The Flexible Company — Austria’s venture to attract Venture Capital

On January 1, 2024, following extensive preparatory work, Austria introduced a new type of closed company, called “Flexible Kapitalgesellschaft” (FlexKapG) or “Flexible Company” (FlexCo). The declared objective of the new statute is to create a corporate form particularly suitable for establishing start-ups. This post provides an overview of the roles and requirements of various stakeholders within start-ups and a brief introduction to the new law.

Historically, Austrian corporate law has been bifurcated, distinguishing between the public stock company (Aktiengesellschaft, AG) and the private limited company (Gesellschaft mit beschränkter Haftung, GmbH). Although GmbH offers a certain amount of flexibility and adaptability, start-up investors and advisors have been lobbying for an even more amendable corporate form, notably as to its corporate finance rules. The new FlexCo combines classical features of GmbH with some finance and governance elements of public stock companies as well as new features, in particular a new tax-subsidized share class designed for employee share schemes.  

1. Start-ups’ Needs: A Company Law Perspective

Start-ups are early-stage companies, which, due to their orientation towards technical innovations and rapid expansion through scaling, have needs and requirements that distinguish them from other enterprises. Importantly, they can neither offer any collateral to investors nor are investors able to reliably assess the founders' capabilities and the company's prospects of success at the time of investment. In other words: information asymmetry and the potential of agency conflicts are particularly high and further exacerbated by the founders’ dual role as shareholders and managing directors. This led to the rise of highly specialized and risk-tolerant investors participating in the company's equity by usually taking a temporary minority stake in the company which they intend to sell at a later point in time in order to generate a return.

In the US, the divergent interests of founders, employees and investors are usually mirrored by establishing different classes of shares. However, since preferred stocks, a standard building block of US Venture Capital, are not easily emulated in most European jurisdictions, investors usually establish complex contractual superstructures of highly specialized and interconnected investment and shareholders’ agreements. These contracts are ancillary to the articles of association and provide investors with additional information and determination rights as well as a preferential allocation of exit profits.

In short, start-ups require legal rules that reduce transaction costs between different shareholder groups, that are sufficiently adaptable to allow investors to intervene, and that provide mechanisms to align the interests of investors, founders and employees.

2. The Anatomy of FlexCo

Governance

In structure and principle, the governance of a FlexCo is akin to a closed company’s. It has two mandatory bodies: at least one director, who represents the company and manages its day-to-day business, and the general meeting, the supreme body of the company. While resembling the governance model of the German closed corporation, the Austrian GmbH and FlexCo are more rigid, particularly because decision rights regarding the financial governance of the company are mandatorily assigned to the general meeting. Since capital increases are the usual route for Venture Capital investors to acquire shares, this decision architecture has proven to be an obstacle to the swift implementation of investments. The FlexCo generally maintains this restrictive approach but offers a number of options for delegating authority from the general meeting to the directors. This increased flexibility is counterbalanced by a tightened co-determination scheme, including the obligation to form a co-determined supervisory board (Aufsichtsrat) in case certain size thresholds are reached.

Minimum Nominal Capital and Capital Maintenance

The new statute sets the minimum nominal capital for GmbH and FlexCo at €10,000. Like all Austrian corporate forms, FlexCo adheres to a very strict capital maintenance regime, which declares null and void any direct or indirect extraordinary wealth transfer from the company to its shareholders.

Shares

The minimum initial contribution for a FlexCo is set at only €1 per share. Articles of association can create denomination shares, divided into initial contributions of at least €1 each, thereby enabling the creation of different share classes for various funding rounds. This contrasts with the Austrian GmbH, where every shareholder is only allowed to hold one share at any given time and shares are by default indivisible. In FlexCo, conversely, shares are, by default, freely divisible and shareholders may hold multiple shares of various classes simultaneously.

Enterprise Value Shares (Unternehmenswertanteile)

Since start-ups are usually unable to pay competitive salaries, they incentivize employees by offering employee share schemes. Under US corporate law, this is done by offering employees (options on) common stock. In Austria, however, neither stock-options nor closed-company shares are viable for that purpose as any share necessarily and immutably conveys certain voting rights and hence opens up litigation risks. Until now, employees have been receiving participatory remuneration through contractual schemes in so-called virtual share programs. In order to lower transaction costs in this regard, FlexCo offers a new type of share with very limited voting and reduced information rights, called Enterprise Value Shares (EVS).

A unique EVS feature is that they come with a mandatory duty to establish a tag-along right for their shareholders. This tag-along right can be exercised whenever a majority of the founders as named in the articles sell their shares. Unless otherwise stated in the articles, these EVS do not receive any pre-emption rights on newly issued shares.

EVS also mitigate a common tax issue associated with employee stock: Usually, shares and options, which are transferred below market value, are taxable at the time an employee receives them. However, shares in a start-up are hard to value, do not yield dividends and their transfer is limited by contract. In other words, the employee receives a taxable but ‘dry’ income. To alleviate this, EVS are coupled with a tax privilege, which delays the tax incidence to the moment the EVS are sold and the employee receives liquid income.

Share Transfers

In order to exclude their public trading, GmbH shares may only be transferred by notary deed. This requirement can be cumbersome in practice, particularly if foreign investors are involved or shareholders are physically unavailable when the transfer is set to take effect. The FlexCo introduces an alternative formal requirement for share transfers and the purchase of shares through a capital increase. This alternative formal requirement is a signed document, established by either a notary or an attorney. The notary or attorney is required to verify the identity of the parties using a photo ID, verify the admissibility of the share transfer and advise parties on the legal consequences of their statements and on the conditions of the transfer.

