Steps to founding a Start-Up

Founding your own innovative company is a milestone for many entrepreneurs. But there are various questions and challenges along the way. What is the process of founding a company and what phases does a start-up go through? Which company form is suitable for a young start-up and what risks are associated with the choice of company form? This article is the first in a series of articles dealing specifically with topics for start-ups.  

The phases of a start-up

Founding phase: First, the start-up is founded in the appropriate corporate form. An investor may already be involved here, but this does not have to be the case. The company agreement is set up, the purpose of the company is formulated, and the first employees are hired.  

Orientation and planning phase (“pre-seed phase”): In this phase, the business model is specified and thought through. A first prototype of the future product is also usually designed here.  

Investment phase: In this phase, the actual product development should begin, for which the start-up usually requires external capital. The appropriate type of financing (venture capital, convertible loan, etc.) is selected and an investor is sought. Once an investor has been found, the investment agreement is negotiated and a company valuation is carried out. The first round of financing is referred to as the “seed phase”, in which the aim is to finance the path to the first product. Once the first product has been successfully launched on the market, the business model needs to be expanded and further financing obtained (so-called “Series A”). Once the company has established itself on the market, the company wants to expand and possibly develop new products, a further financing cycle called “Series B” follows. 

Growth phase (“growth stage”): This is where the day-to-day business takes place, the product is developed, brought to market and sold. If necessary, new employees are hired, the company grows and new customers are acquired. Investments can be made in new resources to allow the start-up to grow further. 

Maturity phase: This phase is about managing the company sustainably and economically. The product range can be expanded here so that the customer base grows, and the company becomes even more established in the market.  

Exit phase: Whether a start-up enters this phase depends on whether the founders want to sell their company or merge with other companies. If this is the case, a suitable buyer or other companies are sought in this phase. 

What type of company can be considered? 

There are many different company forms that can be considered for a start-up. As a start-up is still a very young company, founders need to consider multiple factors when choosing the right company form. 

A basic distinction is made between partnerships and corporations in the various company forms:  

In the case of partnerships (Gesellschaft des bürgerlichen Rechts (GbR), offene Handelsgesellschaft (oHG), Kommanditgesellschaft (KG), Partnerschaft), the partners are at the centre of social life. It is characterised by the fact that the association is based on personal confidence, so that, for example, the consent of all members is required for a change of members. In the case of partnerships, the partners are generally personally liable, as no separate “liability fund” is set up to compensate for any limitation of liability. In addition, the principle of self-management applies, i.e. the company must be managed by the shareholders, which is the opposite of the third-party management that prevails in corporations. 

A corporation (association, stock corporation (AG), limited liability company (GmbH), partnership limited by shares (KGaA), cooperative) is an association whose purpose is intended to be realised independently of the individual members. The association is not based on personal trust, which means that the change of members does not require approval. Corporations are separate legal entities (so-called legal persons) in which a capital participation is in the foreground. The most important characteristic of a corporation is that the liability of the shareholders is limited to the company’s assets. The lack of personal liability of the partners is compensated for by the creation of a liability fund. In contrast to partnerships, third-party management is permitted here, i.e. management can be transferred to external directors.  

Several factors play a role when founders decide which company form is suitable for their start-up:  

• Should the liability of the shareholders be limited? 

• Should there be an obligation to publish annual financial statements? 

• Is publicity in the commercial register desired or acceptable for the founders? 

• Should the shareholders be authorised to issue instructions to the management? 

• Should the company be personalised or rather capitalistically oriented? 

• In which market would the company like to position itself? 

Advantages and disadvantages of the company forms 

1. Partnerships 

A partnership is formed through the conclusion of a private contract. This contract does not require any special form, i.e. it can be concluded without any formal requirements, which is a significant advantage. The partners can therefore theoretically decide everything verbally and are therefore particularly flexible. However, in the case of both the GbR and the oHG, which is a company organised as a commercial enterprise, the partners are personally liable, and the partners can therefore be subject to considerable liability. Due to the risks involved and the early stage of the company, it is not advisable to use the GbR or oHG company forms, particularly in the case of a start-up, due to the personal liability of the shareholders. Although every start-up will initially be a partnership, a conversion to a GmbH or UG should take place at the latest when the business is fully operational. A limited commercial partnership as a partnership divides its partners into the group of personally liable partners (general partners) and the group of limited partners (limited partners), but in this type of company, liability also applies to some of the partners.

2. Limited liability company (“GmbH”) 

The GmbH is the most popular form of company in Germany and is characterised by the fact that the liability of the shareholders is limited to the company’s assets. This means that only the company is liable to individual creditors with its own assets and not the individual shareholders with their private assets. In order to establish a GmbH, it is necessary to raise share capital of at least EUR 25,000.00 to compensate for the limitation of liability. In order to apply for entry in the commercial register, a minimum contribution of EUR 12,500.00 must be made. This can be in the form of a cash contribution or a contribution in kind. A company with a share capital of less than EUR 25,000.00 is called an entrepreneurial company (haftungsbeschränkt). 

3. Entrepreneurial company (limited liability) (“UG”)  

The UG is a special form of GmbH. This form of GmbH was introduced with the “Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen (MoMiG)” (Law for the Modernization of Limited Liability Company Law and the Prevention of Abuse). Here too, the liability of the shareholders is limited, but the minimum share capital must only amount to EUR 1.00. This small share capital must always be available to the company in full as a cash contribution. The UG offers an alternative to other, particularly foreign, legal forms with low share capital. However, the UG is obliged to allocate a quarter of the annual net profit as retained earnings each year. This means that a portion of the profit generated by the UG must always be allocated as a reserve. If the share capital of the UG reaches EUR 25,000.00, it can change its legal form to a GmbH. The UG enables founders of a start-up to utilise the advantages of a corporation without having to invest a lot of equity capital as share capital.  

4. Public limited company (“AG”) 

In the case of an AG, the liability of the individual shareholders is also excluded. To compensate for the lack of personal liability, a liability fund of EUR 50,000.00 is also set up here. A special feature of the AG is that membership of the company is linked to the acquisition of a share. Membership of the AG can therefore be established by acquiring shares when the company is founded or by purchasing shares in an existing company. The AG is therefore a kind of capital collection centre in which many investors acquire shares in the company. It therefore represents a rather anonymous association. For this reason, an AG as a company form is not suitable for the start of a start-up in most cases.  

Checklist 

1. Drawing up a business plan
2. Selecting a location
3. Choosing a company name
4. Selecting the company form
5. Forming the company
6. Financing
7. Developing the product

Conclusion 

Founding a start-up is a complex process that requires careful planning and a large number of decisions. Firstly, the desired development and then the goal of the company should be determined so that a thorough assessment can then take place when choosing the company form. The factors and criteria mentioned above should definitely be included in this consideration and decision. However, with thorough preparation, a strong team and a clear vision, you can seize the opportunities and lead your start-up to success. We help you to master the legal challenges so that you can concentrate on the essentials – your business idea.