World Law Group member firms recently collaborated on a Global Venture Capital Guide that covers more than 30 jurisdictions on investment approval processes, typical investment sectors and investment structures on Venture Capital deals (and more!).
The guide does not claim to be comprehensive, and laws in this area are quickly evolving. In particular, it does not replace professional and detailed legal advice, as facts and circumstances vary on a case-by-case basis and country-specific regulations may change.
This chapter covers Germany. View the full guide.
1) In your jurisdiction, which sectors do venture capital funds typically invest in?
According to the latest studies, e-commerce is still the sector attracting the most venture capital (VC) investors in Germany. In addition, the number and volume of investments in FinTech and InsureTech start-ups grows constantly. Recently, we noticed a rapidly increasing interest and larger investment volumes in healthcare, artificial intelligence, food, and mobility.
2) Do venture capital funds require any approvals before investing in your jurisdiction?
No. Approvals (other than antitrust clearance, as the case may be) in general have minor significance for German VC investments.
3) Are there any legal limitations to an offshore venture capital fund acquiring control or influencing the business, operations, or governance of an investee entity?
Such legal limitation becomes relevant only if a foreign investor envisages investing in a company which operates in sectors that affect national security interests (e.g., war weapons, military key technology, IT security software). In this case, the acquisition of 10% or more of the shares in the investee entity is subject to a governmental control under the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz). Recent amendments to the law identified additional critical technologies to be covered by the national investment screening, including artificial intelligence, robotics, semiconductors, biotechnology and quantum technology. In light of the Covid-19 pandemic also companies from the healthcare sector have been included in the list of particularly safety-relevant companies, such as vaccine manufacturers and manufacturers of medical protective equipment.
4) Would an investor be required to undertake an antitrust analysis prior to investment? When would such a requirement be triggered?
The acquisition of a majority shareholding may be subject to an antitrust analysis by the Federal Cartel Office (Bundeskartellamt) or, in EU-wide affairs, by the European Commission. In some cases, the acquisitions of minority shares may be subject to such analysis as well. A thorough analysis is required if an acquisition of shares enables the investor to exert a decisive and thus anti-competitive influence on the target company. Control over shares or voting rights of at least 25% is a precondition for such influence. An antitrust analysis also has to be carried out if two or more investors would exercise joint control. A filing with the Federal Cartel Office (Bundeskartellamt) is always required when the parties involved in a transaction have a combined worldwide turnover of more than EUR 500 million (approx. USD 554 million), and, within Germany, one of the parties achieves a turnover of more than EUR 25 million (approx. USD 27 million) and one of the other companies achieves a turnover of at least EUR 5 million (approx. USD 5.5 million). In cases of the aforementioned criteria of one of the other companies having a turnover of at least EUR 5 million not being met there would still be a requirement for a filing in cases where the value of the consideration for the transaction is higher than EUR 400 million (approx. USD 443 million).
5) What are the preferred structures for investment in venture capital deals? What are the primary drivers for each of these structures?
Due to a lower statutory share capital, a cheaper and quicker foundation process as well as less restrictive legal regulations, VC-funded companies tend to choose the legal form of the German limited liability company (GmbH) rather than the German stock company (AG).
VC deals take place in subsequent equity financing rounds and usually result in a minority shareholding for the investor(s). In the scope of an equity financing round, new “preferred shares” in the target company are issued by a shareholders’ resolution. In most cases, the new preferred shares have divergent rights and obligations compared to the common shares and the already existing preferred shares. The preference rights usually include a liquidation preference leading to a preferred distribution of potential future proceeds. In earlier financing rounds (Series Seed and Series A) such liquidation preferences are senior; in Series B and later, pari passu liquidation preferences on the same level with existing preferred shares have become more common.
VC investors frequently provide companies with capital via convertible loans. The underlying agreements tend to be less complex and allow a quicker inflow of cash, which is often utilized in the company’s seed stage or as a bridge financing between two equity rounds. The conversion is advantageous as it occurs with a discount on the share price of the new preferred shares or even with a valuation cap.
6) Is there any restriction on rights available to venture capital investors in public companies?
No. According to German law, there are no particularities with regard to VC investments in public companies.
7) What protections are generally available to venture capital investors in your jurisdiction?
Besides the liquidation preferences mentioned above, there are numerous protections to safeguard VC investors and their contributed capital. The statutory provisions entitle investors, as shareholders of the company, to a variety of information rights, access to the books and records of the company, dividends, voting, or subscription rights. In addition to such statutory rights, VC agreements usually contain further protective rights for the investors such as anti-dilution provisions, the establishment and composition of an advisory board, approval requirements for business matters, rights of first refusal, or co-sale rights.
8) Is warranty and indemnity insurance common in your jurisdiction? Are there any legal or practical challenges associated with obtaining such insurance?
Warranty and indemnity insurance is rather unusual in VC transactions. Such insurance appears more frequently in conventional private equity deals or majority sales. VC investors rely on contractual indemnities, the right to claim damages, and specific relief in law.
9) What are common exit mechanisms adopted in venture capital transactions, and what, if any, are the risks or challenges associated with such exits?
Exits, meaning at least the disposal of the VC investors’ participation in the company, usually occur in four ways: (i) initial public offering (IPO), (ii) sale of the company’s shares outside the stock exchange to another investor (Trade Sale), (iii) re-purchase of the investors' shares by the founders or company, as well as the (iv) winding up of the company subsequent to an asset deal involving the majority of assets and liabilities.
Each of these exits confronts the involved parties with its own challenges. This is especially the case with IPOs. The formation and administration costs of a German public company is a time-consuming and expensive process and the legal requirements for the structuring are restrictive. Furthermore, many IPO provisions contain lock-up periods that keep the investors from disposing their participation until a longer period of time (e.g., six or twelve months) has elapsed. Given this lack of flexibility, the IPO is rarely chosen as an exit in the VC environment. Instead, exits primarily occur in the form of a Trade Sale (particularly to strategic investors or private equity funds).
10) Do investors typically opt for a public market exit via an IPO? Are there any specific public market challenges that need to be addressed?
As mentioned above, the IPO as an exit mechanism is rather uncommon in German VC.
Dr. Jens Wolf
Want to Learn More?
The objective of this publication is to serve as a Q&A-style multi-jurisdictional guide to venture capital law in countries where WLG member firms have offices. The guide intends to provide a high level overview of the venture capital market, including key sectors, preferred investment structures, regulatory approval requirements, limitations on acquisition of control in portfolio companies, restrictions on investment, investor protection, and exits; and hopes to provide readers the benefit of the shared global knowledge and local insights among the WLG member firms.