Session report – Crossing borders: obstacles and challenges in venture capital funding
Tom Ensink
Ploum, Rotterdam
Conference: 8th Global Entrepreneurship Conference, Madrid
Committee: IBA Closely Held Companies Committee
Session Date: 14 May 2024
Session title: Crossing borders: obstacles and challenges in venture capital funding
Session co-chairs
Noreen Weiss gunnercooke, New York; Vice Chair, IBA Closely Held Companies Committee
Álvaro Mateo Gómez-Acebo & Pombo, Madrid
Speakers
Javier Cebrián Monereo General Partner, VC Bonsai Partners, Madrid
Tobias de Raet lindenpartners, Berlin
Bernhard Niesner Founder, Busuu, London
Horacio Vianello BC / F / PZ Abogados, Buenos Aires
Introduction
Vice Chair of the IBA Closely Held Companies Committee, Noreen Weiss, kicked off by stating that the in the previous days of the conference we had seen a great number of big issues such as unruly cap tables, friction among angels and venture capitalists (VCs), geopolitical pressures and post deal integration. The ‘Crossing borders’ session, in contrast, focused on some of the more granular issues that founders and VCs face when doing deals. After the introduction of all speakers, the panel touched on a number of subjects, in response to a series of questions. The questions were posed by the session Co-Chairs, Noreen Weiss and Álvaro Mateo.
When considering the notion of barriers to overcome when crossing borders for the growth of company finance, what do you perceive as the greatest challenges?
Javier Cebrián sees that, over the last five years, important developments have taken place to overcome barriers in the European space. We all speak the same language (English), the documents have been further standardised (investment agreement, shareholders agreements, etc), he sees that across the continent people are using the same metrics as his fund to measure the performance of the start-ups, etc. He does not see very big barriers, but companies need to use a certain governance to document their efforts to standardise certain key performance indicators (KPIs) and keep all these documents in a neatly standardised way to enable access to any investor. These KPIs are also important at the exit stage.
Bernard Niesner has his own perspective, having to establish a new business in a (for him as an Austrian) foreign country (Spain). He decided to stay in Madrid. Later, his business was moved entirely to the UK, as it had a more developed ecosystem which worked very well for the business. Then the Covid-19 lockdown period proved to work even better for his business (which developed a language app) and later he sold the business for US$400m to a listed US company. He was amazed how difficult the process seemed to be – to sell a Spanish company to a US company. He had to deal with US lawyers and all the complexities of the deal. He encountered lots of barriers, impediments and hoops they had to jump through but in the end he managed to complete the sale. He advises to remain commercial and not get stuck in the details.
How do you experience the different cultures in the different jurisdictions? What are the nuances?
Javier Cebrián, from the standpoint of the VC, sees some differences, but these are micro. For example: the way the employees are managed; how governance is maintained; and the way you negotiate and close a deal. In southern Europe you tend to play with bigger ranges in negotiations; in Germany, for example, this tends to be smaller. But, in the end, it is a common space. You are dealing with investors from various jurisdictions and we all need to work to reduce the differences. Europe is a complex case with lots of history.
Bernard Niesner adds that the alignment of cultural differences with investors is very important. In his deal it was important that potential barriers were constantly considered. A fundamental factor in the success of his business was the participation of the employees, to whom an amount of US$50m was distributed through a stock option plan. This had to be aligned with some investors, who were maybe hoping to get more return.
Javier Cebrián points out that start-ups are often ‘multicultural animals’, so they tend to have people from different places, and cultural differences play a role when the startup is going to expand into other jurisdictions.
We are seeing more and more protections against foreign investment. What has been your experience around foreign investment controls when venturing outside your home country?
Tobias de Raet sets out that foreign direct investment (FDI) has become of increasing importance in VC transactions. If you are an investor from the EU – where you have a level playing field – it is usually not critical unless you touch certain sectors such as defence or infrastructure. But in anywhere that is not in the EU (Japan, the US and the UK) you have to factor in the time for registration and time is usually what you don’t have in VC transactions. Tobias states that in Germany, which is famous for its bureaucracy, the periods for registration are two months plus four months, so this increases the time between signing and closing. Then the process starts to get all the facts straight. You think you have filed all facts, but then the authorities inform you right at the end of the first two months period that they need even more facts. So, this process must be considered early on. FDI often becomes more relevant in strategic investments and private mergers and acquisitions (M&A) transactions. Tobias gives the example that Cosco, specifically the Chinese branch, wanted to take a 33 per cent stake in a German terminal where ships were unloaded. In that case, the authorities put conditions to the deal stating that Cosco could in fact only exercise 25 per cent of its shares.
Horacio Vianello states that in Latin America, there are lots of differences between the jurisdictions. Some of the smaller countries have quicker processes. Most notably Chile has a well-developed venture capital system that is well above the rest of the region. Brazil has a comparable system, based upon its sheer size, and countries like Uruguay have developed structures. In terms of FDI, there are some industries and sectors that have restrictions. Right now, there is a relative lack of FDI or government veto, but this might change in the future – we will see how the political system will develop.
