Angel investing is a social activity. The best investment decisions are usually made by investors who work together, exchange ideas, and share the load of managing their portfolio. So syndicated deals amongst groups of Angels make a lot of sense.

From the startup’s perspective, it is also generally advisable to have the backing of a syndicate of Angels. The syndicate’s members give the startup access to a broader set of skills. Often, a syndicate of Angels can also include investors from multiple countries to facilitate the underlying company’s international expansion.
The Challenge: Navigating German Pitfalls

But how do you set up an Angel syndicate properly? Especially in Germany, there are some significant pitfalls to be aware of.

Of course, you want to make sure the startup’s cap table remains clean. Having too many individual shareholders can lead to logistical nightmares in the future, especially given the German notarization requirements. Having too many small shareholders could literally be a reason for future investors to walk away. That’s a worst-case scenario.

But when you pool investors together into an entity, or set up a syndication agreement, there are significant legal complexities to be aware of. If you set up a syndication agreement, how do you know for sure that the investors will actually do what was agreed upon in the future? What happens if they simply ignore the agreement?

Instead, you could use a legal entity that functions as a Special Purpose Vehicle (SPV) for holding the shares. But now you need to make sure that the SPV isn’t seen as a regulated investment company, and you need to make sure that the SPV doesn’t get taxed on top of the tax already owed by the underlying investors.

Finally, how do you choose a SPV structure that is practical to set up, but maintains the right balance of power between the investors amongst each other, and towards the startup? It is not an easy task.

A simple shareholders’ agreement (“Stimmbindungsvereinbarung”)

The simplest way of pooling investors in Germany is just to get them to sign a shareholders’ agreement that contains restrictions on their decision-making. In this model, the investors all become direct shareholders in the underlying startup. But the shareholders’ agreement will bind the investors to block-vote in all major decisions, and generally will commit the investors to act as if they were a single shareholder in situations like a sale of the shares, approving future investment rounds, etc.

Often, a single investor is designated to act as the central spokesperson, and the other syndicate members delegate their powers as shareholders to that syndicate leader. From a tax perspective, there is no complexity: the investors pay tax on their shares as usual.

This seems to be a sensible approach, but there are some disadvantages. This kind of agreement generally requires notarization in Germany from each syndicate participant. That’s because the powers that you are trying to bundle include powers like selling the shares, which themselves would require notarization. An agreement that bundles those kinds of powers, therefore, needs notarization itself. If every investor needs to visit a notary to sign a power of attorney, then it is quite difficult to set this up initially. 

The system with a shareholders’ agreement also suffers from a practical difficulty: the investors are generally stuck with the originally designated central spokesperson. That’s because changing the spokesperson often requires signing a new agreement, and that means everyone has to go back to the notary. But the initial choice of syndicate leader may not make sense a year later, let alone 10 years later. Things change. So that is a major potential problem.

A solution that is sometimes used is to ask the startup itself to act as the central figure in the syndicate. That seems strange, because the startup has fundamentally different interests from the syndicated investors. The key is to make sure that the startup as syndicate leader is bound to act only after instructions have been received from the actual investors in the syndicate. That can work: the startup will run the decision-making within the Angel syndicate just as it runs the decision-making within its general shareholders’ meetings. 

But there is another, more fundamental, perceived flaw in syndication through a shareholders’ agreement: all agreements can be broken. What do we do if one of the investors in the syndicate simply decides that they will not respect the syndication contract? What if they even announce that they wish to terminate the contract for cause? The contract may contain some kind of penalty clause, but those are hard to enforce.

Remember that in this model, each investor is a direct shareholder in the startup: if the investors decide they wish to ignore the shareholders’ agreement, then you will once again have a ‘flee-circus’ on the cap table, and if that happens during an exit negotiation, it could really do some harm.

Hard pooling through a separate legal identity (“Kommanditgesellschaft”)

To prevent a syndicate from disintegrating when the pressure is on, you can simply give the syndicate its own legal identity. If the syndicate is represented by a separate legal entity, it can never break. A common German form for this kind of entity is the Gesellschaft bürgerlichen Rechts (“GbR”).

The GbR itself is the shareholder, and the investors in the syndicate become partners in the GbR for the value of their share. That generally works fine if the syndicate consists of a relatively small number of investors who know each other. However, the partners in the GbR accept unlimited liability for the actions of the GbR… and so as the syndicate grows in numbers, it is worth going through an upgrade. If there are larger numbers of investors in the pool, the chances are that they won’t have as much trust, and limited liability becomes necessary.

