Startup financing rounds in Germany - from seed to Series A-D to exit
Seed Stage, Early Stage, Growth Stage and Later Stage explained by lawyer
As a company grows, its capital requirements also increase. Since only a few startups are able to make a profit from the outset (bootstrapping) in german practice, they are dependent on investors to finance product development and growth. Depending on the growth phase of the financed company, different financing rounds or financing phases are distinguished in Germany.
Our expertise on the topic of financing rounds in german practice
Our lawyers, certified specialists and tax advisors at our offices in Berlin, Hamburg, Munich, Frankfurt and Cologne provide comprehensive advice to founders, shareholders and investors on financing rounds / VC financing in Germany:
- Advice on deciding on the appropriate form of financing
- Drafting, reviewing and negotiating NDAs and term sheets, convertible loan agreements and silent partnerships
- Drafting, review and negotiation of participation agreements / investment agreements
- Drafting, review and negotiation of accompanying contracts such as articles of association, shareholders' agreements, managing director agreements and rules of procedure as well as employee participation programs
- Out-of-court and judicial enforcement or defense of claims arising from investment agreements and financing obligations
An overview of our range of consulting services for german startups can be found here:
Venture capital in return for shares in the german company / equity investment
The term venture capital financing (or venture capital, risk capital or VC for short) describes the equity financing of growth-oriented young german companies. In contrast to conventional loan financing in german practice, venture capital financing does not require collateral, in particular physical collateral. In return, however, VC investors are promised special economic advantages or guarantees in Germany (see below).
In contrast to lending banks, investors themselves participate in the german companies they finance as part of a financing round. This is regularly done by the investors acquiring new shares in the company as part of a capital increase in return for paying a so-called premium into the company's coffers. In simple terms: for a share with a nominal value of EUR 1.00, the investor must put in EUR 10.00 as capital.
Unlike in the case of a sale of company shares, the invested capital thus does not flow to the founders, but to the company itself in german practice. This ensures that the financed company can continue to grow.
Depending on the classification, a distinction can be made between four different development phases under german law: Early stage (seed stage); actual start-up phase (early stage), growth stage (growth stage), late stage (later stage).
Seed Stage - Business Angels, Accelerators and Incubators in Germany
(Pre-)seed financing, which is at the beginning of the early stage financing of a start-up, regularly takes place before the actual company is founded under german law. Its purpose is to enable the german company to be founded and to finance the initial development of a business plan. The seed investment is intended to enable the founders to further elaborate their business idea and to develop a "prototype" of their product or service on this basis.
Since the capital requirement in the seed stage is regularly still comparatively low in german practice, seed financing can often still be financed by the founders' own financial resources or capital from their friends and acquaintances ("Family, Friends and Fools"). However, business angels are often already involved as investors in this early phase.
The financing volume in the seed stage includes at least the start-up costs (share capital and notary fees), but can also be in the mid-six-figure range, depending on the product and the industry.
In addition to seed financing, german startups in the seed stage can also receive further material support through participation in accelerator or incubator programs, in particular through the free provision of premises and infrastructure. Well-known names here include German Accelerator, SpinLab, 1st Mover and hub:raum; however, new names are constantly pushing their way in.
German students and university graduates in particular are supported by the EXIST start-up grant from the German Federal Ministry of Economics and Technology (EXIST program for start-ups). Universities often also offer corresponding consulting services, for example in Berlin (TU, FU, HU), Munich, Frankfurt, Cologne and Hamburg.
Early Stage - (silent) participation, convertible loan, High-Tech Gründerfonds (HTGF) in Germany
The seed stage is followed by the startup stage or early stage. In this phase of the company's development, the focus is on developing its product to market maturity.
Depending on the specific industry of the german company, this may require capital-intensive testing or approval procedures, which are made possible by an early stage financing round. The additional capital raised in this phase is also used to build up basic corporate structures that are essential for controlled corporate growth at a later stage. In the early stage, part of the financing is also used for the company's start-up marketing.