Do you see that the structuring of a deal, especially from the perspective of the investor, and the valuation of the start-up, requires that the holding company is moved to another jurisdiction of the investor, eg, the US or the UK?
Javier Cebrián does not believe in moving a holding just for tax reasons. He has experienced a couple of times failures of tax or other issues, where certain structures were moved or changed outside the natural markets of the company. You can certainly open a holding company somewhere else, but he would generally prefer the focus to be on where the holding company really is, rather than doing it the other way around.
Bernard Niesner answers that great companies, which are great partners and which are growing, will always get their funding, no matter where their holding is located. But he stresses that the ecosystems in Europe have evolved so much over the years. The ecosystem in Madrid these days is incomparable to the days when he was setting up his company in 2008. All the VCs and growth funds now have offices in London, Paris and Madrid, and it is very easy to travel around Europe and make visits. He agrees that it is important that there should be a business reason why you should move the holding to another place from where the operations. If you move it just for tax optimalisations, then this should appear as a big red flag. He thinks companoies spend too much time and too much money on legal fees in setting up these structures, while it is uncertain whether it will be earned back. So, he says, always put business first, eg, try to set up an investor board that is supportive of the day-to-day business.
Javier Cebrián supports this view and adds that setting up a holding just for tax reasons will not only lead to discussions with the tax authorities but also lead to internal issues.
Horacio Vianello and Tobias de Raet support that changing the holding structure only for tax reasons will most of the time not work. Horacio mentions that in Latin America you have tax treaties requiring a certain structure, eg, that a holding company must be incorporated in a certain jurisdiction. Tobias said that a structuring for this reason, when funds were coming from a US fund, worked well but this was structured very early in the process. US funds tend to come with their own structures. But it will generally not work very well in a later stage if there are already domestic funds invested, and then you cannot do the flip. In his experience, you can do a US flip if there are early investments, like seed investments, coming from US investors. Generally, it makes more sense to pick an investor that helps you expand into the next markets, or to get to know the cultures thereof. For example, maybe your business model does not work the same way in these new markets.
Do you agree with the impact and importance of the standardisation of documents and methods, eg, the lean documents project that has been initiated by the IBA Closely Held Companies Committee?
All speakers fully supported this. It is very important to have standardisation of investment agreements, shareholders agreements and terms of a deal. Tobias de Raet states that, of course, there are still differences, but the terms of the shareholders agreement and the investment agreement are essentially identical. The lean documents project will definitely help to achieve this. It also helps that the investors and start-ups recognise certain aspects. If you are familiar with these terms and you look for certainty it gives you a sense of security, and that is something that the lean documents project can provide.
Can, apart from standardisation, other deal logistics or practicalities be a challenge or impediment, or cause potential tensions around deal structure, diligence and the like?
Javier Cebrián mentions the administrative burdens for investors when you want to acquire more than ten per cent of the shares. This has proven to be troublesome for some of the deals he has been going through. For example, if the target has a tight cash flow and is in urgent need of cash, a delay of four months is stressful for all the parties. Usually, this is solved in such a way that certain investors extend a note, simply on the basis of the initial documents or the term sheet. But he would rather see fewer formal rules.
Bernard Niesner remembers how hard it was to get through all the formalities, eg, by obtaining powers of attorneys from more than 90 shareholders. He remembers having to chase them, sometimes they were responsive and he didn’t know where they were. This caused a lot of stress, because he and his partners just wanted to get the deal done. Bernard also remembered there were issues around the stock option plan. Certain branches of banks had to call other branches in order to find the relevant share certificates. It is difficult to focus on the main deal when there are so many little things going on.
Let’s consider the impact of public/private partnerships and how collaborations between investors, startups and governments from different countries can overcome obstacles in venture capital financing. What initiatives exist to encourage cross-border collaboration?
Tobias de Raet answers that unfortunately he does not see much of that in his country. There is, of course, the activity of the European Investment Bank but aside from that what he sees at the domestic level is that companies who are active in research and development (R&D) can get credit facilities early on. But this often creates new problems because the national documents are drafted in the domestic language, and it creates anxiety for investors in future rounds. In Tobias’ view, domestic credit usually creates new hurdles and does not lead to a climate that attracts foreign investors.
Tobias furthermore touches on the development of talent and creating an atmosphere that is good for start-ups. 15 years ago a place like Berlin was virtually nothing; now you see that this place attracts a lot of talented people and fosters the environment. So, there should be an interest of the government to this attractiveness coming to your country.
Horacio Vianello added that in Latin America there are on the national level programmes to help start-ups and there are also tax regimes aimed at fostering start-up companies and paving the road for start-up companies in the field of, eg, R&D.
The session co-chairs thanked the speakers and wrapped up the session.