befi august 26 startup legal 101

AXEL SPRINGER PLUG AND PLAY ACCELERATOR

Stefan Kimmel, Thomas Skowronek, Lukas Kawka

16 July 2014

Legal // Tax // Accounting

(selected topics)

2 © 2014 KPMG AG Wirtschaftsprüfungsgesellschaft, a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG

International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

Agenda

Founding 1

Employees 2

Investment Agreements 3

Selected Tax Topics 4

Accounting 5



Agenda

Founding 1

Employees 2



Accounting 5



Growth stages of STARTUP COMPANY

Stage overview

1. Founding

The business idea of STARTUP

COMPANY has moved into a legally

existing company

■ Choosing the legal form that is suited

best

■ Considering the set-up from an

employment side (own staff/

subcontracts/ leased workers

■ Choosing the right type of

employment contract

■ Setting up a tax efficient corporate

structure (i.e. regarding a future exit)

■ Tax optimized contribution of existing

assets (e.g. IP) in the startup

company

3. Exit

The business idea of STARTUP

COMPANY has moved into a legally

existing company

2. Development

STARTUP COMPANY has gained

higher market share and needs to

expand its personnel to cope with the

growth

■ Search for investors

■ Negotiate investment agreements

■ Working Time restrictions

■ Handling disputes with employees

■ Implementation of employee

participation programs

■ Employees vs. freelancer

■ Internationalization of the business

model (tax aspects)

■ Tax compliance

Legal aspects 1



Typical legal questions of founders

What do I have to do to secure

my investment from a legal

perspective?

How to avoid common

legal mistakes (e.g.

data/consumer

protection)?

What does an investment

agreement mean for my life?

How to form a

company?

What do I have to

consider to adequately

protect my Intellectual

Property?

When should I

involve legal

advisors?



Legal Entities

AG

Verein

Kapital-

gesell-

schaften

Personen-

gesell-

schaften

BGB-

Gesell-

schaft

OHG

Körper-

schaften

KG

GmbH &

Co. KG

Zusammen-

schlüsse

von

Personen

Personen-

handels-

gesell-

schaften

Publikums-

gesell-

schaft

Genossen-

schaft

GmbH



Corporate

Overview: Typical Legal Forms for Startups

Minimum Share

Capital

Liablitiy of the

Shareholders

Formal

Requirements for

the Foundation

(Management)

Bodies Transfer of Shares

GbR None Unlimited None None Consent of the other

shareholders required

GmbH € 25,000 Limited to the

company‘s assets

Notarization required

(costs approx. €

500.00)

Management,

shareholder‘s

meeting, voluntarily:

Supervisory board

In general no consent

of the other

shareholders

required, notarization

mandatory

UG

(haftungs-

beschränkt)

€ 1.00 Limited to the

company‘s assets


(costs approx. €

500.00)

Management,

shareholder‘s meeting


of the other

shareholders

required, notarization

mandatory

AG € 50,000 Limited to the

company‘s assets


(costs approx. €

700.00)

Management, general

meeting, supervisory

board


of the other

shareholders

required, no formal

requirements



Legal Forms

Partnership under the German Civil Code (GbR)

Partnership under the German Civil Code (Bürgerliches Gesetzbuch – BGB) Gesellschaft bürgerlichen

Rechts – „GbR“ (also „BGB-Gesellschaft“)

Minimum of two shareholders

Shareholders need to pursue an economic or ideal purpose

No formal foundation necessary (i.e. no written articles of association)

Therefore: In case two or more persons act together for an economic or ideal reason, in most cases this is already

considered a GbR (e.g. when the business plan is prepared)

Unlimited personal liability of the shareholders

In general all shareholders together are authorized to conduct the GbR‘s business and to represent the GbR



Legal Forms – GmbH (UG)/AG

Corporate Governance and Structure

Limited Liability Company (GmbH/UG)

(haftungsbeschränkt)) Stock Company (AG)

Articles of Association ■ In many areas, flexible provisions and

provisions that deviate from legal regulations

can be laid down in the articles of association

■ Principle of formal strictness of the

articles: Provisions that deviate from legal

regulations are only possible in the case of

explicit legal admissibility

■ Thereby transparency with regard to

applicable provisions on principles about

corporate governance, liability of corporate

bodies, protection of minority shareholders

etc.

