Legal guide to a successful startup investment

Investments in start-ups offer enormous opportunities for both investors and start-ups. They are the basis for growth, innovation and the realization of ambitious corporate goals. At the same time, however, they are accompanied by considerable legal and economic risks, which can lead to conflicts or even failure if insufficient preparation is made. A comprehensive legal framework is therefore essential to protect the interests of all parties involved and ensure successful collaboration. Such a framework includes, among other things, clearly defining the rights and obligations of both parties, safeguarding intellectual property and protecting against unforeseen developments such as disputes or financing bottlenecks. It ensures that the company is legally protected, investors gain confidence and the foundation for sustainable growth is laid. Startups that establish legal standards early on benefit from greater investor appeal and avoid costly legal disputes later on. This guide provides a practical guide that equips startups with the most important legal and strategic tools to successfully manage the entire investment process – from initial contact to collaboration and exit strategy. It not only addresses typical stumbling blocks, but also presents concrete solutions. Startups are strongly advised to always seek individual legal advice to ensure that all agreements are optimally tailored to the specific needs and objectives of the company. This is the only way to ensure that an investment is not only legally flawless, but also strategically successful.

Preparing the startup for investments

1.1. Unternehmensstruktur und Rechtsform A solid corporate structure is an essential basis for convincing investors. For start-ups, it is often advisable to establish a limited liability company such as a GmbH or UG in Germany. These company forms offer investors a clear legal structure, facilitate the management of investments and protect the founders from personal liability.

• Entry in the commercial register: Entry in the commercial register creates the necessary transparency and legal certainty. It signals the professionalism and seriousness of the company, which is essential to gain the trust of potential investors. Such an entry also serves as binding documentation of the company’s existence and makes important information such as the company’s registered office and shareholder structure publicly accessible. In addition, the entry in the commercial register provides third parties, such as investors or business partners, with contractual security by proving the company’s legal capacity. The entry is also a prerequisite for legally protecting company names or taking out loans from banks.
• Shareholders’ agreement: A clear shareholders’ agreement sets out the rights and obligations of the founders and other shareholders. Regulations on decision-making powers, profit distribution and dealing with conflicts are of particular importance here. Furthermore, the agreement should regulate mechanisms for the admission of new shareholders and the exit of existing shareholders in order to ensure long-term stability. The agreement should also contain provisions on the sale of shares, in particular pre-emption rights and protective clauses against hostile takeovers. Last but not least, the shareholders’ agreement is crucial for avoiding conflicts between the founders in good time, for example through arbitration clauses or provisions for conflict mediation.

1.2. Due Diligence vorbereiten Investors will usually carry out a comprehensive due diligence process to assess the economic and legal situation of the startup. Insufficient preparation can significantly delay the investment process or even cause it to fail. The following points are therefore particularly important:

• Bookkeeping and financial documents: Proper bookkeeping and transparent financial documents are essential to create trust and prove the economic stability of the company. This includes balance sheets, profit and loss statements and tax documents. A properly kept cash book and complete documentation of all business transactions can also be decisive in achieving a positive assessment. In the case of start-ups in particular, a forecast of future cash flows and financing requirements should also be drawn up to underline the scalability of the business model. A solid controlling system can also convince investors of the professionalism of the management.
• Legal documents: Investors attach importance to comprehensive documentation, including employment contracts, rental and supply agreements as well as evidence of property rights such as trademark and patent applications. These documents should not only be complete, but also up to date so that there is no doubt about the company’s seriousness. This also includes adhering to all compliance requirements, for example in the area of data protection or tax obligations, in order to identify potential risks at an early stage. Structured storage of all documents, for example in a digital data room, can make the due diligence process considerably easier.
• Business model: The business model should be clear and scalable. It is important to present both the sales potential and the legal framework, for example for software licensing or data protection, in detail. Risks and challenges should also be presented openly in order to strengthen investor confidence and create a realistic basis for decisions. A well-prepared business plan should also show how the startup would react to changes in the market or regulatory challenges. Investors appreciate it when start-ups have already outlined alternative scenarios or worst-case plans.

