regulation in the event of insolvency or liquidation before conversion: What happens if the startup goes bankrupt before conversion takes place? It is often standard that the investor then remains a creditor and can at least theoretically reclaim their money. However, convertible loans are often subordinated (after the normal creditors in the event of insolvency). Founders and investors should be aware that a subordinated loan is effectively equity in the guise of debt – in the event of insolvency, there is usually nothing to be recovered. Nevertheless, the documentation should state this clearly in order to avoid misunderstandings later on.
• Term and maturity: Does the convertible loan have a final maturity date after which it must be repaid if it has not been converted by then? If so, there is a risk that the startup will not be able to meet this repayment (which would then lead to insolvency). Many convertible loans are therefore automatically extended or the due date is suspended as long as both parties remain committed to a conversion. It is important to note that if a startup is likely to fail and no more equity investment is forthcoming, it must be clarified whether the investor can (and wants to) call in the loan. To avoid disputes, the following could be agreed, for example: “If no financing round has taken place by date X, an automatic conversion at a fixed valuation amount Y will take place.” The investor then becomes a shareholder at a predefined valuation. This prevents the investor from going away completely empty-handed, but does not protect him from a loss of value – he then receives shares in a presumably worthless company. At least the process is clearly regulated.
• Interest and incentives: A low interest rate is common (to avoid tax and balance sheet problems), and interest is often deferred until conversion. For risky projects, the investor can insist on slightly higher interest rates, but in the end interest is also lost in the event of a total default. Therefore, the focus tends to be on the conversion discount or the valuation cap in order to reward the higher risk appetite. For founders, this is acceptable as long as it remains within the normal market range (e.g. 20% discount, cap perhaps at the upper end of the current valuation).
• No hidden equity financing: From a legal perspective, a convertible loan must be structured in such a way that it actually passes as a loan until it is converted. Otherwise, the contribution could be made without notarization and entry in the commercial register, which would be problematic in the case of a GmbH. For this reason, convertible loan agreements should always be drawn up with competent help to ensure that the conversion is carried out formally correctly at a later date (in particular resolutions on capital increases, etc.). If mistakes are made here, there is a risk of voidability or the conversion right is invalid. This is indirectly relevant for the “fail fast” issue: If everything goes well, you convert; if everything goes wrong, you at least do not want a formal legal error that subsequently leads to liability (e.g. bogus profit distributions).

SAFE agreements (Simple Agreement for Future Equity)

SAFE contracts, popularized by Y Combinator in the USA, are a type of simplified convertible loan – but usually without a repayment claim and without interest. The investor gives money now and receives the right to receive corresponding shares at the next equity event (usually with a discount or cap). SAFE agreements have been partially adapted in Germany, but there are special legal features:

• Legal nature of a SAFE: In contrast to a convertible loan, a SAFE is not a bond in the traditional sense, but rather a contractual advance subscription right. This means that the investor has no shareholder rights until the capital round, but also no repayment claim. They therefore bear the full risk from day 1, similar to a silent partner without voting rights. If the startup fails before the next round, the SAFE investor is usually simply out of luck – they lose their investment completely as they have neither shares nor a claim.
• Arrangements in the event of closure: Good SAFE contracts contain a clause on what happens if the company is liquidated before conversion. It often states that the SAFE investor is then entitled to receive either his investment back (subordinated) or a share of the liquidation proceeds, whichever is higher. Example: Y Combinator’s SAFE typically provides that upon liquidation, the SAFE investor is entitled to a claim equal to its investment, but after the senior creditors and pari passu with the shareholders. In practical terms, this means that if there is a small remainder, it is divided pro rata between the SAFE investor and the shareholders. This at least prevents the founders from taking money out while the SAFE investor goes away empty-handed. Founders and investors should ensure that such clauses are included in the SAFE to regulate this worst-case scenario.
• Adaptation to German law: Since a capital contribution to a GmbH must always be notarized in Germany, a SAFE cannot simply promise shares at the time of subscription without going the formal route. The solution is usually to formulate it as a contract under the law of obligations that securitizes a claim to the conclusion of a future subscription agreement. Legal expertise should definitely be consulted here to ensure that the SAFE cannot be challenged due to a lack of form. In the context of our topic: Formal correctness does not protect against failure, but it does ensure that there is no legal uncertainty as to who has which claims in the event of failure.
• Investor protection vs. simplicity: SAFEs are investor-friendly in boom phases (quick and easy to invest, without high legal costs), but more founder-friendly in bust phases (no repayment pressure). German investors are sometimes skeptical of SAFE, precisely because they are left with nothing in the event of failure. A compromise could be to provide SAFE-like contracts with certain protective mechanisms – e.g. to include a long-stop date where the SAFE converts into a small share if no round comes (similar to what is suggested for convertible loans). The main thing is that all parties understand the economic consequences: A SAFE investor must be aware that they are effectively carrying equity risk without voting rights.