Organization ■ Two- or threefold structure:

– Managing directors and shareholder meeting

– (in general) voluntarily: supervisory board/

council

■ In general supervision of managing directors by

the shareholder meeting, delegation of

competences to supervisory board/council and

other bodies possible

■ Threefold structure:

Management board, supervisory board and

general meeting

■ Supervision of the management board by

the supervisory board





GmbH/ UG (haftungsbeschränkt) AG

Management The managing directors manage the business

activities and represent the company in dealings

with third parties

The management board manages the

business activities and represents the

company in dealings with third parties

Supervisory Board ■ Implementation of supervisory board only on a

facultative basis

■ Exception: Supervisory board is mandatory

due to co-determination of employees (if more

than 500 employees)

■ Supervisory board is mandatory

■ Supervisory board supervises and controls

the activities of the management board

Organization of the

shareholders

■ Shareholder meeting

■ Convocation by registered mail

■ 1 vote per € 1,- of a share

■ Shareholders have the authority to issue

instructions to the managing directors by

shareholder resolution

■ General meeting

■ Convocation by public announcement or

registered mail

■ Voting right in accordance with the number

of shares respectively the par value of the

shares

■ No authority to issue instructions with

regard to management matters by the

general meeting or the supervisory board



GmbH/UG (haftungsbeschränkt) AG

Information rights of the

shareholders

■ Each shareholder is entitled to request

information from the managing directors

regarding the company affairs and to request

access to the company’s books principally at

any time

■ Information has to be provided “without undue

delay” by managing directors

■ At the general meeting, shareholders can

request information from the management

board regarding company affairs insofar as

they are required to appropriately judge the

object of the agenda

■ No right of information regarding

individual items

Share Capital ■ GmbH: Minimum share capital: € 25,000;

contribution in kind is permitted.

■ UG (haftungsbeschränkt):

– Minimum share capital € 1.00

– Obligation to form a statutory reserve

(gesetzliche Rücklage), 25% of the yearly

profits minus the losses need to be paid into

such statutory reserve until the company

increases its share capital to a minimum of €

25,000

– No contribution in kind permitted

■ Minimum share capital: € 50,000






Duties ■ Full representation of the company in dealings

with third parties

■ If there are several managing directors, they

represent the company jointly,

sole power of representation may be granted

■ Pursuit of the company‘s objects by

determination of how to use the resources of

the company

■ But: Margin of discretion towards shareholders

in case of management measures is smaller

(limited application of the business judgment

rule)

■ Legal obligations like keeping of books,

preparation of annual accounts etc.

■ Full representation of the company by the

management board in dealings with third

parties

■ If there are several members of the

management board, they represent the

company jointly, sole power of

representation may be granted

■ The management board is required to

manage the company under “its own

responsibility”, this includes management

and guidance

(so-called business judgment rule)

■ The management boards’ obligations

comprise its own legal compliance and its

enforcement at lower levels, this includes

organizational obligations and preventive

control


Management I




Management II


Membership ■ Managing directors may be appointed by the

shareholder meeting, the articles of association

may provide for the appointment by the

supervisory board

■ Appointment for an indefinite period of time

possible

■ Further rights and obligations can be

established in the management service

agreement

■ Revocation is possible at any time by

shareholder resolution (or as the case may be

resolution of supervisory board or council in

case of an according determination in the

articles of association)

■ Revocation is also possible without an

important reason

■ Management board members are appointed

by the supervisory board

■ Appointment for a maximum period of five

years

■ A repeated appointment or extension of the

period in office is possible for a maximum

period of five years (contractual

commitments of a longer appointment or

repeated appointment are ineffective

according to the prevailing view in law

literature and jurisdiction)

■ Revocation by the supervisory board only

for good cause, e.g. serious violation of

duties, incapacity to carry out management

duties or withdrawal of confidence by the

general meeting

– Management service

agreement –

■ Management service agreements of managing directors and members of the management board

may determine further rights and obligations, in particular as to the period of appointment and the

remuneration, management service agreements have to be terminated separately from the

revocation




Management III


Management competences ■ Shareholders are entitled to give instructions

by shareholder resolution to the managing

directors also in day-to-day business

■ Extensive catalogue of reserved matters that

require the consent of the shareholder

meeting, supervisory board, council or

additional bodies can be laid down, also in the

area of day-to-day business

■ Principally, shareholders have no influence

regarding the management since the

management board is acting free of

instructions; the management board is not

subject to any instructions from the

supervisory board

■ Catalogue of reserved matters that require

the consent of the supervisory board is

admissible, but only in case of significant

business transactions of a certain type,

reserved matters in the area of day-to-day

business are not permitted

■ Reserved matters that require the consent

of the general meeting are not permitted

■ The supervisory board may adopt rules of

procedure for the management board (in

case of several members)




Management IV


Liability ■ Formal discharge of the managing directors

results in the waiver of claims towards the

respective managing director regarding such

facts, which the shareholders already know or

should have known due to reports made by the

managing directors or arising from documents

submitted by them

■ No liability towards the company in case of

acting on the basis of an effective instruction

by the shareholder meeting, unless creditor-

protecting provisions are contradictory or the

instruction is illegitimate

■ In case a D&O insurance is contracted, the

managing directors are not legally obliged to

agree on an excess

■ Formal discharge of Management Board

and Supervisory Board does not represent

a waiver of damage claims

■ No liability in case of transactions

undertaken due to a legitimate resolution by

the General Shareholders‘ Meeting, for

which the Management Board can

exceptionally ask the General

Shareholders‘ Meeting

(exception: infringement of creditor-

protecting provisions)