Own Shares and Redemption of Shares

An Austrian GmbH is restricted in buying or holding its own shares. FlexCos, however, are able to acquire, hold and redeem their own shares in a manner modeled after an AG. This primarily serves the purpose of facilitating the use of various VC techniques to regulate the forcible exclusion of shareholders and exit procedures, such as good- and bad-leaver clauses, and vesting. Previously, such arrangements were only achievable through complex contractual regulation at the shareholder level, usually in the shareholders’ agreement.

Some restrictions still apply. For instance, FlexCo may only hold a maximum of one-third of their shares and the rights attached thereto cannot be exercised while the company holds them. The redemption of shares is limited to justificatory grounds set out in the articles. Justified redemptions may either be triggered automatically and implemented by the directors, or initiated ad hoc by a shareholder resolution. While the latter alternative is more flexible, it is particularly vulnerable to being challenged through litigation. In either case, the traditionally strict Austrian capital maintenance regime applies. As a result, redemptions will only be allowed if the purchase price is at market value and can be financed by freely distributable company assets.

Resolutions Outside of General Meetings and Split-voting

In contrast to the GmbH, which allows for shareholder resolutions outside of a general meeting only by following a complex process, FlexCo aims at facilitating resolutions outside of general meetings by enabling the articles to allow resolutions in writing on all or specific subjects. In these cases, a written unsigned vote will suffice, even if it is only sent by e-mail stating the shareholder’s name at the bottom. It is, however, mandatory, that all shareholders are given the opportunity to participate in the vote. A different statute has recently vastly extended any company’s ability to hold general meetings virtually.

In addition, shareholders of a FlexCo are allowed to split their votes: For any given resolution a shareholder may vote in favour with some of his shares, while voting against or abstain with others. In the AG this has explicitly been allowed, but courts ruled that the close connection of the shareholders and the limitation to one share per shareholder prohibit split-voting in the GmbH. This restrictive stance has proven problematic for later-stage start-ups, where employees, founders and investors routinely bundle their votes to facilitate the decision-making process and lower collective action costs. One way to achieve this is by appointing one member of the group as a fiduciary and placing the shares with him. The introduction of split voting therefore enables shareholders who act in a fiduciary capacity to express the different preferences of the relevant shareholders in the decision-making process.

Flexible Capital Measures

A core piece of the new statute is the combination of the flexible measures to raise capital of the AG with the governance rules of a GmbH, namely by empowering shareholders to authorize directors to increase share capital by conditional capital increases, authorized capital increases or the issuance of financial instruments, to allow creditors to participate in the FlexCo’s profits or convert their debt to shares. In the case of authorized capital, the statute limits the maximum amount of shares issued accordingly to half of the nominal capital at the time the authorization is granted in the articles. The statutory maximum duration of any such authorization amounts to five years. To protect shareholders the directors must inform them prior to issuing new shares. Theoretically, this enables shareholders to protect their interests by passing a resolution instructing the directors to refrain from issuing new shares or restricting their power to exercise it. If a supervisory board exists, the directors are also required to request its permission before issuing new shares in this manner.

To mitigate dilution risk, shareholders are protected by pre-emption rights in relation to conditional or authorized increases of capital or any financial instruments issued. However, these pre-emption rights can be limited or excluded.

3. A Small Step Forward, Not a Giant Leap

In summary, the new law provides a number of suitable innovations for start-ups. Most of these concern shares, shareholder rights or capital measures. The legislature’s intention to build upon the existing structures of company law makes sense because of the associated predictability and network effects.

However, the statute falls short of addressing many important issues, especially regarding elements adopted from AG law. While most of these will eventually be resolved either by courts or scholarship, more objectionable is the legislator’s lack of courage, as shown by the failure to adopt more innovative rules. Enterprise Value Shares, while useful in principle, offer only limited advantages compared to existing contractual solutions. Especially its limitation to issue just under 25% of the nominal capital in EVS will limit their usage. Additionally, such shareholders’ mandatory right to participate in general meetings will give rise to the practice of gathering them through shareholders’ agreements or the use of trustees. Otherwise, hold-out and other collective action problems could hamper the decision-making process.

On a more general note, it is lamentable that the new law’s international perspective is limited to the authorization of using the English Flexible Company or FlexCo in the firm’s legal name.  It would have been bolder and more useful to allow for the articles of association to be set up in English. Already, most VC investment and shareholders’ agreements in Austria and Germany are drafted in English. Having articles and the ancillary contracts set up in the same language could prevent misunderstandings and substantially reduce transaction costs.

Nevertheless, FlexCo might still prove interesting for international investors. The EU-UK Trade and Cooperation Agreement (EU-UK TCA) does not contain any special provisions regarding corporate law, but extensive protections for UK enterprises and investors (see Art. SERVIN 2.1. and 2.3.). In short, UK enterprises and investors may not be treated less favourably than European ones or those from other jurisdictions. This allows UK investors to invest in FlexCo start-ups or establish it as a subsidiary to invest in Austria and other European jurisdictions. In connection with the new Austrian statute on cross-border mergers and divisions, backed-up by the EU/EEA Mobility Directive 2019/2121 regime, FlexCo could act as an adaptable vehicle to invest in Europe or facilitate complex multi-step cross-border M&A transactions.

In conclusion, the new statute marks a positive step, albeit a modest one, in the right direction. It will likely improve VC contracting and investments in Austria and elsewhere inside the EU/EEA

Florian Hule is a Research Assistant at the Department of Commercial and Business Law and the Centre for Comparative Corporate Finance Law (C3FL) at the University of Vienna.

Chris Thomale is a Professor of International Commercial and Business Law (University of Vienna) and Comparative Law (Università Degli Studi Roma Tre), and Co-Director of the Vienna Centre for Comparative Corporate Finance Law (C3FL).