Employee shareholdings (ESOP, VSOP etc.)

Employee participation programs are essential for attracting and retaining talent in start-ups. Especially in risky business models, top people are often only attracted by the prospect of an attractive equity share. But if the startup fails, these options or shares are worth nothing. Here are a few legal and practical points to prevent disappointment:

• Clarification of risks: Employees should be clearly informed that share options or virtual shares do not mean a guaranteed payout. Employment contracts with participation components can include a note such as: “The employee is aware that the options granted only represent a monetary benefit in the event of a successful exit or IPO; a total loss of company value would devalue the options.” This may sound obvious, but practice shows that many employees do not understand the complexity (especially in terms of tax) of shareholdings. An information sheet enclosed with the ESOP membership explaining how it works can also help here. Although this does not protect the founder from everything (fraudulent misrepresentation cannot simply be avoided), it creates transparency and reduces false expectations.
• Choose a suitable instrument: In Germany, a basic distinction is made between genuine employee share ownership (e.g. via direct GmbH shares or via stock option programs at AG/SE) and virtual share ownership (VSOP), which is more akin to a bonus scheme. VSOPs are often used for high-risk start-ups because they are flexible and do not trigger an immediate tax burden. However, VSOPs are purely legal obligations – in the event of insolvency, VSOP holders are left empty-handed as creditors because the contract usually states that a payout will only be made in the event of an exit. Real shares at least give employees shareholder status, but are inflexible and can also be lost in the event of failure. The Future Financing Act has been in force in Germany since 2023, which provides tax relief for employee shareholdings. Founders should seek advice here in order to choose the right model. It is important that the structure is legally compliant and understandable – employees should know where they stand.
• Vesting and good/bad leaver: By default, employee options should vest over several years (e.g. 4 years with 1 year cliff) to ensure that employees remain loyal to the company. Relevant in a fail-fast context: If the startup fails early, many option shares may not have vested yet – they will simply expire. This can be seen as an advantage (no “overhangs”), but from an employee’s point of view it is bitter if, for example, you have worked for 1.5 years, 25% of the options have vested, then the company fails and everything is worthless. However, this is an inherent risk. It is more important to provide bad leaver clauses for founders: If a founder himself “throws in the towel early” (e.g. exits because things get difficult), most of his shares or option rights are forfeited. This disciplines founders not to give up prematurely in the face of headwinds and creates a certain balance for investors and employees that the founder does not simply carry on with his still high shareholding while others lose out.
• Avoid tax traps: One aspect that is often overlooked: Employee shareholdings can be great if successful, but in the event of failure, they can also trigger taxes without any money flowing (this was particularly a problem with virtual shares – so-called dry tax). The Future Financing Act attempts to counteract this, for example by deferring tax until the exit. Founders should ensure that their programs make use of these new rules. Nothing is more demotivating (and legally vulnerable) than if an employee suddenly has a tax problem in the event of failure because, for example, their options had to be settled by leaving the company. Therefore: set up participation programs properly with experts so that there are no unintended consequences in the event of failure.

Further safeguard clauses and practices

• No-shop and confidentiality: An exclusivity clause that the founder will not negotiate in parallel with other investors is common in term sheets. This protects investors from being used as a stopgap. Indirectly relevant to our topic: It encourages serious negotiations, but does not reduce the risk issue. Confidentiality clauses (NDAs) are standard – they allow investors deep insights into the company without the founder having to worry about data misuse. This allows the investor to better assess the risk. Founders should be open here instead of concealing things out of concern that the investor might back out.
• Allow due diligence: An open book can create trust, especially when there are major risks. Investors who are allowed to carry out thorough due diligence (including technical, not just financial) will be less likely to claim afterwards that something has been deliberately concealed from them. Of course, this does not release the founder from the obligation to tell the truth – but transparency reduces the likelihood of something being “overlooked”. It is difficult for the investor to say later that he was fraudulently deceived if he was able to check all the documents and did not ask any questions about obvious ambiguities. (However, as mentioned, investor negligence does not protect the deceiver in case of doubt. Nevertheless, cooperative openness is the best prevention).
• Communication in the event of a crisis: If it becomes apparent that the startup will fail, it is advisable to involve investors and the core team at an early stage instead of relying on surprise effects. Legally, late information can also be a breach of the duty of disclosure (e.g. if you delay the inevitable against your better judgment and are still raising funds). But above all pragmatically: there are often joint rescue approaches (pivot, emergency financing, sale). Founders who go it alone here – for example, if they become insolvent and go to court alone without informing the advisory board/investor – burn a lot of goodwill and also risk personal liability for delaying insolvency if they leave it too late. It is better to lay all the cards on the table in good time. Although this is not a contractual point, there are often reporting obligations in shareholder agreements or an obligation to report certain events immediately (e.g. termination of a major customer, patent lawsuit, etc.). Such clauses should be taken seriously – they are in the founder’s own interest so that he or she does not later appear to be a taciturn person.
• Legal advice and documentation: Last but not least, both sides (founders and investors, as well as employees in investment programs) should seek qualified advice. Many potential conflicts can be defused by drafting contracts properly. Determining what was “meant” after the fact is difficult and leads to legal disputes. It is better to invest upfront in a lawyer and notary than to pay much more later in court. It is tempting for founders to work with templates from friends or from the Internet (especially SAFE/VSOP etc.), but the trick is in the detail. Terms must be translated correctly, adapted to German laws, etc. One small oversight can render an entire program ineffective. Take profit sharing, for example: If you promise employees profit shares, you need to know that these must not be negative in the event of a loss (no loss compensation). Such subtleties can be overlooked with professional help.

