Category: Venture Capital
The Venture Deals course is free and starts on June 20, 2023.
This is the fourth time we are running the new version of the course (v2!) that was co-created with Techstars and Kauffman Fellows.
If interested, sign up now. I hope to see you in one of the AMAs we will host for anyone who takes the course.
There have been many different language translations of Venture Deals since it was first published in 2012. The first German translation of Venture Deals 4e is out, and Florian Kreis did an amazing job.
Florian aimed to modify the book as little as possible, even if the relevant passages did not correspond 100% to German best practices but were still feasible to implement. He believes the structures originally developed in the U.S. have become the international standard and are a great role model for Germany.
However, the challenge in revising the book this way is putting these structures into the context of German law. Sometimes, this required minor changes or simply using the correct language. In other cases, it was a lot more challenging.
Following, in Florian’s words, are several examples of things he had to modify more extensively.
Corporate law: In Germany, most companies in general and most VC-financed companies are structured in the legal form of a “Gesellschaft mit beschränkter Haftung” (GmbH). Larger companies often convert to the “Aktiengesellschaft” (AG) later, especially if they want to go public. Both the GmbH and the AG are corporations. In addition, many GmbH & Co. KG companies exist in Germany. They correspond in their structure roughly to a Limited Liability Company (LLC). GmbH & Co. KG companies have decisive tax disadvantages for startups and are, therefore, rarely used in this area. The GmbH has a great advantage in that it can be structured very flexibly. You can deviate from the legal regulations to a very large extent, and in practice, you do so. Most of the VC structures from the US best practice can be integrated into the GmbH structure. Often, this integration results in VC-financed GmbH companies having little to do with the GmbH as envisaged by the law.
Board of Directors: There is no board of directors in Germany. In the GmbH, the most important body is the shareholders’ meeting. The shareholders are represented there and usually have voting rights in proportion to their shareholdings. In addition, there are the managing directors as executive bodies. In the VC sector, it is common to introduce a third body in addition to the shareholders’ meeting and the management. This third body is often referred to as an advisory board (Beirat), sometimes also as a supervisory board (Aufsichtsrat). In practice, certain functions of the shareholders’ meeting are transferred to such an advisory board, for example, the appointment and supervision of the managing directors or the decision-making capacity in the case of protective provisions. In the end, however, it is the shareholders’ meeting that remains the most important body in the GmbH.
Conversion right: In Germany, there is generally no conversion right entitling the holder of preferred shares to convert them into common shares at any time. This may not seem like a big deal at first glance, but it has extensive implications under various aspects, such as the structure of the liquidation preference. In the USA, the conversion right ensures that holders of preferred shares are not disadvantaged compared to holders of common shares; in Germany, this legal consequence must result directly from the structure of the preferred shares. In some cases, this causes confusion in terms of terminology: In Germany, the participating preference is referred to as the “nicht anrechenbare Liquidationspräferenz” (non-compensable liquidation preference), while the non-participating preference is referred to as the “anrechenbare Liquidationspräferenz” (compensable liquidation preference). Hence, the negation is exactly in reverse. However, the lack of a conversion right also has implications for anti-dilution protection: in the U.S., this is usually done by adjusting the conversion price. In Germany, anti-dilution protection is achieved by issuing additional preferred shares. The lack of conversion rights must also be considered when structuring voting rights.
IPO issues: Possibly the biggest problem for German venture-backed companies is the very low number of IPOs in Germany. The boom years of 1998 (79 IPOs), 1999 (175 IPOs), and 2000 (142 IPOs) are long gone. In 2022, just as in 2009, there was only one IPO; typically, there are between three and 16 per year. Since the attractiveness of investments is also largely related to exit channels, this aspect affects the availability of capital and company valuation at every stage. It is not uncommon for companies wanting to go public to relocate their registered office to the USA at an early stage. There are also legal differences: Registration Rights, for example, are not legally binding. Piggyback rights are permissible, but due to legal regulations, they are not mandatory. Even though the regulations may not be binding or necessary in individual cases, they can help to bring the topic of going public into focus at an early stage and make it a subject of discussion.
