In Leapfunder’s most recent article you learned about the The Most Important Things in a Shareholders’ Agreement. Now you have the opportunity to learn why an investor pool is critical for your company.
WHAT IS AN INVESTOR ‘POOL’?
An investor ‘pool’ is a separate legal entity that combines several smaller shareholders into a single block. This kind of legal entity is often called a Special Purpose Vehicle (SPV). Pooling via an SPV means that small shareholders will appear as one shareholder in your cap table. The SPV is the single shareholder, while the investors control that SPV. Whenever there is a big decision the small shareholders will have to agree amongst each other what to do. After this, the SPV will act as a single entity towards the outside world. This SPV, therefore, makes sure that a larger group of investors will act as one.
WHY IS POOLING IMPORTANT FOR YOUR COMPANY?
Too many separate shareholders can ruin your company. The more participants in any discussion the harder it is to gain any kind of consensus or agreement. Some formal actions by shareholders require a notary to be present: the more individual shareholders you have the more complex those actions become.
Usually, at least some of the smaller earlier investors are relatively inexperienced as investors. Also, in many cases small shareholders have very limited power: to compensate for this it can sometimes happen that some of them try to increase their power by opposing and blocking the formal processes. For these and other reasons, later professional investors often don’t look forward to spending their time negotiating with some of the earliest investors.
Not all early investors are inexperienced. Some of the early investors are highly skilled and they can add a lot of value. By entering a pool smaller shareholders can increase their collective power and influence. This is a clear and substantial advantage for all smaller shareholders. Usually, the most committed and skilled investor will come forward as the negotiator/speaker for the entire group. An SPV can give them a formal status. For these reasons many early-stage investors actually prefer investing via an SPV, while some even require it.
Every startup should have a clear policy about which investors should go into an SPV. A common rule is that investors <€100.000 will automatically go into an investor pool. This should be communicated and agreed before they invest, of course.
HOW DO I SET UP AN INVESTOR POOL?
How you set up your investor pool depends a lot on the jurisdiction in which you operate. Some countries have specialized legal entities that are used for investor pooling. In other countries, you would use one of the standard legal forms for this purpose.
In Germany, an investor pool can be established by bringing all the investors together in a KG (Kommanditgesellschaft) or GbR (Gesellschaft bürgerlichen Rechts). The KG gives limited liability to the participating investors, while the GbR gives the investors unlimited liability. That means that if the GbR were to make some kind of bad mistake – and it causes a lot of harm – the investors are fully liable to cover the harm done by the GbR. With a KG the investors are only liable for the amount they originally put into the KG. For this reason, the KG is a more suitable vehicle for investors that don’t know each other and don’t want to be responsible for each other. The disadvantage is that the KG is more work to set up: investors have to complete some paperwork with their local notary wherever they are. Both the KG and the GbR are tax transparent: that means that any profits or losses are absorbed directly into the personal taxes of the investors, and the SPV doesn’t pay tax. It’s therefore up to the investor to handle their own taxes, which is probably for the best.
In the Netherlands, there exists a special kind of legal entity that is used for investor pooling. Dutch startups normally use the so-called StAK (Stichting AdministratieKantoor). The Dutch tax law makes sure that this entity is also tax transparent. Any Dutch notary can help you set up a StAK for your company.
It’s sometimes possible to come up with something similar to a pooling SPV through a contract amongst smaller shareholders that stipulates they will act as if they are one group. However, these structures are inherently weaker: such a contract is always just a promise to act as one group. What if someone breaks the promise? Sometimes the pooling contract can even be cancelled. This means this contractual pool could break apart exactly when you need it most: when there is strong disagreement.
We hope you now know much more about pooling. To learn about pre & post-money valuation, stay tuned for Leapfunder’s next article!