As the german company has not yet entered the market in the early stage, it is still difficult to estimate the value of the company. For this reason, convertible loans are particularly popular with investors and companies alike in this phase of corporate financing, as the question of the company valuation of the start-up can be postponed until the next financing round after market entry in german practice. In the case of a convertible loan, instead of repayment of the loan amount and interest, a "conversion" of the repayment obligation into an equity participation in the company is pursued in Germany. Simple: the company exchanges the repayment obligation for shares in the german company (details on our special page on convertible loans).
An alternative form of investment often chosen by state-financed funds in Germany is the silent partnership. This is a more traditional form of financing in german practice. In this case, money is usually injected into the german startup in exchange for the prospect of future profits. Instead of money, the silent partner's contribution can be in the provision of services or operating equipment. The silent partnership also offers great flexibility in other respects; it is usually underestimated in german practice.
Probably the most active and largest early-stage investor in Germany is the High-Tech Gründerfonds (HTGF). This VC fund, which is fed by public and private money, targets young, innovative german high-tech startups in all industries. Investments are only made in start-ups that are not older than 3 years and have not yet been financed with more than 500,000 EUR (equity, silent partnership, convertible loan). Our lawyers, certified specialists and tax advisors have extensive experience with the contracts used by HTGF.
Founders and investors in Germany should not neglect the foresight and drafting of contracts and agreements in what experience has shown to be a hectic early phase. Thus, NDA, term sheets, articles of association, participation agreement, shareholders / investment agreements set the course for the future!
Growth Stage - Growth Financing with Series A to D under german law
Once the early stage has been completed with the company's market entry, the growth stage begins, also known as the second stage or growth stage. The focus in this phase of the company's development is on establishing the german company as a permanent fixture in the market and ensuring that it can hold its own and prevail against the competition. Since rapid growth is regularly required in order to successfully occupy a highly competitive market, german companies have a particular need for capital, especially during the growth stage in german practice.
The successive financing rounds in the growth phase are regularly designated according to the alphabet in Germany (Series A, Series B, Series C, Series D). However, there is no exact nomenclature, so that in some cases even the first major financing round in the growth phase is referred to as Series A - the designation of the subsequent financing rounds then "shifts" accordingly.
Overall, the risk for investors in the growth phase tends to decrease with each additional financing round, as the german company has been on the market for longer and its performance and market position can therefore be increasingly assessed. On the other hand, the volumes of financing rounds continue to increase as the company grows and expands. As a result, professional venture capital funds are increasingly acting as investors, rather than private individuals or individual business angels in german practice.
What is stated in the german participation agreement (shareholders' and investment agreement)?
As the company grows, the amount of funds involved, and therefore the risk, increases. In addition, the number of investors involved usually increases. In german practice, this leads (or, in the best case, should lead) to the relevant contractual documents becoming more professional and differentiated.
Particular importance is attached to the participation agreement under german law (or >>shareholders' agreement, investment agreement).
The investment agreement usually contains provisions on the following aspects, among others
- Investment obligations
- cap table
- drag along / tag along,
- revenue preferences and liquidation preferences in favor of the investors
- Company valuation (pre-money, post-money),
- Guarantees of the founders
- Vesting at the expense of the founders
- Non-competition clauses to the detriment of the founders
- Dilution protection
Participation agreements are complex contracts which must be approached with respect due to their length of often 20+ pages. In particular, german founders who frequently relinquish "power" in participation agreements are advised to examine them carefully. The involvement of experienced advisors on both sides professionalizes the negotiation process and the negotiation result.
Later Stage - Working towards Exit, Initial Public Offering (IPO) in Germany
Especially when the german company has achieved a turnaround and is in the black, classic financing rounds are no longer the means of choice in german practice. It is not uncommon for this phase in Germany to be followed by a (partial) exit by the founders and VC investors.
This exit often consists of the sale of the investment to long-term oriented investors. In this phase, these strategic investors increase an existing investment or acquire the company in its entirety.
It is rather rare for a successful startup to exit via the stock exchange. It is equally rare for a startup with a market valuation of over one billion US dollars to become a so-called unicorn. But you never know.