Employment Issues: There are significant differences between Germany and the U.S. regarding employee issues. There is a reason why on page 264 of Venture Deals 4e, it states, “We’ve encountered some challenging situations in certain states in the United States that made firing almost as challenging as firing in parts of Europe.” This must have meant Germany… If a company regularly has more than ten full-time employees, terminations may only be made for certain reasons. Then you may only terminate those employees you actually still want to keep. These issues were problematic twenty years ago when the unemployment rate in Germany was relatively high, and terminated employees could not easily get a new job. Today, things are different: For some years, German has had a shortage of skilled workers, and companies are usually happy if they can find suitable employees.
Employee option pool: The framework conditions for employee option pools remain a major problem in Germany. The tax framework and valuation issues are particularly complex and not very employee-friendly. While there was a major law reform in 2021, the regulations are still inadequate. Even after the 2021 reform, employee option pools will continue to be structured via phantom stocks, as this is the only way to reliably avoid the dry-income problem. This topic is important and complex, so I dedicated a separate chapter (chapter 20) to it in the German edition.
Regulatory framework: There are major differences between the U.S. and Germany in the regulatory framework, which in Germany is supervised by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). This affects not only the large IPO in the late stage but also the small crowdfunding round in the early stage.
Other special features: At various points in the book, there are references to the German Standards Setting Institute (GESSI), which was founded by the Business Angels Netzwerk Deutschland e.V. (BAND) and the Bundesverband Deutsche Startups e.V. (German Startups Association). GESSI develops standardized sample contracts comparable to the National Venture Capital Association in the USA, which are available online at www.standardsinstitute.de. The book also contains information on the INVEST program, with which the Federal Republic of Germany supports investments in early-stage companies. Unfortunately, some of the explanations in this regard are already out of date following the most recent amendment to the law on February 6, 2023.
Samples: The samples in the Annex of the German edition, i.e., the Term Sheet and the Letter of Intent, are essentially based on the samples of the U.S. edition. The detailed work here was probably the most time-consuming. In the case of sample contracts, every word and every concept must be correct and corresponds 100% to the German legal situation. Both samples are bilingual. I partially dealt with the additional space requirements associated with bilingualism by merging the two-term sheet samples from the US edition into a single document.
Florian – thank you for the incredible and time-consuming effort here.
The course is free and starts on March 21, 2023.
This is the third time we are running the new version of the course (v2!) that was co-created with Techstars and Kauffman Fellows.
If interested, sign up now. I hope to see you there in one of the AMAs we will host for anyone who takes the course.
There have been many different approaches to ranking VC Firms over the years I’ve been an entrepreneur and a VC. Each approach I’ve seen has issues. Most are easily gamed or have statistical bias issues.
I got the following note from Roy Bahat at Bloomberg Beta a while ago about a new approach called Founder’s Choice.
We and a few other firms sponsored a “founders choice” version of the Midas List, with a legit (IMHO) rating methodology, built by two Penn students. No vitriol possible (unlike The Funded, etc.). We’ve wanted this to exist for a long time — NPS of us as a firm is too forgiving a metric, everyone scores well.
My first question was:
How are they dealing with sampling bias on this one? For example, we send to all our founders and say “please fill this out and give us high scores.” Mostly just curious on methodology.
Roy had a thoughtful answer that made me a believer after a few more questions.
You are literally the only one (and I’m relieved someone did) to ask on sampling bias. For context, the general way it works is founders auth with LinkedIn and then the product tosses away their identity (or, more accurately, only keeps a hash and disconnects it from their ratings). Then the founders get asked for pairwise comparisons of only the VC firms who have backed them (so this is about who founders like as investors, not who has sour grapes from a pitch). How this addresses, to a degree, sampling bias:
1. Dampens outliers: because it only asks for pairwise comparisons between firms (like an ELO rating in chess, if you’re familiar), one very un/happy respondent can only affect so much, and same for a sample. (As opposed to giving one firm a 10 and everyone else 2’s or something.)
2. At the same time, it forces comparisons. A firm can ask founders to rate them highly, but ultimately founders have to choose who gave them more value. Can’t rate everyone a 10.
3. This is why we’re looking for as broad participation as possible, because the sampling bias will actually probably most show up in which firms even have enough ratings to count. (Like ELO in chess, more ratings doesn’t necessarily help you — you get more “points” if a founder rates you as better than a highly-rated firm. More ratings can just as easily hurt as help.)