■ Incorrect statements regarding the state of

the company in the General Shareholders‘

Meeting are penalized, § 400 AktG

■ In case a D&O insurance is contracted, the

management board is obliged to agree on

an excess in the amount of 10% of the

claim up to at least 150% of the fixed

annual remuneration




Shareholders I


Duties ■ Comprehensive rights of control and

instruction of the shareholder meeting

towards the managing directors

■ Competences may be delegated to council/

supervisory board, so that these bodies then

fulfil duties of the shareholder meeting

■ The general meeting is the decision-making

body for the shareholders and has the

competences described by law

■ Rights of co-determination are limited to

participation in the general meeting, rights

of information and voting in the general

meeting

■ No right of instruction towards

management board or supervisory board

■ In charge of resolutions regarding

periodical measures (allocation of profit or

loss etc.), structural measures (capital

increase) and special cases (compensation

claims against the members of corporate

bodies etc.)




Shareholders II


Resolutions ■ Shareholders‘ resolutions are principally to be

recorded in written form

■ Resolutions by written procedure (circulation

procedure) are principally allowed provided

that no shareholder rises any objections

■ Resolutions amending the articles of

association require notarization

■ Only resolutions amending the articles of

association have to be submitted to the

commercial register

■ Minutes of the protocol of the general

meeting

■ Circular resolutions of the general

meeting are not permitted, but casting of

a vote per postal vote or electronic

participation (Online-General Meeting)

■ Notarization is required in case of a non-

listed company, if a three-quarter majority

or a larger majority is legally required (e.g.

alteration of the articles of association,

fundamental resolutions, capital increase)

■ Apart from that non-notarial minutes, which

have to be signed by the chairperson of the

supervisory board

■ All minutes have to be submitted to the

commercial register




Shareholders III


Meeting ■ Convocation of the shareholder meeting with a

notice of (at least) one week by registered

mail

■ Significant defaults in the convocation

(invitation, which is not directed to all

shareholders, by unauthorized persons, by

regular mail etc.) are resulting in nullity, slighter

defaults (inadmissible place or time, shorter

notice period) result in the voidability of the

resolutions

■ Convocation of the general meeting with a

notice of at least 30 days by registered mail

or announcement in the company’s

designated publications (at least EBAnz)

■ Defaults in the convocation result in the

nullity of resolutions

Protection of minority

shareholders

■ The shareholder meeting has to be convened

if so required by a minority representing 10%

of the registered share capital

■ Minority shareholders may effect the

convocation themselves in some cases

■ The amendment of the agenda can be

requested by a minority of 10%

■ The general meeting has to be convened

upon request of a minority representing 5%

of the registered share capital

■ Minority shareholders may effect the

convocation by themselves after

authorization by court

■ The amendment of the agenda can be

requested by a minority of 5% or a minority

of € 500.000




Shareholders IV


Information rights ■ Each shareholder is entitled to request

information on company affairs and access to

the books of the company in principal at any

time

■ Information has to be provided „without undue

delay“ by the managing directors

■ The information rights are limited by a

„considerable need of information“ (not each of

the shareholders can arbitrarily „browse“ the

company‘s files)

■ The principle of proportionality has to be

respected

■ Information and access to books may be

refused in case of concerns that the

information obtained might be used for non-

company purposes

■ In the general meeting, shareholders may

request information on company affairs

from the management board, insofar as this

information is required to appropriately

judge the object of the agenda

■ Information individual items is not

allowed in the general meeting

■ Information may be refused only under

certain conditions established in Sec. 131

para. 3 AktG (in case of concerns on

disadvantageous transactions)




Shareholders V


Shares ■ Purchase agreement and transfer of shares

need to be notarized

■ Shares are freely transferable, if there is no

restriction on transferability

■ Differentiated constitution of memberships‘

rights possible (participation in profits, voting

rights)

■ Shares may be transferred without

observing any formal requirements

■ Shares are freely transferable, if there is no

restriction on transferability

■ Setting-up of different types and classes of

shares is possible (par value or non-par

value shares, ordinary or preference

shares)

■ Obligation to keep a shareholder‘s register

(in case of registered shares with restricted

transferability)

– Restriction on

transferability –

The restriction on transferability has to be provided for in the articles of association, but may be

limited in accordance with the specific requirements, such as that transfers of certain shareholders

or for specific reasons do not require prior approval




Shareholders VI


Liability ■ Liability is principally limited to the payment of

the registered share capital (not an issue in

case of transformation)

