Legal Basics: These Financing & Contract Pitfalls Every Founder Must Know – Christian Brehm, Lawyer & Partner at Dissmann Orth

About this episode

The financing landscape for startups has changed dramatically in recent years. What used to be a founder's market has become significantly more investor-friendly today. Christian Brehm, Partner at law firm Dissmann Orth, explains in conversation with Fabian which legal pitfalls founders should be aware of and how they can protect themselves from unfair terms.

Market Changes and Their Impact on Founders

Current market shifts have direct implications for funding negotiations. Where founders previously could choose from various offers, they now often have to settle for less attractive term sheets. This shift makes it even more important to know and protect your rights.

A common mistake is focusing exclusively on company valuation. While a high valuation may seem attractive, restrictive clauses can have serious long-term consequences – not just for founders, but also for employees and the entire company.

Key Term Sheet Conditions Overview

When reviewing a term sheet, founders should pay particular attention to the following points:

Liquidation Preferences are at the center of attention. These clauses determine who gets paid out in what order during an exit. There are different types of liquidation preferences that have varying impacts on founders. The N26 example impressively shows how loans, interest rates, and corresponding consequences can affect the final outcome for founders.

Vesting arrangements, on the other hand, offer both opportunities and advantages for founders. They can serve as a protective instrument while creating incentives for long-term commitment.

Reputation vs. Reality: When Good Fund Brands Mislead

A widespread misconception is that renowned funds automatically offer fair term sheets. Reality often looks different: reputation and actual performance don't always correlate. Even established investors can propose terms that are disadvantageous for founders.

It becomes particularly dangerous when founders have no alternatives and must accept the "worse" term sheet. In such situations, careful consideration between short-term liquidity and long-term consequences is crucial.

Additional Pitfalls and Important Clauses

Beyond the main negotiation points, there are other potential traps:

• –Transfer restrictions: These clauses can significantly limit founders' freedom of action
• –Advisory Board structures: The allocation of board seats should be strategically considered
• –Convertible loan terms: Business Angels and VCs differ in their standard terms here

Most Common Mistakes in Funding Rounds

Apart from the actual term sheet, founders often make avoidable mistakes. These include insufficient due diligence, inadequate preparation for negotiations, and underestimating the long-term impact of certain clauses.

Incidentally, convertible loans are used more frequently by Business Angels than by VCs, with both groups using different standard terms.

Finding the Right Legal Counsel

Choosing the right lawyer can determine the success or failure of a funding round. A good startup lawyer should not only bring legal expertise but also understand the business model and specific challenges of the company.

What's crucial is that legal counsel works for, not against, the founders. This can be recognized through transparent communication, understandable explanations of complex matters, and proactive advice that goes beyond merely processing documents.

Conclusion: Preparation is Key

The legal aspects of a funding round are complex but certainly manageable. With proper preparation, competent legal counsel, and a basic understanding of the most important clauses, founders can negotiate fair deals even in difficult market phases.

Investing in qualified legal advice pays off in the long run – for founders as well as the entire company and all stakeholders involved.