Austria: Start-Ups – Common Legal Issues

Austria recently experienced a significant boom in start-ups1 and has produced some major international players (eg, Runtastic, bwin, last.fm and Whatchado). That said, starting a business in Austria requires an understanding of the peculiarities of the legal system. This update discusses some of the common legal risks and issues that come along with starting a business in Austria.

Legal form and liability

Start-ups usually take the legal form of a sole entrepreneur (if there is only one founder) or a civil law association (if there is more than one founder). Neither of these legal forms provide limitations of the founders' liability. As such, founders are exposed to personal liability.

As soon as the first commercial activities commence, founders often seek to avoid personal liability by founding a limited liability company – one of the most popular company forms in Austria. In limited liability companies, shareholders' liability is limited to their underwritten contribution to the share capital. However, in a start-up, the founders are also usually the managing directors of the company. By law, managing directors assume statutory liability for conducting the company's business with the diligence of a prudent businessperson. Failure to comply with this standard may make managing directors liable for damages. The liability of a managing director of a limited liability company is not limited in amount and, unlike in other countries (eg, the United States), in Austria limited liability companies cannot indemnify managing directors for damages caused by them. Thus, founders should consider their potential personal liability when assuming and exercising the roles of managing directors.

Continuation of existing start-up businesses as limited liability companies

In addition to liability considerations, there are further reasons2 to continue to grow a start-up business in the form of a limited liability company.3 In particular, as soon as an investor comes on board, the continuation of the business in the form of a limited liability company or partnership is generally advisable.

The continuation of a start-up business as a newly founded or acquired limited liability company or partnership requires some careful structuring. Three options are generally available:

  • Found the limited liability company with the in-kind contribution of the start-up business;
  • Sell and transfer the start-up business to the limited liability company after its foundation; or
  • Found the limited liability company with a cash contribution and subsequent in-kind contribution of the start-up business.

Founding a limited liability company with an in-kind contribution is burdensome, as it requires, among other things, an audit of the contributed business.4 The associated costs (particularly for the auditor) and deadlines make foundations through in-kind contributions unattractive for start-up founders.

From a legal perspective, the sale and transfer of a start-up business to a limited liability company after its foundation is not advisable, as it may be deemed a hidden foundation by in-kind contribution and require an audit of the business. As outlined below, any transaction between a limited liability company and its shareholders must be made at arm's-length terms. As such, arm's-length terms may be commercially unattractive for start-up founders.5

From a legal and practical perspective, the foundation of a limited liability company through a cash contribution and subsequent in-kind contribution of the start-up business is the easiest way to continue a start-up business in the form of a limited liability company. It requires the foundation of the limited liability company with a cash-only contribution and the execution of an in-kind contribution agreement between the founders and through limited liability company.

Any contribution to the share capital of a limited liability company (including in-kind contributions) generally triggers a 1% capital transfer tax, which is calculated on the basis of the value of the contributed assets.6 Start-up businesses should thus be contributed to a limited liability company (as long as the start-up has a low valuation) as soon as possible, in order to keep the tax base for the capital transfer tax low.

Further, the transfer7 of the start-up business from the founders to a limited liability company may be subject to the asset deal provisions under Austrian law, including Article 38 of the Commercial Code. These provisions set out specific rules for transferring a business (eg, notification of contractual counterparties that have a right to object to the transfer within a certain period following notification) and which further provide for the statutory (and partly mandatory) liability of the parties involved in the business transfer for liabilities incurred in connection with the business. These peculiarities are an additional reason to transfer a start-up business to a limited liability company (or any other desired legal form) as soon as possible in order to avoid complex legal situations.

Foundation with cash contributions and minimum capital requirements

Since the abolishment of the 'Austrian limited liability company light' – which had a fixed minimum share capital of €10,000 – in 2014, any limited liability company that is newly established must either:

  • have a minimum statutory share capital of €35,000; or
  • be founded using the foundation privilege, under which a limited liability company can be founded with a preliminary minimum statutory share capital of at least €10,000.

