Start-ups – founding a start-up – and now what?

The first major milestone after completing the (pre-)seed phase is to reach the break-even point. This phase is particularly challenging for management. The product and the business operation must be continuously developed, while at the same time the (legal) obligations of a managing director must be fulfilled. There are obligations specific to the legal form, but also general obligations.

What should a start-up focus on from the outset and what measures should be taken?

There are many to-do’s when founding a start-up company and afterwards. But who wants to deal with the homework that is “part of proper business management”? For example, the general monitoring obligation under Section 1 StaRUG (monitoring primarily with regard to developments that threaten the existence of the company). Especially in the beginning, this is not perceived to be an important issue for company founders. The focus is on growth, the further development of ideas and the concrete business model, as well as attracting investors. But even if currently there does not seem to be an apparent reason and you as a managing director do not anticipate a crisis in the company, it makes sense to protect yourself (legally).

Milestones set for financing – but when will the money arrive?

In most cases, start-ups need funds from investors for a considerable period of time to cover the cash burn associated with growth. However, this does not make a start-up a restructuring or reorganization case. In the beginning, many founders receive money from family and friends in a process known as bootstrapping, or they use their own funds. Later on, business angels and venture capital, and depending on the business model, crowd investing, become the main sources of funding.

The scope of financing is usually limited in time. Financiers grant funds for the next 12 months, for example, request regular interim reports, and then allocate further funds depending on developments. This type of financing process is very common. Reporting to and for investors is therefore not the only thing that is of considerable importance. It is just as important for the managing directors to know how the 12-month financing commitment and any follow-up financing are structured. If the managing director has control over the company’s financing by achieving milestones, this is not only a good motivation to drive the start-up and their own business idea forward, but also relevant for the managing directors’ monitoring obligations.

Securing financing rounds – avoiding crisis mode

But what does the duty of supervision actually mean for the managing director? Essentially, it is about early crisis detection and crisis management, i.e., avoiding a situation that requires reorganization or restructuring. Management must recognize early on if the company’s existence is at risk and then take appropriate countermeasures. However, the legal requirements are not always suitable for start-ups. A start-up is fundamentally dependent on third-party financing, it is still in the process of being built up (often with high cash burn), and instead of early crisis detection, the focus is on scaling.

However, there are no special legal rules for start-ups. So, what does the managing director need to bear in mind when starting a business? In order to prevent a crisis, solvency must be ensured at all times and there must not be an over-indebtedness under insolvency law. Solvency is usually easy to verify. It is more difficult for managing directors to rule out over-indebtedness under insolvency law, whereby it will usually depend on the assessment of the “positive going concern prognosis.” If there is a positive going concern prognosis, a company is not over-indebted under insolvency law despite being numerically over-indebted. A “predominant probability” is sufficient for the prognosis. And the continuation of the company is predominantly probable if the company is fully financed according to a cash-flow forecast.

Problem – Solution – Measures

However, when it comes to start-ups and their financing rounds, practice and legal requirements diverge. Especially in the early stages, it is clear that break-even will not be achieved in the foreseeable future and that there will be a high cash burn. This is particularly true since the funds are not always provided solely by existing investors, but sometimes require the entry of new investors. It becomes difficult when the current financing round does not go as hoped for. In addition, the conditions for financing rounds have deteriorated significantly compared to two or three years ago.

It is crucial that the managing directors can prove retrospectively that they were aware of their own obligations – including those relating to insolvency law – and that they could always assume a positive going concern prognosis. This documentation can take the form of a “director’s dashboard,” for example, which summarizes the status quo under the heading “liquidity, financing, growth” and records the key assumptions. The managing director should keep the director’s dashboard up to date with regular updates and continue to record the (positive) development of the key milestones. This enables a managing director not only to prove that he has fulfilled his own monitoring obligation, but also that no further measures were necessary.

What can or should a start-up managing director do in the course of restructuring?

In the absence of special legal regulations for start-ups and due to the different approaches in case law, determining the prognosis for the continued existence of start-ups is always a case-by-case decision. In order to counteract the threat of insolvency and the associated liability risks for managing directors, it is therefore advisable to seek professional advice and to review the company’s situation regularly together with the advisors.

Specialized law firms, such as Anchor, can use financial planning and insight into the company’s current situation to determine whether a company is on the verge of or already in crisis and then support the management in taking the relevant steps during this phase. These preventive measures not only protect the start-up and its management, but also offer financiers greater certainty that their investment will not be lost in insolvency proceedings. Such advice can also be helpful in communicating with investors.

Even if there is no (acute) crisis in sight, it can still be worthwhile for management to talk to experienced advisors at regular intervals. This ensures that the company does not head unnoticed toward a crisis and allows for the company to establish itself in the market at its own pace in order to reach break-even. Then nothing stands in the way of the next milestone.

Anchor’s services at a glance

Added value provided by Anchor for the management and financers of start-ups

Creation of transparency regarding the current situation for all parties involved
Highlighting options for action and the time frames available for them
Identifying necessary measures
Reliable assessment of the stage of the crisis and the associated (insolvency law) obligations
Documentation of compliance with management obligations in the “Director’s Dashboard”
- Review of existing or future causes and obligations for filing for insolvency (insolvency or over-indebtedness)
- Documentation of the liquidity status and the assumptions underlying the going concern forecast, with regular updates

Facilitation of a solution between stakeholders based on the transparency created (e.g., conclusion of term sheets for further financing)
Advising management on causes and obligations for filing for insolvency that have already occurred (keyword: emergency management)
Structuring a reorganization with the help of the legal instruments of StaRUG and InsO

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