In the foundation and growth phase, funding rounds for start-ups are the order of the day. Young companies use this to raise funds from investors in order to start the next phase of their development. When founding, new companies first have to get a public or private sector financier who is enthusiastic about the business idea. In the next step, managers further develop their business model until it is ready for the market.
This development phase can be time-consuming: for example, sustainable energy startups often have to carry out intensive research and development work for years. These efforts are offset by uncertain earnings expectations. The same goes for tech companies that first build their platform and then have to acquire a certain number of users for it. At the same time, the founders must also establish an organizational structure in their own company.
As the development of a start-up progresses, the demands of investors also increase: in exchange for financing, they always expect detailed business plans and, in some cases, potential financiers demand proof of the development of sales in the first test markets.
What start-ups need to know about insolvency law
The founders are busy with many issues, especially in the initial phase, but especially not with the requirements of the restructuring law or with the obligation to declare bankruptcy. At the same time, start-ups are often unable to pay obligations arising out of their own resources and do not yet have any significant assets that their creditors can use as collateral. As a result, many startups are over-indebted on the balance sheet. This may also give rise to the obligation to declare bankruptcy.
A solution to this dilemma is offered by corporate planning, and a positive forecast for the going concern is derived from it: despite the over-indebtedness on the balance sheet, there is no over-indebtedness in the sense of bankruptcy law if the continuity of the company in the coming years twelve months is largely likely. The company then does not have to file for bankruptcy. To do this, however, the start-up must remain solvent in the forecast period, that is, have sufficient liquidity in the following twelve months to be able to pay current liabilities no later than when they come due. This liquidity development can stem from corporate planning. This results in a certain synchronization of the over-indebtedness with the so-called impending insolvency.
When is funding likely?
Therefore, in order to make the forecast, the start-up must show that its financing for the next twelve months is quite probable. However, this is hardly possible with the often short-term funding rounds. If a funding round fails and insolvency occurs, start-up management is threatened with personal liability: the insolvency administrator may then take the position that further funding in the twelve months is no longer predominantly likely. prior to the declaration of insolvency.
Furthermore, since the beginning of 2021, the legislator has introduced an obligation for each directorate to recognize and manage crises at an early stage. To do this, companies have to anticipate whether insolvency is imminent in the next two years. However, such forecasts do not reflect the circumstances in most funding rounds in the startup sector.
Careful documentation is important for startups
Therefore, the management of a start-up company must provide documentation that is kept up to date. You must demonstrate in detail and irrefutably that the individual requirements of total financing for the next twelve months are met. With such documentation, management can demonstrate a positive going concern forecast. All preparations, discussions, and other relevant events for which there is an overriding probability of funding should be included in the evaluation.
However, when third-party funding contributions are considered, case law places high demands on the evaluation standard: the Federal Court of Justice last ruled in 2021 that the mere prospect of funding is not enough to be allowed to take it into account. bill. However, a legally binding guarantee is also not mandatory. Rather, the deciding factor is whether management can expect a financial contribution from third parties with a high degree of probability.
Risks affect both start-ups and investors
However, legal uncertainties remain for startup founders and CEOs. These also affect investors. When insolvency arises, for example if there are delays in the next funding rounds, financiers risk losing their investment. If an insolvency application is filed, the right course can also be used to successfully restructure start-ups. However, there is no guarantee for the investor that he will stay in the money.
“Management should already have documentation in the early stages of the foundation that also includes bankruptcy law experience.”
In a decision last year, the Düsseldorf Higher Regional Court took into account the special characteristics of start-ups. Consequently, under certain conditions, the mere expression of willingness to finance by an investor may already be sufficient to assume a predominant probability of direct financing. The court ruled that funding that has already been completed is no longer a prerequisite for the positive forecast of continued existence. For founders and CEOs of start-ups, this court ruling at least serves as a guide as to the legal requirements they must meet.
Finally, managers must ask themselves if their business plan includes the possibility of financing. In its previous case law, the Federal Court of Justice is less concerned with operational concepts than with a reliable liquidity forecast. Therefore, the management must already have documentation in the early stages of the foundation, which also includes experience in bankruptcy law. Investors should also work to obtain such documentation and have the startup present it to them.