■ In general no liability in regard to company’s

debts

■ Direct liability of the shareholders possible in

case of undercapitalization, intermixture of

assets, dependent relationships and

economically destructive intervention or other

cases of intentional damage of creditors

contrary to public policy

■ Each shareholder is obliged to file for

insolvency if the company lacks management,

unless the reasons for filing for insolvency or

the lack of management are unknown

■ Liability is principally limited to the payment

of the registered share capital (not an issue

in case of transformation)

■ In general no liability in regard to

company’s debts

■ In practice the direct liability of

shareholders is hardly seen, theoretically

possible in case of undercapitalization (in

case of capital investment of a certain

amount ), intermixture of assets, dependent

relationships and economically destructive

intervention




Supervisory Board/ Council I


Structure ■ Optional establishment of supervisory board/

council

■ Respective provision is required in the articles

of association

■ Provisions of German Stock Companies Act

are largely dispositive, therefore possibility of

flexible provisions about competences,

meetings etc.

■ The supervisory board has to be composed

of at least 3 members (or a number of

members divisible by 3) according to

mandatory law

■ The supervisory board has to supervise the

company‘s management by the

management board and should have the

required expertise

■ Regulations regarding the supervisory

board (§§ 95 – 116 AktG) are largely

mandatory

Duties ■ Control of the management board, articles of

association can provide for the extent of such

control and further duties

■ Control of the management board, no right

to issue instructions, exercising influence

possible through catalogue of reserved

matters requiring approval (see below)




Supervisory Board/ Council II


Membership ■ Members of the supervisory board may be

elected by shareholder resolution or seconded

by certain (groups of) members

■ The period of appointment or secondment as

well as the revocation may be stipulated in the

articles of association

■ Members of the supervisory board may be

represented by third parties

■ Members of the supervisory board may be

elected by the general meeting or

seconded by certain shareholders

according to a respective provision in the


■ Appointment for a period of maximum 5

years with the possibility of reappointment

■ Members who are seconded may be

revocated and replaced at any time

■ Elected members may be revocated with a

three-quarters majority (dispositive)

■ Representation by third parties is only

possible in case of a respective provision in

the articles of association and without an

own speaking and petition right of the third

party („messenger“)




Supervisory Board/ Council III


Liability of Supervisory Board

Members

■ Members of an optional supervisory board are

liable towards the company due to general

provisions, the liability may be reduced by the


■ In exceptional cases, third parties may claim

damages directly from the members of the

supervisory board in accordance with general

provisions of civil law

■ Release from liability by shareholders‘

resolution is possible

■ Members of the supervisory board shall

execute their duties with the diligence of a

prudent and diligent member of a

supervisory board, they are responsible for

non-compliance towards the company and

third parties according to §§ 116, 93 AktG

■ Incorrect statements of the supervisory

board in the general meeting regarding the

state of the company are penalized, § 400

AktG

■ Each member of the supervisory board is

obliged to file for insolvency if the company

lacks management, unless the reasons for

filing for insolvency or the lack of

management are unknown

Tax aspects 2



Founding a company

Taxation of Income

Startup GmbH

Shareholder

■ Corporate income tax (Körperschaftsteuer) plus

solidarity surcharge (Solidaritätszuschlag): 15.825%

■ Trade tax (Gewerbesteuer), trade tax rate depends on

the respective municipality:

– Berlin: 14.35%

– Schönefeld: 7%

■ (Total) tax rate (Berlin): 30.175%

TAXATION AT THE LEVEL OF STARTUP GMBH

>1%



Founding a company

Participation possibilities – Tax effects (dividends)

Startup GmbH

Shareholder

>1%

■ Dividends: 100

■ Dividends after WHT approx.: 73

■ Capital gains: 100

■ Capital gains after tax approx.: 98

DIVIDENDS

Startup GmbH

Shareholder

Holding UG

(haftungsbeschränkt)

>15%

100%

DIVIDENDS

DIVIDENDS



■ Dividend distribution after tax approx.: 72



Founding a company

Participation possibilities – Tax effects (dividends)

Startup GmbH

Shareholder

>1%

■ Dividends: 100




DIVIDENDS

Startup GmbH

Shareholder

Holding UG


<15%

100%

DIVIDENDS

DIVIDENDS






Founding a company

Participation possibilities – Tax effects (capital gains)

Startup GmbH

Shareholder

100%

■ Dividends: 100




DIVIDENDS

DISPOSAL X

Startup GmbH

Shareholder

Holding UG


100%

100%

DISPOSAL X






Founding a company

Participation possibilities – Tax effects (capital gains)

Startup GmbH

Shareholder

100%

■ Dividends: 100


DISPOSAL X

Startup GmbH

Shareholder




Holding UG


5%

100%

DIVIDENDS

DISPOSAL X



Founding a company

Tax issues

Founder

A-C

= partnership (e.g. GbR)

= business assets

Startup GmbH

Founder

A Founder

B

Founder

C

100% 1. Founders incorporate

Startup GmbH

2. Startup GmbH “uses” IP

1. Taxation of the IP value

(at fair market price)!