By going through a notarized registration, the basic structure of a GbR can be upgraded to a Kommanditgesellschaft (“KG”). The partners in a KG have limited liability. To have a KG, you do need to have each investor visit a notary, but only once, namely at the time when the KG is being set up. 

A KG will designate only one general partner as the unlimited liability bearing partner, while the other partners have limited liability. So that is a more sensible structure if you are bringing together investors who don’t have existing relationships of trust.

Of course, using the KG does raise the question of who is going to take on the role of the liability-bearing partner. Here again, it is a useful trick to ask the startup itself to take on that role. The startup is already responsible for managing its cap table, so taking on the responsibility for managing the KG is just more of the same. Again, the structure seems strange because the startup has fundamentally different interests from the syndicated investors.

But the key is to make sure that the startup, as general partner of the KG, can only act after instructions have been received from the actual investors in the syndicate, who are just the other partners. That can work: the startup will run the decision-making within the KG just as it runs the decision-making within its general shareholders’ meetings. If they mess it up, the startup is responsible for the damage they do to investors, but the startup is already responsible towards its investors for that kind of damage. It works. Problem solved.

The GbR and the KG are tax transparent: they don’t pay tax themselves, but the partners have to pay tax on the assets held by them, as usual.

Creating a small investment fund

The structures we have talked about until now are always intended for deal-by-deal syndication. That means they can be used by a group of inventors who want to set up a pooling structure for an investment in a single startup. Sometimes, Angel investors in Germany will choose to use the same vehicle for multiple investments. That means they have formed a kind of mini VC fund, with their own money in it.

Generally, these structures are legally more complex, because they always test the border of becoming regulated financial service providers. There is a range of exemptions that allow small informal groups of Angels to form a mini VC fund with minimal registration requirements with the financial regulators. In fact, the simplest forms simply require no registration with the regulators at all, but they are subject to very tight restrictions on the number of investors that can participate. From there, you can choose more and more sophisticated structures, all the way up to highly regulated managed investment vehicles.

In general, these kinds of structures are legally more complex while providing less flexibility. The group of investors that forms the mini VC will have to work together for the duration of the mini VC fund. Things change, and over time, the priorities of the participating investors may evolve. Choosing deal-by-deal syndication is generally a safer option: investors can be added or subtracted for each successive deal. Deal by deal, syndicates are generally unregulated from the perspective of financial regulators, so there are fewer complex restrictions to work around.

International options: StAK (‘Stichting AdministratieKantoor”)

Just as legal entities from Ireland, Estonia, and the Netherlands are gaining popularity with startups throughout Europe, there is a trend towards using international investor pooling vehicles. A tried and true option that is currently gaining popularity in the Berlin startup scene is the Dutch StAK. 

The StAK is a legal entity that is specially designed for pooling smaller shareholders. It has been a stable part of the Dutch corporate machinery for as long as anyone can remember. It is basically a foundation (“Stichting”), which will own the startup shares on behalf of investors. The StAK can issue Depository Receipts to investors, which entitle them to all the economic benefits that come from the underlying startup shares. It requires a notary to set up the foundation, but this can usually be handled through an online call.

After the initial setup, the StAK can be run by the startup itself. The startup is then responsible for managing this subsection of the cap table, just as they are responsible for managing the cap table overall. The StAK doesn’t pay any tax, doesn’t require annual accounts, and is generally maintenance-free, except that it needs a postal address in the Netherlands. It is common for a startup to have some Dutch Angel investors, and they will often volunteer their own office address. That’s considered a small favor. The StAK is specifically designed to be tax transparent: it pays no tax, but the recipients of the Depository Receipts pay tax on that investment, as usual.

Leapfunder’s online approach

Leapfunder has developed online tools that allow Angel syndicates to be formed online, at the click of a button. Investing on Leapfunder is about as complicated as buying an airline ticket. When the startup sets up its funding round, it will specify what pooling structures it would like to use.

As part of its standard options, Leapfunder offers a German Stimmbindungsvereinbarung and a Kommanditgesellschaft. Leapfunder also offers a Dutch StAK. All options have their pros and cons: Leapfunder will advise the startup on the best option for them. Leapfunder will work directly with Angel syndicates, advising them on the best approach to setting up their portfolio. If you want to know more, just get in touch.

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