VC-raising through a U.S. entity may result in disclosure of
German start-ups still tend to look to the United States when
thinking of raising capital. Unfortunately, this can create German
tax issues for the founders.
The reason the US is so attractive lies in its much more
developed Venture Capital infrastructure. The capital market for
VC-financings in the U.S. is by far larger than the German market
and valuation is generally higher. Additionally, deeper sectoral
diversification often leads to better know-how of investors which
can be of much help for further development of the company or for
the exit process. The more technology-based a business model of a
start-up is the stronger these effects are. As of seven-figure
investments, the U.S. VC-market is clearly the superior market.
Generally, U.S. VC-investors want to invest in a U.S. company
(most often a Delaware Inc.) through established and familiar
investment instruments. Therefore, the German enterprise has to be
transferred to a U.S. company first. Such transfer is feasible, but
may create difficulties under German tax law.
Typically, shares in the business-carrying German company are
transferred to a U.S. company which then becomes the
"parent" company and in turn issues shares to the
founders (exchange of shares or so-called "flip"). For
German tax law purposes, shares in the German company are deemed to
be transferred at a fair market value. A taxable gain will arise,
if such value is higher than the book value, the latter often still
being equivalent to the initial small capital contribution.
Taxability of the gain is particularly unfortunate because the
founders do not benefit monetarily from the subsequent entry by the
U.S. investor – his money goes into the company.
A common mechanism of mitigating the taxable gain in the EU and
EEA is a "roll-over" by way of a transfer of shares at
book value (e.g. transfer of shares in a German GmbH to a Dutch
BV). However, the roll-over regime is not applicable in the case of
a flip into a U.S. corporation. Hence, mitigation of the taxable
gain is not possible. However, there are some tax reliefs. In case
of a natural person only 60 % of the gain is taxable, which may
still have a prohibitive effect in many cases, though. A
corporation will often only have to pay tax on 5 % of the gain. For
holders of minimum participations, other rules again are
Contrary to what German tax authorities like to believe and
allege, the actual taxable gain of the founders as per the above
can typically not be valued based on the VC valuation (e.g. $3
million for 25%). Investments on an early stage usual do not
reflect an actual company value but rather finance a mere idea.
Moreover, such investments are regularly structured as preferred
equity which grants preference payments in case of liquidation or
other preferences compared to founders' shares. This
demonstrates that the founders do not benefit personally from the
entry of the investor in a tax relevant way. Instead, transferred
shares should be valued in accordance with common valuation
The foregoing illustrates that corporate structuring should be
taken seriously and addressed by the founders at an early stage.
Much can be achieved by initially interposing a
"personal" holding company that holds the shares in the
German start-up company. Also, fees for professional valuation of
the founders' shares are likely to be well spent. The U.S.
investment itself should be looked at to disprove the tax
authorities' approach of basing German tax values on the VC
valuation. Further structuring options should be assessed on a
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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