If you are a founder, go spend five minutes and anonymously rank your VCs on Founder’s Choice.
Registration for the Venture Deals Fall 2022 course is open.
The course is free and starts on September 20, 2022. This is the second time we are running the new version of the course (v2!) that was co-created with Techstars and Kauffman Fellows.
If interested, sign up now. I hope to see you there in one of the AMAs we will host for anyone who takes the course.
Connie Loizos is one of the long-time tech industry writers who I respect. I don’t respond to many interview requests these days, but I’ll always talk to her.
She has a good article today in TechCrunch titled Embrace the down round (it’s going to be okay, maybe). I like the quote she pulled out of me in our conversation.
[Brad Feld] says his “strong belief” that “just doing a clean resetting — at whatever the valuation so that everybody is aligned and dealing with reality — is much, much better for a company.”
Now, I’m not encouraging anyone to do a down round if unnecessary., especially when many existing investors are currently willing to add on additional dollars at the most recent valuation. If you can do this cleanly, take the money.
Rather, when you have a choice between a financing at a lower valuation and a financing with all kinds of crazy structure to try to maintain a previous valuation, negotiate the best price you can but do a clean financing with no structure.
If you don’t know what I mean by structure, they are terms like:
- Multiple liquidation preferences (you’ll start seeing lots of 2x and 3x on new money)
- Participating preferred on new money
- Weird ratchets (other than the typical weighted average), including full ratchets, on next round financings
- Annual preferred return, including PIK and cash pay on new money
- Blocks on all kinds of things that a new investor should not have blocking rights on
… and a bunch of other things.
Sometimes, given your syndicate configuration, you have no choice but to take structure in a new round. But if you can do a clean financing at a lower price, I always think that’s a better option for everyone (founders, employees, and existing investors.)
While my optimistic personality hopes this downturn/adjustment is short-lived, I fear it won’t be. So, as an entrepreneur, I encourage you to deal with reality.
Like many people, I’m currently deep in SPACland. I’ve been writing privately about it a lot but have now crossed over into a zone where I feel like writing more publicly about it.
When Jason and I wrote the first edition Venture Deals in 2011, we built off a series of 30+ blog posts we wrote in 2005 about Term Sheets. It’s fun to explore them for historical reference since Jack Bauer plays a major part in the posts.
While these posts were the seed for what is now a book (Venture Deals: Be Smarter Than Your Lawyer And Venture Capitalist), it was also a way for us to think through all the elements of a VC financing, back at a time when there was enormous opacity about how these worked, along with massive information asymmetry between people who did them all the time (e.g., us) and the entrepreneur, who did a few of these over her lifetime.
While the web is a much noisier place in 2021 than it was in 2005, the opacity and information asymmetry around SPACs are remarkably similar to what existed 16 years ago around venture deals.
The cliche “everyone’s an expert, but no one knows anything” applies. Yes, there are some experts, but not that many. And the amount of misinformation, misperception, opacity, and information asymmetry is enormous.
As I continue to write privately, I’m going to start writing more publicly. And I encourage comments, feedback, and corrections.
While there is much debate about SPACs, I believe they are a long-term part of the capital stack. They are evolving rapidly, which is part of what is so interesting about them, at least to me.
We are running the Venture Deals Online Course from March 7, 2021 – April 30, 2021.
We’ve moved the Venture Deals Community from Slack to Mighty Networks where we have much more functionality and flexibility.
Once again, we’ll do a weekly AMA with a variety of people participating.
For now, registration is open. Please sign up if you want to take the Spring 2021 Venture Deals Online Course.
We are running the Venture Deals Online Course from September 13, 2020 – November 6, 2020.
Our summer session had over 10,000 registrants and over 2,000 people completing the course. We got a lot of feedback about things to improve, several of which we are introducing into the Fall session.
Once again, we’ll do a weekly AMA with a variety of people participating. We are also creating a new Venture Deals online community available to all past and current participants of the course. We’ll provide the link for the online community on day one (we’ll be using Mighty Networks, which I’ve loved for my virtual Startup Community.)
For now, registration is open. Please sign up if you want to take the Fall 2020 Venture Deals Online Course.