2. Tax neutral transfer

possible under certain

formal conditions

Developed:

IP (e.g. Software, etc.)



Agenda

Founding 1

Employees 2



Accounting 5



Freelancer vs. Employees

Freelancer or Employee?

Freelancer or Employee?

Clarification

necessary

Classification as Employee?

■ Formal approach is not possible

■ Consideration of all circumstances of each individual case

■ Decisive: Actual execution of the employment relationship

Indicators ■ Bound by instructions and operationally integrated in organization

■ Business risk

■ Primarily and permanently active for one principal

■ Activities that are typically performed by employees

Measures to

obtain legal

certainty

■ Application for a binding ruling regarding the social security status for statutory pension scheme

(Sozialversicherungsrechtliches Statusfeststellungsverfahren der Rentenversicherung)

■ Application for a binding ruling for wage tax purposes



Freelancer vs. Employee

Possible Legal Consequences for Incorrect Attribution

Possible Consequences for Mistaking an Employee for a Freelancer

Timeframe ■ Claim for restitution over a number of years

Wage Tax ■ Salary is subject to wage tax, possibly withholding category VI

■ Responsibility to properly pay wage taxes

Social Security ■ Social insurance contributions are subsequently due (both employer‘s and employee‘s contribution), recourse to

the employee usually not possible

VAT ■ VAT wrongfully invoiced – disguised employment (Scheinselbstständiger)

■ Input VAT must be refunded (recourse to the employee usually not possible)

Labor Law ■ “Scheinselbstständiger” will become employee with protection against unfair dismissal, right to paid vacation and

continued payment of wages in case of illness

Commission of

an Offense

■ Possible punishability for withholding social security contributions and wage tax evasion

■ Fines are possible – even detention in severe cases



Employment Law Issues I

■ German law on General Terms and Conditions has many pitfalls; any unclarity will be interpreted in favor of the employee.

■ Certain rights of the employer, e.g., the option to ensure that possible inventions of the employee remain with the company, need to be

ensured.

■ In certain instances, it might make sense to agree on post-contractual non-compete obligations – this is, however, rather expensive.

The employer needs to pay half of the total compensation of the employee during the period in which the employee is not allowed to

compete.

■ It may be relevant to have fixed term or project-limited contracts

■ It is essential that the contract reflects the actual status of the employee as employee or freelancer and that the employment

relationship is executed in line with the contract.

DRAFT OF EMPLOYMENT CONTRACTS

■ In Germany, working time is restricted to a daily general maximum of 8 hours. However, it may be prolonged to 10 hours if – in a period

of 24 weeks – the average is not more than 8 hours. Since the law assumes a 6-day-working week, it is generally possible to work up

to 10 hours at 4 days a week and 8 hours on day 5. Please note that the threshold of 10 hours may not be exceeded. An

exception is only possible in very rare circumstances.

WORKING TIME



Employment Law Issues II

■ Disputes can occur in many instances – employees may ask for better employment conditions, fall ill (too often), would like to go on

holiday at a time that is inconvenient for the company, violate their employment obligations etc.

■ In a small company, the employer can terminate the employment „at will“, he only has to observe the applicable notice period and

notice must be given in writing. If the company has a work council, the work council must be heard (caution: the hearing of the works

council is a pitfall)

■ Once the company employs more than 10 employees, the employees enjoy termination protection. This means that the employer must

not dismiss employees who he considers to be, e.g., low performing. Rather, the employer is restricted to three legally recognized

reasons that he must prove in the event of a dispute.

■ The legally recognized reasons are:

– Violation of obligations. Please note that most violations are not per se qualified as a reason to terminate the contract, but the

employee needs to receive a formal warning and only repeated offenses may suffice to terminate the contract. An exception are

serious and grave violations like stealing.

– Personal incapacity to perform the obligations under the contract; e.g., if the employee is ill for more than 42 days each year over a

period of three years and it may be expected that he will not get better.

– Redundancies. Please note that in the event of redundancies, the employer may not freely choose, which employee he dismisses,

but must keep the employees who are the socially weakest. In order to determine, who is socially strong or weak, the marital status,

the number of children, the age, and the seniority of the employee are generally taken into account

DISPUTE WITH EMPLOYEES



Agenda

Founding 1

Employees 2



Accounting 5



Growth

Typical Clauses in Investment Agreements

Vesting 1

Tag along 2

Drag along 3

Duty to Sell/Right of first Refusal 4

Liquidation Preference 5

Audit Obligations 6

Non-Compete Obligations 7

Employee Participation Programs 8



Vesting

Vesting

(“We want You (to stay)“)

■ Vesting means: In case the founders leave, they need to

sell (part of) their participation.

■ The vested part usually diminishes with a certain lapse of

time.

