3 questions to smart minds

DOs and DON’Ts in negotiations with VC investors

For this 3 questions to Mauritz von Einem

ARQIS Attor­neys at Law, Munich
Photo: Mauritz von Einem
16. Janu­ary 2020

Start-ups and compa­nies in the growth phase are depen­dent on finan­cing from exter­nal capi­tal provi­ders. Due to the special risk profile, such finan­cing will regu­larly be struc­tu­red as equity or by means of equity-like finan­cing instru­ments. Finan­cing provi­ders and borro­wers should — despite funda­men­tally diffe­rent inte­rests — have the common goal of being relia­ble “part­ners” and of jointly leading the company to success with concur­rent interests. 

For this 3 ques­ti­ons to Mauritz von Einem, Attor­ney at Law and Tax Advi­sor ARQIS Attor­neys at Law, Munich

1. What constel­la­ti­ons exist among the parties in inves­tor negotiations?

In the context of an equity invest­ment, an inves­tor seeks to maxi­mize the terms of his own invol­vement in a company, prima­rily via the para­me­ters of low valua­tion, assu­rance of special finan­cial rights, such as liqui­da­tion prefe­ren­ces, and special non-mone­tary rights, such as appr­oval requi­re­ments or advi­sory board seats. Foun­ders natu­rally seek to opti­mize their own posi­tion prima­rily by maxi­mi­zing valua­tion and limi­ting co-deter­mi­na­tion rights.

In prac­tice, it can be obser­ved that in many finan­cing rounds of young, fast-growing compa­nies, there is often one party with a clear prepon­derance of nego­tia­ting power and ther­e­fore does not neces­s­a­rily nego­tiate with the other side on an “equal footing”. If, howe­ver, this bargai­ning power is exploi­ted too much when estab­li­shing the VC parti­ci­pa­tion, which is typi­cally struc­tu­red as a mino­rity inte­rest, a coun­ter­ac­ting effect often occurs and the goal of a balance of inte­rests is missed. The parties fall into a mode of suppo­sed opti­miza­tion of parti­cu­lar inte­rests, which is seldom to the bene­fit of the company and, in the end, of all invol­ved. Against this back­ground, both parties should have an inte­rest in agre­e­ing on appro­priate, fair and trans­pa­rent condi­ti­ons and para­me­ters for a good and profes­sio­nal coope­ra­tion from the very beginning.

2. What recom­men­da­ti­ons do you have for foun­ders when nego­tia­ting with investors?

The core of a successful finan­cing round and often also of successful growth is solid prepa­ra­tion on the part of the company. The valua­tion is a central para­me­ter for the extent of the investor’s econo­mic parti­ci­pa­tion in the company to be finan­ced. Here, a reali­stic self-assess­ment of the foun­ding team is stron­gly advi­sed. Contrac­tual arran­ge­ments should include appro­priate mone­tary privi­le­ges for inves­tors. — Mile­sto­nes can be an important part of a funding agree­ment as inter­me­diate steps and inter­nal and exter­nal check­points, and can serve as a useful stock-taking exer­cise at appro­priate times. In addi­tion to special mone­tary rights, infor­ma­tion and co-deter­mi­na­tion rights are another key element of VC finan­cing. In this area, too, an adequate and balan­ced struc­tu­ring of rights can posi­tively accom­pany the company and promote its development.

3. What measu­res in parti­cu­lar can be helpful for the founders?

Adequate ongo­ing report­ing and up-to-date accoun­ting should be a matter of course. The foun­ders should also leave no doubt about the IP (Intellec­tual Property) situa­tion of the company from the outset.

Of course, when it comes to the concrete design of the para­me­ters of parti­ci­pa­tion, there are nume­rous possi­ble designs that vary in detail and are deter­mi­ned by the indi­vi­dual nego­tia­ting power and skill, infor­ma­tion asym­me­try and indi­vi­dual assess­ments and level of expe­ri­ence of the parti­ci­pants. — The aim should be to imple­ment clear, fair regu­la­ti­ons that can also be imple­men­ted and are appro­priate to the company’s stage of deve­lo­p­ment and that posi­tively accom­pany the company’s development.

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