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Why I was wrong about ditching the German GmbH for a Delaware C-Corp

Peer_Rich

Four months ago I've wrote a piece about How I would start my next Startup in Germany without a GmbH .

It was written at a time when I was still processing shutting down my previous company.

A lot of times, when you're on cloud 9 you're having a blind spot for all the bad things that are happening while running a company. With good reasoning: if you only focus on the problems, you won't get too far. Optimism is your life line.

However, when things ended with Mage I was overwhelmed with the pure amount of problems we had while getting started and running the company.

My previous post was both a way for me to cope but also to protect fellow entrepreneurs from the one or the other misstep, especially in regards of incorporating.

With more than 6 months having passed since shutting down I'm getting a clearer picture of the whole situation: It's not that bad incorporating in Germany. Yes. There are definitely some tricky situations, regulatory fuckups, yada yada. But if you're in Germany, from Germany and want to continue working from here, there is nothing against starting out with a GmbH with some caveats.

Caveat #1: Holding

It is still important to form your private holding UG (i.e. First Name UG). It is important to do this before incorporating your startup. Without this structure you can run into tax issues selling or moving your corporation, which can always happen when building a startup.

Caveat #2: Hiring

Defer hiring via payroll. Payrolling is by far the most bureaucratic job when getting started. We've started to love Deel (W19) that enables both hiring international contractors and employees. When hiring contractors in full-time from Germany as a German company you can run into "false self-employment", so look out for this to not run into any legal issues.

The good part: most early stage startups usually don't need a ton of full-time employees. You can most definitely build an MVP or even get to product/market fit with a team of founders and potentially one or two part-time contractors. To derisk hiring, go for a Lean hire¹ instead.

Caveat #3: Fundraising

When getting started, do not raise your first funding on a priced round, i.e. involving a notary, selling equity at a certain price per share, thereby setting a valuation of the company.

On paper, a two weeks old pre-revenue company can "become valued" north of $5M by doing a priced round.

The transaction of selling shares sets a benchmark of your asset. It'll create huge headaches moving the company to a new location and could in some countries even create tax burdens with 0 dollar in revenue or profit.

Instead, always go for a convertible note, which is a form of short-term debt that converts into equity at a later point in time. This will help you defer the valuation of the company until you have a better setup to deal with this.

Y Combinator introduced it's Safe (simple agreement for future equity) in late 2013 and it's an alternative to the convertible note since it doesn't have an expiration date.

The safe was a simple and fast way to get that first money into the company, and the concept was that holders of safes were merely early investors in that future priced round – Y Combinator

It's an amazing tool for "high-resolution financing" which essentially means that you'll not be closing a "round", trying to get every investor to the "round table" at the same time and sign a document on same time, but closing multiple documents on (possibly varying terms) on different dates.

The Safe converts into equity when raising the next priced round of financing. (You know, the thing I'm recommending against in the beginning of getting started).

Unfortunately, we don't have a German Safe equivilant yet. In fact, this is something I am advocating for in the next few years to come. Sounds crazy? Well, one of our previous investors in Mage App Inc. told me about the iSafe in India, so we should be able to create an equivilant in Germany, too. Let's call it gSafe.

Anyway: try fundraising on convertible notes when getting started in Germany and do not run to the notary right away when an investor is interested.

Caveat #3: American Investors

Yeah, that's tougher. If you happen to have a network of angel investors in the US ecosystem you might be able to convince your potential angels to sign a convertible note and wire their money to a German IBAN. Most of the time, great angels invest in you no matter the company structure. I've heard of angels flying from San Francisco to Kazakhstan to invest in a local company. They want you to succeed. If a German GmbH is your best shot of getting there, they'll understand.

VC: not so much. That is because they have stricter limitations by their LPs (limited partners, the investors in the VC fund). Some American VCs invest in German GmbHs but expect the vast majority, including Y Combinator, will simply not.

Another amazing area where I've seen a lot of innovation lately is the use of SPVs for fundraising. An SPV is a "special purpose vehicle" that is a newly formed entity (mostly in Delaware) whose sole purpose is to hold shares of another company. AngelList has popularized the idea of Syndicates, however a colleague of mine is working on Allocations.com which is creating a SPVs-as-a-Service for angel investors.

Not only does the new SPV appear as a single entry on your cap table, it also enables investments in international companies while still offering investors shares in a Delaware entity. A group of investors would purchase shares in My New Startup SPV, LLC which would then invest in the German My New Startup GmbH.

I did reach out to YC whether this is an option for them, however they do not invest in SPVs and require their Safe to be tied to the holding company as of today. Hopefully this might change soon? Who knows.

Remember: You can flip your German GmbH to a Delaware C-Corp at any time and doing #1 and #3 makes it much easier and cheaper for you.

Reasons why I've changed my mind

The most compelling reason to not go for a Delaware C-Corp is straight up the fact that you might not need US investors or access to the US market. The European startup space is flourishing!

In fact, I am writing this at a coffee shop from Budapest with another YC founder and another Entrepreneur with a Delaware C-Corp.

More and more funds are being raised on a monthly basis and successful European entrepreneurs return to Europe due to uncertanties in North America and do their angel investments in Europe.

The recent ban on immigration and the rise of COVID19 in the US have made it incredible unattractive to put foot on American soil.

A global, remote-first culture enables any entrepreneur to work from home/anywhere which results in a huge "urban flight" away from the Bay Area towards areas of higher quality of life and less risk of corona, the lucky ones with a dual citizenship are currently trying to find a way to Europe.

Silicon Valley is about to move into the cloud. A local presence might not be neccessary, even years after we've beaten COVID19.

On a more ethical level I just don't feel comfortable generating tax revenue to a fascist administration that has spend the last 4 years alienating all European allies. If Trump wins November 2020, I imagine even more brilliant American entrepreneurs and investors leave the US and more importantly: less Europeans will take the journey to the US.

We all need to hope and vote that November will be a month of celebration and not dispair. However if you'd ask me today I cannot say with confidance whether the current administration will stay in power or not.

Until November I do not plan to incorporate another Delaware C-Corp, even though it might be the economically correct decision.

Incorporating locally in Germany means strengthening the local economy. COVID19 has taken a huge toll on every country on the planet. When I wrote my previous article I had no idea how bad the impact would be and how much worse it might get in the future.

It just does not feel right to incorporate outside of your home country when you see your communities struggle.

Lastly, during a downturn it is more important than ever to focus on revenue, profitability and personal runway. Let's face it: uncertain times are not really great for investing in hyper risky ventures.

A lot of angel investors are focussing on their current portfolio company or financial future. Even though you might incorporate in Delaware, it can be much harder to raise the same amount of funding which you could've raised in 2019.

That being said: if you're generating revenue and become profitable quickly you might not need investors at all!. There's a lot of new innovation in licensing future revenue, namely Licensed Capital and other financial instruments that can help your startup succeed without raising money from investors from American VCs. No US VCs also means no Delaware C-Corp required.

At the end of the day it is up to you to choose the country of incorporating your startup, but having some months to reflect has clearly shown me that there are more metrics to consider other than the most economical arguments.

🇺🇸 American readers: Please vote.

🇩🇪 German readers: You're probably fine incorporating a GmbH.

Yours, Peer

(¹) I am the creator of leanhire.com


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