Legal and governance details founders must know if they wish to enter the US market!
• Legal setup
• Supervisory board
• Learn Silicon Valley best practice as early as possible!
I’ve done a little writing and speaking on the burgeoning EU tech scene, and the benefits and challenges of being a European founder moving to the US: TechCrunch Things Happen Fast Pioneers Festival 2014 ‘How to do Everything Perfect…’ A lot of this information has become standard knowledge among European entrepreneurs, but there are some specifics concerning company formation and investment agreements that you, as a European founder, need to take into consideration as early as possible if you have any hope of moving to Silicon Valley, scaling fast, raising money from a top Sand Hill Road fund, or being accepted to YCombinator and enjoying the kind of massive exit that happens disproportionately here in California.
European entrepreneurs have quite a few well known advantages when it comes to building companies: great educational foundations in tech subjects, low-cost development, governmental support in the form of grants and subsidies, and a fast growing community of early stage funds and ‘super angel’ investors. But there are also serious disadvantages: very few serial entrepreneurs on the ground in Europe, modest scaling opportunities, sometimes inexperienced or highly ‘local’ investors, a culture that punishes risk taking, and did I already mention local investors? I want to concentrate on just one of these points, because it is incredibly important, and almost always overlooked.
If you have a company that has a shot at making it big in the US, you need to start planning early, and one thing you absolutely must consider is your choice of early investor (and especially the legal details of your first investment agreements). There is no point in lingering too long in Europe if the market and the capital you need are in the US, and you should start the transition well before you buy your first plane tickets.
First time European founders are almost universally ignorant of Silicon Valley legal ‘best practice’ when it comes to company formation and investment. What seems like a good idea in Germany is sometimes a terrible idea in California. Founders often discover far too late, after they have put a deposit down on an apartment in Palo Alto, rented a Regus office and started booking VC meetings to capitalize on their early customer traction, that some decisions they made 24 months earlier with their pre-seed investors have pretty much destroyed their dreams. And in many cases they may not discover the very specific reason their YC application was rejected or why Accel never called back. But I’m about to tell you.
I would advise European founders to seek some basic US legal advice, at the very least on Silicon Valley best practice, as early as possible. You don’t need to hire an expensive lawyer, but please consult with one of us, or talk to someone who has been through the process of flipping to a Delaware corp, moving to the US and acquiring customers and raising capital there. Founders in our portfolio who have been through YCombinator are great sources of information, and are often test cases in overcoming early EU legal hurdles. Find them here: www.bitmovin.com & www.flaviar.com.
When you begin discussion with your very first angel investors, consider the following points very carefully, take US legal advice, and by any means possible incorporate Silicon Valley standards into your earliest contracts. As a general rule, US investors hate EU corporate law, they hate foreign language board minutes, they hate foreign accounting standards and anything else that raises the risk profile of their investment. Silicon Valley is a gold mine. Why should they take any unnecessary risks, even if your tech is amazing and the team is filled with genius?
European early stage investors tend to be risk averse, but in a very different sense: legal specifics in their investment contracts generally contain control and permission and transfer provisions that are indicative of a deep-rooted, cultural aversion to risk. Founders will often unwittingly agree to things that are an absolute ‘no go’ for US investors, and then find themselves having to renegotiate shareholding and investment agreements with EU seed investors at a terrible disadvantage when trying to raise a series A. In these situations, founders almost always suffer.
Here are key areas to be on the lookout:
Permission and control – it is not uncommon to find EU investors demand that founders seek permission for simple things that should be under the mandate of a company board. Information sharing, term sheets, onboarding customers, all of these things can later find themselves under the micromanagement of distant, early investors who are far removed from the later-stage, operational needs of a company. While EU investors are in many cases willing to give permissions, and even if they are perfectly aligned with founders, the communication requirements and lag time this introduces into US discussions are deadly. I’ve had US lawyers tearing their hair out with frustration over this exact sort of arrangement (and these are very high profile lawyers who later share with colleagues the EU legal horror stories, and further handicap your chances). One solution is to form a supervisory board as early as possible. Much earlier than you would normally consider appropriate for a seed-stage European company. Empower the board, and roll with it. Insist that your investors support this, and if they don’t, consider new investors.
An even better move is to set up a Delaware corporation early, and assemble a US-based board. This gives you greater freedom to act, and much more speed when you will most need it. Like I said, flip early, flip hard!
Transfer – EU contracts often have a wide array of transfer provisions that are non-standard for Silicon Valley. EU early stage investors sometimes insist on cumbersome drag-along clauses that they feel compensate for their considerable early stage risk. In the Valley, early stage risk is a well understood commodity, and there are standards that later stage investors will expect. There is no way that Sequoia will put their upside at risk because a small law firm in Switzerland requires minority drag along rights for their 100,000 euros. Again, you if you agree to this sort of thing early without consulting US support, you will find yourself in a position to re-negotiate at a tremendous disadvantage with early stage investors, or kiss your dreams goodbye. And at the very least, agreements will require full re-writes with additional legal costs and lost time.
In both of these situations, bridging the gap is time consuming and costly, and rather than adapting legacy EU contracts, new US-based agreements are often the best move. In some cases, US investors are wary of even considering EU investments based on their experience. Very recently, high profile investors in the US have expressed their growing fatigue with EU legal headaches. If we all work to fix this now, it’s better for everyone.
One other piece of advice is to use US-based support to help educate your early stage investors before you sign anything. We are more than happy to help, and you can of course use our transfer and control provisions as an example of what works.