In all cases, half of the minimum share capital must be paid in at foundation in cash.

At the latest, the foundation privilege expires 10 years after the limited liability company is founded. If the foundation privilege expires, the share capital of the limited liability company must be increased to at least the statutory minimum share capital (currently €35,000). The foundation privilege must be noted in the Commercial Register entry of the limited liability company, in order to make third parties (in particular, creditors) aware of it.

Arm's-length principle

For any start-up that is founded or continued in the legal form of a limited liability company, the founders (shareholders) must comply with the applicable capital maintenance rules. Pursuant to these rules, all transactions between a limited liability company and its shareholders (including related parties of shareholder),8 must be concluded and executed at arm's-length terms. Austrian capital maintenance rules thus require the proper structuring of all transactions between the founders and limited liability company.

In particular, founders cannot use the funds of the limited liability company for private or personal purposes other than pursuant to an arm's-length agreement or if the funds were distributed as dividends.9

The legal consequences of breaching applicable capital maintenance rules include:

  • invalidation of the transaction;
  • an obligation for the recipient to repay or retransfer unlawfully received payments or other assets to the limited liability company;
  • liability of the managing directors towards the limited liability company for any damage caused; and
  • taxes for hidden dividends.

Grants

Austria offers a variety of grant schemes, which makes the country interesting for many start-ups – in particular, those in the biotech sector. The two main players in the grant sector are the Austrian federal promotional bank (Wirtschaftsservice Gesellschaft mbH (aws)) and the Austrian Research Promotion Agency, which foster start-ups in the early stages of formation, including first stage and pre-seed investments.

However, grant schemes commonly provide strict conditions that must be met throughout the funding period and sometimes thereafter, including change of control provisions that may be triggered if an investor invests in a start-up or other founders come on board. The conditions of a grant scheme must be closely monitored and complied with in order to avoid the funding institution reclaiming its grant.

Trade licences

Commercial activities may require the prior issuance of a trade licence pursuant to the Trade Act. 'Commercial activities' are broadly defined and include all activities that are conducted independently (ie, on one's own account and at one's own risk), regularly and with the aim of achieving a financial gain or other advantage. Most start-up activities will thus qualify as commercial activities within the meaning of the Trade Act and require a trade licence.

The person or entity conducting the commercial activity must apply for a trade licence before commencing the activity. If an applicant is a legal person, a natural person who will be responsible for compliance with the Trade Act (ie, a managing director under trade law) must be appointed. A managing director under trade law must also be appointed if the person conducting the trade is domiciled outside Austria. The Trade Act provides prerequisites for appointing a managing director under trade law, including that he or she be either member of the statutory management board or a qualified employee.10

Trade licences must be obtained for certain trades. The Trade Act lists free trades and regulated trades. Free trades can be conducted with no specific proof of qualification, whereas regulated trades require specific proof of qualifications, depending on the type of trade. Free trades are generally granted on application; regulated trades are granted after approval by the competent authority.

IP rights

Technology, IT and marketing-focused start-ups often have no realisable assets other than IP rights (eg, inventions, software code, brand names and know-how) created by their founders, employees and other third parties (eg, advertising agencies). In many cases, IP rights are improperly transferred to the start-up entity or improperly protected against use or misuse by third parties due to a lack of legal knowledge and support in the early phases of the start-up.

This potential lack of ownership or protection of IP rights often complicates and hinders the development of, or investment into, a start-up11 and should therefore be rectified as early as possible – by transferring or licensing any IP rights to the start-up by way of a written agreement, registering the rights (where possible) or concluding non-disclosure agreements with third parties that have access to the rights (including know-how).