■ There might be different scenarios (good leaver/bad leaver)

IMPLEMENTATION

■ The investors want the „brain“ (i.e. the founders) to stay as

long as possible.

BACKGROUND



Tag Along Rights

Tag along Right for Investors

(“Sell my shares also“)

■ In case of a sale of a participation, the investors can

demand that (part of) their shares are sold as well at the

same conditions as the selling founder.

■ Management is under a duty to report any offers to the

other shareholders.

IMPLEMENTATION

■ The Investors want to safeguard that they can participate in

exit-scenarios.

■ Therefore, they need to have the opportunity to (partly) sell

their shares when the founders want to sell their shares.

■ Also, in case of a minority participation of the investors,

they want to safeguard that the new majority shareholder is

acceptable to them.

BACKGROUND



Drag Along Rights

Drag along Right for Investors

(“We want to sell all shares, including yours“)

■ Implementation of a drag along right for the investors.

■ Means: The investors have a right to drag along all other

shares in the company.

■ For the founders this means that they are under an

obligation to sell all their shares at the same conditions as

the investors.

IMPLEMENTATION

■ Economic aim of the investors is the (profitable) exit.

■ Chances of a higher profit if the investors are in a position

to sell all shares in the company.

■ Often times, the sale/acquisition of all shares is a

prerequisite for the potential purchaser.

BACKGROUND



Duty to Sell/ Right of First Refusal

Duty to Sell to Other Shareholders/Right of First Refusal

(“Never change a winning (Shareholder-)Team“)

■ The potential seller is under an obligation to first offer his

shares to the other shareholders.

■ The offer needs to be at the same conditions as with the

potential purchaser.

■ The remaining shareholders may then purchase the shares

of the selling shareholder at the ratio of their current

shareholdings in the Company.

■ Any remaining shares (not purchased by the current

shareholders) may then be acquired by the other

shareholders.

■ Any remaining shares after that may be acquired by the

potential purchaser.

IMPLEMENTATION

■ Investors would like to have a word as to who becomes

shareholder of the company.

■ Investors want to avoid that the company is owned by

competitors or persons unwilling/unable to invest.

■ Protection of know-how and investments.

BACKGROUND



Liquidation Preference

Liquidation Preference

(“We give the Cash, we get the Cash“)

■ The investors are granted a preference when the

liquidation proceeds are distributed, meaning he gets a

higher share.

■ He will receive at least his earlier investment prior to any

further distributions.

■ Sometimes, further preferences are agreed upon such as

– interest on the investment or

– multiple of the investment.

IMPLEMENTATION

■ The investors provide more cash to the company then the

founders.

■ Sometimes a liquidation is necessary or economically more

sensible.

■ In case of a liquidations the investors need a protection of

their investment.

■ The interest of the investors is the same in case all shares

are sold at a value below the initial evaluation.

BACKGROUND



Audit Obligations

Audit Obligations

(“We need to control what you are doing there“)

■ The company is obliged

– to prepare the annual accounts in line with certain

criteria and

– to have them audited.

■ Regardless of the existence of any legal necessity (e.g.

under Section 316 HGB).

IMPLEMENTATION

■ The investors want to safeguard that they have the full

picture of the operational business.

■ Also, they need to safeguard that the annual accounts are

in line with statutory requirements.

BACKGROUND



Non-Compete Obligations

Non-Compete Obligations of the Founders

(“We paid for the idea so it needs to stay”)

■ Clauses on non-compete for the time while the founder is

working for the company and afterwards.

■ Often combined with contractual penalty.

IMPLEMENTATION

■ The investors want the founders to stay in the company

and not transfer their ideas to a new entity.

■ The non-compete shall remain effective

– for the time the founders are in the company and

– for a certain period afterwards.

BACKGROUND



Agenda

Founding 1

Employees 2



Accounting 5



Main Principles of Business Taxation

Wage Tax

■ Wage is subject to wage tax

■ Cash benefits are basically always considered as wage income

■ Non-cash benefits (free of charge/ provision of goods and services at a discount price) are subject to wage tax and social

insurance in the amount of the respective cash benefit.

Liability of employers and employees for wage taxes!

