This is why start-up founders in Germany should consider vesting at an early stage!

Vesting clauses ensure fair distribution of shares

Founding a start-up in Germany regularly involves a lot of effort, sweat and tears, perhaps also doubts, but above all financial risks. Logically, a german start-up does not have that much money at its disposal at the beginning.

However, if you cut corners at the beginning of the venture and do not seek legal advice on drafting articles of association, you may find yourself years later confronted with contracts that are not necessarily advantageous for the german founders. A lack of vesting for start-up founders (so-called founder vesting) can be very annoying in retrospect. Why? Find out in the following!

What is "vesting" under german law?

The principle behind vesting clauses under german law is as follows: Founders or employees of start-ups in Germany have to 'earn' their stake in the company for a certain period of time, so to speak, by making their work performance available to the start-up for a certain period of time (the so-called vesting period).

If they leave the german start-up prematurely, they may lose some or all of their shares. Depending on the time and reason for leaving, they receive a reduced amount of compensation for the lost shares based on the market value of the company - sometimes nothing at all. The various constellations are defined by so-called bad and good leaver clauses.

This is why vesting clauses bring advantages for german founders:

It makes sense to include vesting provisions when the start-up is founded in Germany. The following example illustrates the background: Let's assume that three founders (A, B, C) each have a one-third stake in the german company. In the first few months, all three put all their work into the project - but then founder A loses interest and switches to another job. Although B and C continue to slave away alone for the project, founder A is still entitled to a third of everything. B and C rightly feel that this is unfair at some point.

If a vesting arrangement had already existed, the consequence would have been that A would only be allowed to keep his full number of shares as long as he made his full labour available to the joint venture. If he wants to leave the joint enterprise at an early stage, he has to hand over part of his shares again and may be remunerated (at a discount) according to the value of the enterprise at the time of his departure. In this way, the work he has done to date is sufficiently and fairly rewarded - but he no longer participates to the same extent in future increases in the value of the start-up, which are achieved solely through the work of the two remaining founders, B and C. The start-up's value is increased by the work of the two remaining founders.

Subsequent vesting by investors in Germany

If no vesting clauses were taken into account at the beginning of the venture, this often happens at the latest when an investor is brought on board. What is the investor's interest in a subsequent vesting provision? Quite simply, he wants to prevent the heads of his acquired company from jumping ship with the fresh money shortly after the exit, but rather to make their know-how available to the company for a certain period of time even after the investment.

Reverse vesting for german start-up founders - does it make sense?

If the issue is already considered at the time of founding, a so-called reverse vesting is regularly agreed upon in german practice. In other words, german founders do not receive shares on a monthly basis, but all at once. However, these are only vested and secured at the end of the vesting period. It is also possible to agree on a pro rata adjustment of the vesting in relation to the work performance by adjusting the vesting period.

If a founder leaves the company prematurely during the current vesting period, he loses the part of his shares that is not "secured" (possibly in return for compensation, possibly with a discount).

Avoiding disputes through a legally secure shareholders' agreement under german law

In order to prevent a delay in the process, a transfer of the shares subject to a condition precedent is regularly agreed in Germany. If an exit from the company occurs, the existence of the leaver event only has to be established and the non-vested shares of the exiting shareholder automatically revert. In a next step, the purchase price is considered first. In this way, the german company remains capable of acting and can act quickly.

In order to prevent disputes, we recommend that an irrevocable resolution of consent to the transfer of the vesting shares be included in the shareholders' agreement subject to a condition precedent. In this resolution, all shareholders agree to the transfer of the shares in the event of a leaver event and, as a precaution, waive all other rights under the partnership agreement, such as pre-emptive rights and tag-along rights.

If a dispute does arise later between the german founders, it at least does not paralyse the entire company - for example, because it is temporarily unclear who actually owns the company and who is entitled to make the relevant decisions. Only when a court decision is handed down do any changes have to be made retrospectively.

If you need legal advice in connection with vesting in Germany, the lawyers of ROSE & PARTNER, in particular our lawyers for german corporate law, are generally at your disposal. You will find further information on our website: https://www.rosepartner.de/en/vesting-startup-germany-lawyer-lawfirm-esop-vesop.html