Shareholders' agreements

The founders and shareholders of a limited liability company start-up may want to agree and regulate certain rights and obligations which will govern their joint shareholding in the limited liability company, including:

  • corporate governance matters (eg, the right to appoint members of corporate bodies and reporting obligations);
  • investment obligations (eg, for future investment rounds); and
  • share dealings and exit rights and obligations.

These rights and obligations may (and in some cases must) be governed by the statutory articles of association of the limited liability company or in a separate agreement (usually referred to as a shareholders' agreement or syndicate agreement). As the articles of association of a limited liability company are publicly available, founders may want to move any sensitive information to a shareholders' agreement. However, separate shareholders' agreements create not only more paperwork, but also more complexity some provisions may not be fully enforceable if set out only in the shareholders' agreement and not the articles of association). Further, any new shareholder must accede to the shareholders' agreement separately, whereas any new shareholder accedes automatically to the articles of association. Shareholders' agreements and, in general, any dealings among shareholders must be carefully structured to reflect the commercial agreement in a proper legal way.

Exit scenarios

Although the founders of a start-up are naturally enthusiastic about the going concern of their venture and their future involvement – and should therefore predominately concentrate on the development of their business – it is crucial to discuss and concentrate on potential exit scenarios to avoid any conflicts at a later stage. For limited liability companies, it is particularly important to agree on proper exit scenarios, as the Act on Limited Liability Companies generally12 does not provide exit options (in particular, a shareholder of a limited liability company has no statutory right to terminate and liquidate the limited liability company without holding the majority of the votes).

Exit scenarios are typically structured via put and call options, tag and drag-along rights and rights to terminate the limited liability company (eg, after a certain lock-up period). Termination rights should always be combined with a right for other shareholders to take over the share of the terminating shareholder for a fee (eg, the fair value of the share at the time of termination) in order to avoid liquidation of the limited liability company.

Exit options should also be carefully structured from a tax perspective, to avoid the risk of incurring adverse tax consequences.

From a practical standpoint, it is generally advisable to find a simple mechanism to avoid discussion or disputes when an exit option is exercised.

Footnotes

(1) Examples such as Red Bull – which entered the market in 1987 – demonstrate the success of Austrian start-ups. Due to recent advances in technologies, the number of technical start-ups in Austria has significantly increased in the last few years.

(2) For example:

  • tax considerations (ie, limited liability companies are subject to a fixed-income tax rate of 25%, whereas sole entrepreneurs are subject to a progressive income tax rate between 0% and 55% (from 2016));
  • corporate governance considerations (eg, where limited liability companies are represented by one or more managing directors or proxies that have statutory powers or representations; no statutory representation for sole entrepreneurs exists (ie, they would have to issue powers of attorney on a case-by-case basis)); and
  • other corporate and commercial considerations.

(3) Alternatively, in the form of a limited partnership, if such a partnership is desirable. However, this update concentrates on limited liability companies, as they are the most common legal form of start-up.

(4) An exception to this rule exists if a limited liability company is founded in order to continue a business that existed for at least five years and is continued by the founder or a close relative of the founder. For start-up founders, this rule is essentially irrelevant.

(5) For example, if the start-up has achieved or is about to achieve a high valuation in an investment round, which would have to be reflected in the terms of the sale and transfer.

(6) Under certain circumstances, contributions can be structured as contributions in kind within the meaning of the Reorganisation Tax Act, which provides certain tax benefits.

(7) Alternatively, by way of an in-kind contribution.

(8) Austrian capital maintenance also applies to transactions with third parties that are concluded for the benefit of a shareholder or a related party of a shareholder.

(9) Alternatively, after a capital decrease of the limited liability company's share capital.

(10) That is, an employee who is employed for at least 50% of the normal working hours in a week and who is fully insured under Austrian social security laws.

(11) Alternatively, create legal disputes with the actual owners of the intellectual property.

(12) Other than in special situations (eg, if a shareholder is in default of payment of its contribution or in cases of minority squeeze-outs).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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