1.3. Geistiges Eigentum sichern The protection of intellectual property (IP) is essential, as it often represents the core value of a startup. Without appropriate protective measures, there is a risk that key assets will be lost or exploited by competitors.

• Trademark applications: Protecting the company name and important products through trademark registrations offers a clear competitive advantage and signals to investors that the startup is thinking strategically. Furthermore, registered trademarks can form the basis for legal action against copycats or free riders in the long term. International trademark registrations can also open up new markets with legal certainty, which strengthens the confidence of globally active investors. It should also be regularly checked whether existing trademark rights are being infringed by competitors.
• Copyrights and patents: Software, designs or inventions should be copyrighted or patented in good time. This is particularly important in order to secure the unique selling point of the start-up. Strong intellectual property protection can also significantly strengthen the company’s position in negotiations on license agreements or partnerships. In addition, the documentation of such IP rights increases the value of the company during a due diligence review. It is advisable to develop an IP strategy that includes both the creation of new rights and the protection of existing ones.
• Non-disclosure agreements (NDAs): When talking to potential investors or partners, it is essential to conclude NDAs in order to protect sensitive information such as technical details or financial plans from unauthorized disclosure. In addition, the company should ensure that the contents of the NDAs are comprehensive and clearly formulated in order to be legally sound in the event of a dispute. Particularly in discussions with international partners, country-specific differences in the enforceability of NDAs should be taken into account. Finally, the introduction of technical protective measures, such as encrypted data exchange, can also increase the security of sensitive information.

1.2. Due Diligence vorbereiten Investors will usually carry out a comprehensive due diligence process to assess the economic and legal situation of the startup. Insufficient preparation can significantly delay the investment process or even cause it to fail. The following points are therefore particularly important:

• Bookkeeping and financial documents: Proper bookkeeping and transparent financial documents are essential to create trust and prove the economic stability of the company. This includes balance sheets, profit and loss statements and tax documents. A properly kept cash book and complete documentation of all business transactions can also be decisive in achieving a positive assessment.
• Legal documents: Investors attach importance to comprehensive documentation, including employment contracts, rental and supply agreements as well as evidence of property rights such as trademark and patent applications. These documents should not only be complete, but also up to date so as not to cast doubt on the company’s reliability.
• Business model: The business model should be clear and scalable. It is important to present both the sales potential and the legal framework, for example for software licensing or data protection, in detail. Risks and challenges should also be presented openly in order to strengthen investor confidence and create a realistic basis for decisions.

1.3. Geistiges Eigentum sichern The protection of intellectual property (IP) is essential, as it often represents the core value of a startup. Without appropriate protective measures, there is a risk that key assets will be lost or exploited by competitors.

• Trademark applications: Protecting the company name and important products through trademark registrations offers a clear competitive advantage and signals to investors that the start-up is thinking strategically. Furthermore, registered trademarks can form the basis for legal action against copycats or free riders in the long term.
• Copyrights and patents: Software, designs or inventions should be copyrighted or patented in good time. This is particularly important in order to secure the unique selling point of the start-up. Strong intellectual property protection can also significantly strengthen the company’s position when negotiating license agreements or partnerships.
• Non-disclosure agreements (NDAs): When talking to potential investors or partners, it is essential to conclude NDAs in order to protect sensitive information such as technical details or financial plans from unauthorized disclosure. In addition, the company should ensure that the contents of the NDAs are comprehensive and clearly formulated in order to be legally sound in the event of a dispute.

 

Selecting the right investors

2.1. Strategic considerations Choosing the right investor is a decisive factor for the long-term success of a start-up. Investors not only bring capital, but often also strategic resources, industry knowledge and networks. It is therefore important to focus not only on the amount of financial resources, but also on the shared vision and compatibility of the partnership.