In summary, all of these contractual precautions serve to manage expectations between founders and stakeholders and minimize legal conflicts. If failure is a consciously accepted part of the plan, then this should be contractually underpinned in such a way that nobody is “fooled”. This does not mean that you have to paint the devil on the wall – but clear rules for the worst-case scenario make it easier for everyone involved to deal with it if it occurs.

Conclusion: “Fail Fast” – the courage to be honest is the best protection

The culture of rapid failure undoubtedly has its place in the modern start-up world. It can fuel innovation and accelerate learning processes. But for founders, “fail fast” does not mean that they can put diligence, loyalty and law and order to one side. Failure becomes deception when founders knowingly or recklessly conceal the true risks and state of their company in order to get or keep stakeholders on board. The victims are then business angels, early-stage investors or employees who rely on false promises.

To avoid this, founders should internalize the following principles:

• Honest risk disclosure: Informing stakeholders about significant risks is part of the basics of serious entrepreneurship. Anyone pursuing a high-risk model should not conceal this, but should state it openly – be it in the investor deck, in employee meetings or in the press. Transparency creates credibility and provides legal protection against accusations of deceit.
• Realistic communication instead of hype: Of course, a start-up thrives on enthusiasm. But it is important to find a balance between a visionary story and factual accuracy. “Storytelling” must not slip into “peddling lies”. Founders should check themselves regularly: Do the current facts and figures still support the picture painted? If not, the narrative must be adjusted or at least relativized. In short: only promise what you can deliver – and use subjunctives instead of definitives in the case of uncertainties.
• Fail fast = learn quickly, don’t act recklessly: In essence, the motto should be to experiment quickly and recognize mistakes early on. It does not mean jumping blindly into adventures. Every step should be responsible. Or as it was aptly put: “Understand the ‘fail’ in ‘fail fast’ as quick experimentation to find alternatives, not as a license to take ill-conceived risks“.
• Stakeholder management in the event of a crisis: When failure becomes apparent, proactively and honestly seek dialog with investors and employees. Together, a plan B or at least an orderly withdrawal (“fail gracefully”) can often be devised. This is not only fairer in human terms, but also preserves reputations and can be legally relevant (keyword: insolvency regulations, liability for delays).
• Legal advice and clean contracts: As a preventative measure, it is essential to do your legal homework. Take disclosure obligations seriously from the outset, prepare documentation carefully and check promises legally. Make targeted use of contractual clauses to clarify who bears which risk. In case of uncertainty: seek legal advice – there is a lot at stake, often existential questions.

Ultimately, a certain degree of trust is essential. Investors know that not every startup flies; employees know that a job in a young company is not a lifelong job guarantee. But this trust is based on founders acting honestly and responsibly. The romanticization of failure must never go so far that honesty and a sense of duty fall by the wayside. Otherwise the “Fail Fast” becomes a “Fail Ugly ” – with legal and moral wreckage.

For founders, this means that the courage to tell the truth is the best protection. Anyone who pursues their vision with courage but speaks openly about the pitfalls and abysses will, in case of doubt, receive more leniency and support – both from the courts and from their partners. Failure is then not a flaw, but a step on the learning path that everyone has taken together, in good faith. And this is the only way to keep the start-up culture of trial and error alive in the long term without slipping into cynicism or breaking the law.

tl;dr: Fail fast – yes, but stay fair. Resolutely take risks without leaving stakeholders in the dark. Then failure is not cheating, but part of the entrepreneurial adventure that everyone involved has consciously entered into.