Guest Post by Roman Rericha
Roman Rericha is a partner at BTP and specializes in M&A transactions, financings, corporate and capital markets law. He is in charge of complex and cross-border M&A and private equity transactions, both on the vendor and customer sides, and advises national and international companies on reorganizations and financing.
Their initiave BTP Nährboden supports startups with important legal advise.
Finding the right type of financing
When raising money as a start-up, one of the first questions regarding is likely to be: What needs to be considered from a legal point of view? There are, indeed, many aspects that founders of new businesses should bear in mind in case they seek either debt or equity financing. This choice is often made for the start-up as most start-ups will only have very limited access to debt financing given the status of their business and the limited assets available as security. Thus, this article focuses on aspects to be considered when performing an equity financing round.
Equity Financing / Shares
Equity financing means that the respective investor will become a shareholder in the company and, as a consequence, obtain certain rights and obligations with respect to the company. For example, an investor may share in the company’s profits (either on a pro rata basis or with the investor benefiting from dividend preferences) or vote at the shareholders meeting. Additional rights that institutional investors (such as venture capital funds) commonly require include the incorporation of certain reserved matters, meaning a list of actions that might not be performed without the investor’s prior written approval. Such reserved matters usually include
- changes to the company’s operative legal documents,
- important business decisions for the company,
- capital expenditures above a certain threshold or
- any party-related transactions between the company and the founders.
The investor will also be subject to obligations as a shareholder such as transfer restrictions in relation to the shares in the company. Such restrictions usually include
- lock-up periods (meaning periods during which no shareholder may sell its shares,
- pre-emptive rights (meaning under specific circumstances (e.g. in case of an envisaged sale of its shares in the company) the first offer or first right of refusal of its shares by or to the other shareholders),
- tag-along rights (meaning the right to participate in a sale negotiated by another shareholder) and
- drag-along rights (meaning the right of the majority shareholder to force the minority shareholders to participate, on the same terms and conditions, in a sale).
While the rights and obligations introduce complexity to the company, the capital is vital to its success and the expertise of external investors can be of pivotal importance for development and growth of the business. In many cases institutional investors provide access to their network to start-ups, thereby supporting them to be successful in a competitive environment.
However, when choosing strategic partners, start-ups should be very careful as – in most cases – they enter into a long-lasting relationship and, by nature, lose some of their initial influence. Taking an equity investment means choosing a strategic partner who will assist your business but require ownership (and influence). You should ensure that you view the business similarly and have realistic expectations about the shared endeavor so that the relationship will be a long-lasting one.
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