• Long-term vision: Startups should ensure that investors share the same long-term goals. A conflict in growth strategy can lead to important decisions being blocked or delayed. In addition, a shared understanding of innovation and corporate values can make collaboration much easier. In order to legally secure this long-term vision, so-called “lock-in” clauses can be integrated into the contracts, which stipulate the investors’ obligation to hold a minimum stake over a certain period of time. Such clauses prevent investors from exiting prematurely and ensure a stable partnership. In addition, contractual provisions can ensure compliance with the corporate strategy by requiring consent to significant changes, for example in the use of funds or the strategic focus. This gives the startup control and prevents conflicts of interest between the parties.
• Network and industry knowledge: A good investor can significantly accelerate the growth of a start-up by establishing contacts with relevant partners, customers or other investors. Especially in highly competitive industries, such contacts can offer a decisive competitive advantage. An investor’s industry knowledge can also help to identify potential risks at an early stage and avoid them in a targeted manner. Support in the recruitment of managers or market analyses can also be a valuable contribution. In order to contractually secure this involvement, so-called “value-add” clauses can be introduced, which stipulate the investor’s obligation to actively use its network. Such clauses can also include reporting obligations that document the success of the contacts and recommendations made. In addition, provisions can be made to ensure the investor’s availability for important strategic decisions. These approaches create clear expectations and reduce the risk of passive investors.
• Reputation of the investor: The reputation of an investor has a direct influence on the perception of the startup in the market. A respected investor can strengthen the trust of other potential partners and customers. It is advisable to find out about the potential investor’s previous investments and how they deal with conflicts. Due diligence can help to objectively assess an investor’s reputation. Contracts from previous investments can be analyzed to obtain information about the investor’s compliance with commitments and conflict resolution. References can also be obtained from other companies that have worked with the investor. Information on legal disputes or disputes in which the investor has been involved can also provide important indications of the investor’s reliability. Finally, an investor with a positive track record also strengthens the position of the start-up in difficult negotiation situations.

2.2. Arten von Investoren There are different types of investors who differ in their approach, their expectations and their influence on the startup. The choice of the right investor should therefore be well thought out.

• Business angels: Business angels are often experienced entrepreneurs who not only provide capital, but also their knowledge and experience. They are particularly valuable in the early phase, as they support start-ups not only financially but also strategically. Business angels are often flexible and can make decisions quickly, which is an advantage in dynamic phases of the company. Their support often goes beyond pure financial assistance and also includes mentoring or help with the market launch. From a legal point of view, it is important to make clear agreements in the form of an investment contract that defines vesting regulations for the founders and exit clauses for the angel investor. In addition, the duties of the angel, such as advisory boards or specific reporting obligations, should be contractually defined.
• Venture capital companies: VCs are professional investors who invest large sums of money and generally take an active role in management. They often expect rapid growth and frequently aim for an exit within 5-10 years. Their processes are often more structured and require intensive preparation on the part of the startup. One advantage of VCs is their ability to provide follow-up investments and accompany the startup through various financing phases. In terms of contract law, specific clauses such as anti-dilution rules, liquidation preferences and control rights are important for VCs. It is advisable to negotiate these terms in detail in order to avoid long-term disadvantages for the founders.
• Corporate investors: Companies that make strategic investments in start-ups often pursue the goal of exploiting synergies or integrating innovations into their own business. These investors can be particularly valuable if they provide additional resources such as technology or sales channels. However, the startup should be aware that corporate investors often pursue strategic interests that are not always in line with the startup’s long-term goals. Transparency and clear agreements on rights and obligations are of particular importance here. From a legal perspective, exclusivity clauses and regulations to avoid conflicts of interest should be worked out in detail in the contracts. It is also important to clearly regulate intellectual property arising from the collaboration in legal terms in order to avoid conflicts later on.

2.3. Vorbereitung auf Verhandlungen Negotiating with potential investors requires intensive preparation in order to safeguard your own interests and build successful long-term partnerships.