– Examples of employee benefits:

■ Special topic: granting of company‘s shares to employees free of charge or at a discount price

■ Use of a company car; benefit equals 1% of the car’s gross list price and 0,03% per each kilometer driven between

domicile and place of work

■ Non-cash benefits possibly tax-exempt if < 44 EUR per calendar month (tax exemption limit)

■ Discount allowance of 4% up to 1,080 EUR per calendar year

■ Maximum amount for a usual company event: 110 EUR (twice a year)

■ Private use of company‘s telecommunications (telephone/ internet) is exempt from wage tax

■ Flat taxation of non-cash benefits at tax rate of 30% is possible (10,000 EUR limit per fiscal year and employee)

■ Gifts (e.g. on birthday occasion) are tax-exempt if their gross value does not exceed 40 EUR




Forfeiture of Tax Loss Carry forwards

■ Tax losses can be carried forward to the next fiscal year

(and/or carried back to the previous fiscal year)

Tax losses can be offset against future profits

(minimum taxation rules may apply)

TAX LOSS CARRY FORWARDS

■ Indirect (e.g. through a holding company)/direct

acquisition of

– >25% of voting rights within 5 years:

pro rata forfeiture of losses carried forward

– >50% of voting rights within 5 years:

forfeiture of all losses carried forward

■ Escape clause where applicable (group exemption

clause (Konzernklausel), built-in-gains clause)

FORFEITURE OF TAX LOSS CARRY FORWARDS

DUE TO DETRIMENTAL CHANGE OF OWNERSHIP

Startup GmbH

Founder Purchaser

Share transfer

1) >25%

2) >50%

Effect: basically (pro

rata) forfeiture of

tax loss carry

forwards



Internationalization Issues from Tax Perspective

Withholding Tax

■ Possible obligation to withhold taxes in Germany

– License = Remuneration for the temporary transfer of

a right of use (e.g. trademark, copyright, etc.)

– Licensee is responsible (and liable) to withhold taxes

of the licensor in Germany

– Withholding tax rate: 15.825% (including solidarity

surcharge)

– Licensor may apply for a withholding tax exemption

LICENSE FEES ABROAD

■ Right to remuneration from a German company (e.g.

granting a license abroad) can be subject to withholding

tax in a foreign country

■ Possible tax issues:

– Crediting of foreign taxes

– Problems occur where no tax treaty exists (e.g.

Brazil)

(LICENSE) FEES RECEIVED FROM ABROAD

Startup GmbH (DE)

License fee (84) 1. Right (temporary

transfer)

2. Invoice (100)

WHT (16)

IP Owner

(US)

Refund claim? (16)

Federal Central

Tax Office




Withholding Tax

■ License fees for granting copyrights

– As a rule, software is subject to

copyrights under German tax law

– Exception: „Standard Software“

– IA as, SaaS, Papas? Differentiation

between provision of services/ granting

of rights?

– Relevant also for trade tax

ESPECIALLY RELEVANT IN PRACTICE:

License fee

Startup GmbH(DE)




Value Added Tax

■ VAT identification number – where applicable,

obligation to register for VAT purposes abroad

■ Tax liability inversion – Reverse Charge

Mechanism

The recipient of goods and services is obliged

to self-account for VAT and to report VAT. No

stating of VAT in the invoice

■ Obligations to file VAT returns abroad –

sales threshold have to be observed

■ Different treatment of turnover issues in the

EU and so-called third countries possible

■ New regulations regarding e-commerce

within the EU with effect from 1 January

2015

INTERNATIONAL BUSINESS RELATIONSHIPS

Turnover

Startup GmbH(DE)




Value Added Tax

■ VAT identification number – obligation to register

■ Ensuring the input VAT claim – purchase invoice have to meet formal requirements

■ Electronic invoice – domestic and, where applicable, foreign documentation requirements

■ Requirements to file monthly preliminary VAT returns during the first two years and filing of annual VAT

returns

IMPORTANT ISSUES



Agenda

Founding 1

Employees 2



Accounting 5



Accounting – Agenda

Road map: The structure of accounting 1

Internally generated intangible assets 2

Revenue recognition 3

Road map: The structure of accounting 1



I. Road map: The structure of accounting

Stages of development

Start of business operations

Second round financing

Exponential growth

Number of business

transactions, turnover and

employees

Further development Process implementation Basics Routine and audit

Developmental stages of

accounting

Internationalization First round financing Incorporation




Stage 1 Basics

Functions:

Essential decisions

Ensure compliance

of obligations

relating to German

Commercial Code,

tax liabilities and

obligatory social

charges

Legal certainty

during daily course

of business

■ Registration with tax authorities (Tax number, tax ID number, …)

■ Decision between in-house accounting and external service providers

– Continuous accounting, personnel accounting, annual financial statement accounting,

processing/ transfer of incoming invoices, VAT-declaration, income tax statement

■ Assignment of a tax consultant (Matching of financial accounting software)

■ Preparation of an opening balance sheet, short business year

■ Consideration of contracts of association for the year-end closing (voluntary auditing,

annual report)

■ First process structures and responsibilities:

– Cash, payment transactions

– Invoice receipt (electronically?, control, stamp)

– Monthly VAT declaration (permanent extension of payment deadline)

■ Development of model contracts for the sales department and preparation of general

business terms (control by attorney-at-law, coordination with sales model)

■ Draft of outgoing invoices (in consultation with a tax consultant)

– National/international, individual/entrepreneur, down payments




Stage 2 Process implementation

Functions:

First business

operations

Proper presentation

of business

transactions in the

financial accounting

system

Preparations for due

diligence and

shareholder

reporting

If required, special

audit for VAT

■ Development of process cycles, formulation of process instructions for:

– Cost allocation/Invoicing (interfaces between feeder system/inventory management,

processing of payment service providers)

– Recruitment and personnel accounting

– Travel expenses and benefits (directives, hospitality expenses of employees and other

parties, accommodation, vehicles, credit cards)

■ Establishment of an internal control system for essential areas:

– Sales (four eyes principle and IT controls/interfaces)

– Purchase (function separation)

– Higher Level Controls

■ Structure of controlling:

– Monitoring and planning of the liquidity monthly/weekly delayed filing of insolvency

– Conversion of the business plan into a monthly reporting based on the latest accounting

■ Implementation of communication structures and hierarchies




Stage 3 Further development

Functions:

Adaption to

exponential growth

Internationalization

Subsidiaries

Additional

complexity

■ Adaption of the process structure and the operating procedures to an increasing amount of

business transactions

■ Adjustment of the communication structures

■ Revision and standardization of contracts

■ Consultation with the tax advisor/ auditor in relation to the Internationalization:

– VAT, income tax/ business premises, royalties, transfer price, …

■ Implementation of accounting guidelines, set-up of an internal reporting system




Stage 4 Routine and Audit

Start of business operations

Second round financing

Exponential growth

Number of business

transactions, turnover and

employees

Further developmentProcess implementationBasics Routine and audit

Developmental stages of

accounting

InternationalizationFirst round financingIncorporation

Routine and Audit:

Adequate

implementation of

processes and

internal control

system

Audits

Year-end audit

■ Quality improvement of the month-end closings (accrual, …)

■ Transition from external service providers to internal accounting (if required, internal

preparation of annual financial statements)

■ Support of audits during the year

■ Preparation and support of year-end audits

Internally generated intangible assets 2



II. Internally generated intangible assets

■ Basics – Option to capitalize the costs of internally generated intangible assets according to § 248 par. 2 HGB

– Not to be capitalized are e.g. internally produced brands and customer lists

■ Requirements – Asset relating to German commercial law (independent usability, valuation and future economic benefits)

– Determination of production costs if possible:

■ Direct costs

■ Indirect costs

■ Costs of depreciation of fixed assets

■ If required, an adequate proportion of costs for the general administration

OPTION TO CAPITALIZE ACCORDING TO GERMAN COMMERCIAL CODE (HGB)



II. Internally generated intangible assets

■ Complex evaluation of production costs

■ Difficulties in determining the start of use

■ Constant development of the asset: after the start of use an additional capitalization is not possible

repairs and maintenance expenses

■ Post-capitalization is possible, if the asset is improved significantly very restrictive standards in the German Commercial Code

(HGB)

■ Effects on the financial statements

– Performance improvement (Capitalization of expenses)

– Increase of balance sheet total (higher fixed assets)

– Decline of equity ratio due to report of deferred tax assets and liabilities

PROBLEMS ENCOUNTERED IN PRACTICE AND THEIR EFFECTS ON FINANCIAL STATEMENTS

Assets Balance sheet Liabilities

Capital/ profit +70

DTAL + 30

Intangible

+100

assets

+100 +100

Revenue recognition 3



III. Revenue recognition

■ Realization principle

– …; profits are only to be taken into account, when they are realized until the closing date § 252 par. 1, phrase 4 HGB

– Therefore: before posting revenue (and expenses), check if the company has acquired an absolute entitlement of remuneration or

an equivalent when executing contractual performances

■ Crucial: Point of time, when the services are rendered

– After delivery of goods or after the services are rendered

– Criterion: when has the risk been transferred to the buyer? (transfer of risk)

– Identification of performance period is more difficult for work performance and goods in transit

– Further criterion: the turnover must be „secure“, i.e. there are no uncertainties about the amount of turnover and the expenses have

to be assigned accurately

– But: in general, the right of return of the customer and right of warranty do not affect the revenue recognition provisions has to be

recognized for that cases

BASICS



III. Revenue recognition

■ Depending on the revenue model, there are different accounting issues:

– What kind of services are due?

– Are there any additional services, are they autonomous?

– Is the company the service provider or the intermediary? (gross or net result)

– Who bears the risk of invoices, returns and credit notes?

– Do I have to accrue not realized periods of services? (deferred income)

– Which obligations result after the rendering of services?

– Is a time-based license or a license unlimited in time provided for?

■ Types:

– Revenue recognition at the time of sale (when risk is transferred)

– Revenue recognition for service contracts – e.g. long-term contract production

– Revenue recognition for service periods – e.g. rents, subscriptions

– Special case: revenue recognition for licensing

REVENUE MODELS



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KPMG AG Wirtschaftsprüfungsgesellschaft,

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Thomas Skowronek Manager

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