At an event we held at our favourite co-working space, Factory, a member of the audience asked: “When should I incorporate my startup in Germany”? This sparked a debate about incorporating a startup in Germany pre- vs post-funding, the essence of which we distilled in this article for you.
Like most things in life, context is everything. Your individual situation will affect the answer to this question. Below we explore the different circumstances that would warrant incorporating before being funded, as well as the reverse.
- Scenario 1: Incorporate first. Funding second
- Scenario 2: Funding first. Incorporation second
- Understand who your potential investors are
When the time is right, I can help you get started
Hi, I’m Andreas. I have over a decade of experience advising companies on doing business in Germany. Let’s schedule a one-on-one consultation to answer any questions you may have about setting up your company.
First up, let’s explore a number of scenarios that could make pre-investment incorporation the better option.
Your business is raring to go
If you already have an MVP and the ability to go to the market then incorporating to gain limited liability in your business activities would be the way to go. This applies doubly if you’re also in the next category.
You need to test the waters first
If you discovered that you need to demonstrate your product’s market viability to be of more interest to investors, then incorporating a company to start attracting as many customers as possible would be the best option.
You want to take the driving seat
If you’re a seasoned entrepreneur and are confident that you’ll get a lot of interest from investors and want to play hardball, then incorporating a company puts you into the driving seat. Take initiative and decide what your terms are. Use this as a solid ground to negotiate with prospective shareholders.
Also, being in the driving seat can be advantageous if you’re only looking for a modest investment, as larger amounts of money usually come with more strings attached.
Your funding won’t be big-time VC money
Being in the driving seat can be effective if you’re targeting business angels and/or friends and family.
You want to be taken more seriously
Incorporating your business can also project legitimacy and make your operation appear bigger than it actually is. Depending on what type of business you have, some investors may want to invest in something more tangible.
A company before money: Things to think about
Go into the process with your eyes open. Incorporating first is usually only the best course of action if you are a sophisticated business person and have at least €12,500 to form a GmbH. Chances are, you’re not going to be taken as seriously if you opt to form a ‘mini-GmbH’ (a colloquial name of the UG). This point is also relevant if you want to start market testing – some customers will be wary if your company isn’t at least a GmbH.
If you’re forming a company just for the sake of it – entrepreneur beware! Below are some situations in which holding off on incorporation is the wise thing to do.
You’re bootstrapped until you can find funding
If you have a tight budget (i.e. because you’re still searching for funding) and are considering the UG option – carefully weigh up the pros and cons. Chances are you’ll convert the UG to a GmbH anyway, causing more of a costly bureaucratic headache than it’s worth.
You’re a startup newbie
If you are inexperienced and don’t know what you’re doing then waiting for a seasoned investor to guide you through the process as well as funding the €25,000 required GmbH share capital would be the best option.
Deferring incorporation is far better than stumbling through the dark with a UG, especially if you’re unsure of the terms you actually want to negotiate for. You’ll be faced with double the administration costs if you need to convert to a GmbH later down the track.
Also, if you’re a newbie entrepreneur dealing with a sophisticated investor, having a UG is neither going to be impressive nor strengthen your negotiating position. Ultimately, your company incorporation efforts are redundant in this situation.
You’re not ready for a serious commitment
Incorporating a company in Germany is in many ways like getting married. You can’t just annul it if your business doesn’t work out. In fact, after you decide to wind down a company you’re tied to it for at least another year as well as being faced with a host of accounting and associated expenses.
Remember, just like a divorce, winding down a limited liability company will be costly!
You’re pitching for big money
Most VC firms are staunch about the terms of their investment. If you want their money you’ll have to accept their terms. Thus, if you’ve incorporated your company beforehand, you’ll be forced to take a costly trip to your notary to get things changed.
However, that being said, if you have a lot of offers on the table then incorporating a company and setting down your own terms could position you in a stronger bargaining position.
You have an accelerator/incubator in your sights
If there’s a high probability that you’ll get into a structured startup program, then hold off from incorporating your company. This is important for two reasons:
First, many of the programs – similar to VC investors – will come with strings attached (especially if there’s funding involved) and you’ll have to accept their terms.
Secondly, many accelerators/incubators have company incorporation as part of their programs in which participants are guided through the process by an expert. For example, Entrepreneur First (EF) brought in us to manage the incorporation process of their latest cohort. Participants of the program were then advised to create holding structures because of their tax advantages.
EF embeds deadlines into its programs that necessitate its cohort to move quickly (something that all entrepreneurs should have as their modus operandi). Thus, being slowed down by the bureaucracy of company formation isn’t an option.
It is imperative that you learn everything about your business landscape. Only a comprehensive analysis of your particular situation will yield the right answer to the incorporation question.
If you think that there is a strong probability that your investor will come from outside of Germany, e.g. England, then there’s the possibility that they’ll only want to invest in an entity incorporated in their country of origin to take advantage of tax concessions.
Overall, however, this all depends on your type of business and who your investors might be. So, know your customer but – just as importantly – know your investor!
And, don’t forget sometimes you don’t need to incorporate at all. If you’re not in a risky business then save your money and just register as a business (get some professional tax advice to help you make an informed decision).