• Valuation of the company: A realistic company valuation is the basis for every negotiation. Start-ups should know the value of their company and how this can be justified. An independent valuation by an expert can help with this. It is important to objectively present both past successes and growth potential. In addition, scenarios such as best-case and worst-case projections can be drawn up to underpin the attractiveness of the investment. The determination of the valuation method (e.g. DCF or multiples) is legally relevant here in order to prevent disputes about the company value during the negotiation process.
• Understanding term sheets: The term sheet is a non-binding document that sets out the main features of the investment. It should be reviewed carefully as it forms the basis for the subsequent contract. Important points include the valuation, voting rights and exit conditions. Particular attention should be paid to anti-dilution clauses, control rights and liquidation preferences. A detailed understanding of these clauses can avoid conflicts later on. It should also be checked whether all points are legally enforceable and in line with the startup’s long-term strategy.
• Legal support: Professional legal support is essential to ensure that the contractual conditions are fair and legally sound. This includes checking anti-dilution clauses and control rights. An experienced lawyer can also help to identify unclear wording or disadvantageous clauses and make appropriate adjustments. Alternative suggestions for improving the contractual terms can also be made. Legal advice is also important to assess the long-term impact of certain clauses on the company structure and the founders’ freedom of choice.

Investment negotiations and contract conclusion

3.1. Bedeutung des Term Sheets The term sheet forms the basis for the subsequent contract negotiations and should be prepared and checked with great care. It defines the main features of the investment agreement and provides both parties with a legal framework for advancing the negotiations in a structured manner. It is important that the term sheet remains non-binding, as it only serves as a guideline for the detailed drafting of the contract. Critical points such as the valuation of the company, the way in which capital is provided and the investor’s co-determination rights should already be clearly outlined here. Legal advice is essential to ensure that no disadvantageous wording is used that could weaken the startup’s negotiating position. 3.2. Verhandlung von Vertragsklauseln The precise drafting of contractual clauses is the most important step in investment negotiations. Anti-dilution clauses play a central role here, as they protect investors from a devaluation of their shares in future financing rounds. Liquidation preferences should also be discussed in detail, as they regulate the order in which investors and other shareholders are paid out in the event of a sale or liquidation. Other important points are vesting clauses for founders’ shares, which ensure that founders remain in the company in the long term. Drag-along and tag-along rights should also be negotiated to avoid conflicts in the event of a sale of the company. Without sound legal support, disadvantageous clauses could have a negative impact on the startup in the long term. 3.3. Abschluss und notarielle Beurkundung Once all contractual terms have been successfully negotiated, the formal conclusion of the agreement is the next step. In Germany, changes to the articles of association, such as the addition of new shareholders or capital increases, must be notarized. This ensures that the agreements are legally effective and fully documented. The notary takes on the role of a neutral auditor who ensures the legality of the contract. After notarization, the agreement is entered in the commercial register, which makes the new agreements public and binding. It is important for the startup that all documents are finally checked before notarization in order to rule out errors or unclear provisions.

After the investment – cooperation and conflict management

4.1. Zusammenarbeit mit Investoren Once the investment has been completed, effective collaboration with investors is crucial for long-term success. Regular reporting through financial and annual reports can help to create transparency and build trust between the parties. To this end, reporting obligations should be contractually defined, specifying the frequency and scope of reporting. Investors can also act in an advisory capacity by taking a seat on the startup’s advisory board. It is important to contractually define the exact role and expectations of investors to avoid misunderstandings. This promotes clear communication and prevents potential conflicts. 4.2. Conflict Management Conflicts between start-ups and investors are not uncommon, despite good preparation. To resolve such conflicts, contractual dispute resolution clauses such as mediation or arbitration can be agreed. The advantage of these methods is that they are faster and cheaper than court proceedings. In addition, the contract should stipulate how disagreements over strategic decisions are to be handled, for example through majority decisions or veto rights. Well thought-out conflict management avoids escalation and ensures stable cooperation. Legal support can help to formulate fair and enforceable clauses. 4.3. Exit strategies A clearly defined exit plan is essential for both sides, as it enables investors to realize their return and opens up new prospects for the startup. Typical exit options are an IPO, the sale of the company (trade sale) or the repurchase of shares by the founders. It is important to make contractual arrangements that clearly define the conditions and processes of an exit. These include drag-along and tag-along clauses, which ensure that all shareholders participate in a sale or that an investor can pull his shares. A transparent and well-prepared exit strategy strengthens the partnership and minimizes the risk of disputes.