EU First – Venture Capital Funds, Start-ups and the German Foreign Investment Control
The draft bill of the German Federal Ministry for Economic Affairs and Energy (BMWi) dated 22 January 2021 for the 17th Amendment of the German Foreign Trade and Payments Ordinance underlines that the German Federal Government wants foreign investments in German companies active in promising, future-oriented industries in particular to become subject to foreign investment control. This planned tightening of the German foreign investment control is of particular interest for venture capital funds and start-ups. The BMWi is currently consulting on the draft law with a small, select group of experts in foreign trade law. Dr Christian von Wistinghausen and Dr Patrick Alois Huebner both belong to this group of experts and explain in more detail what the draft law means for venture capital funds and start-ups.
I. Investment control
The German Foreign Trade and Payment Ordinance distinguishes between two types of examination: (i) the sector -specific examination and (ii) the cross-sectoral examination, which can be outlined as follows:
All foreign investors (including those from EU Member States)
- Sector-specific examinations: Notification is required for the acquisition of 10% or more of the voting rights in a German company with business activities in a sector that is directly related to security (e.g. armaments, but also certain encryption software) by a foreign investor.
All investors from third countries (Non-EU/Non-EFTA foreigners)
- Cross-sector examination: Notification is required for the acquisition of 10% or more of the voting rights in a German company with business activities in a critical sector by an investor from a third country;
- Cross-sector examination: Notification is not required for the acquisition of 25% or more of the voting rights in a German company by an investor from a third country (however, the acquisition may still be examined by BMWi ex officio).
Venture capital funds that acquire shares directly or indirectly in a German company must therefore consider whether these acquisitions fall within the scope of the German Foreign Trade and Payments Ordinance. Since 1 January 2021, the answer to this question may as well become significantly more important for investors based in the UK as a freshly minted third country.
II. Notification obligation
For venture capital funds and start-ups, the critical sectors of the cross-sector examination, in particular, will be of fundamental significance, i.e. those sectors that the German Federal Government has classified as particularly relevant to security. The draft law proposes to significantly extend the list of sectors, in particular, to include future-oriented technologies, i.e. sectors in which, in our experience, start-ups are often quite active.
In these critical sectors, there is already an obligation to notify an acquisition of 10% or more of the voting rights so that the direct acquirer must report the proposed acquisition to the BMWi and the acquisition cannot be implemented (closed) until clearance is granted. For VC funds, this means that the investment round cannot be completed where notification is required. The closing of the transaction remains suspended until the BMWi issues its approval.
III. Critical sectors
Sectors requiring notification currently include operators of critical infrastructure, software developers for the operation of critical infrastructure, cloud computing services, telecommunications surveillance services and electronic data transmission infrastructure, media and parts of the health sector. In accordance with the provisions of the EU Screening Regulation, which entered into force in October 2020 and requires further critical technologies to be covered in the future, the BMWi proposes to significantly expand the list of sectors requiring notification under the German Foreign Trade and Payment Ordinance to include the following areas:
High-quality geospatial systems
Automated driving or flying
Cybersecurity/IT security products
Air and space travel
Certain dual-use goods
Quantum and nuclear technologies
Additive manufacturing (“3D printers”)
Smart metre gateways
IT and telecommunication technology services
Critical raw materials
Patents or utility models that constitute state secrets
Agriculture and food sectors
This expansion of the notification requirement – assuming the German Government does not shorten this proposed list – will significantly raise the obstacles to investment for venture capital funds from third countries or those with investors attributed to third countries. In light of the prohibition to implement (close) an acquisition, investors will not approve the payout of any venture capital by the VC fund before the investment has ultimately been cleared. Start-ups should definitely be aware of this when looking at their financing and take the duration of the investment review procedure into consideration when planning a new investment round.
IV. Control-free investments
It is worthwhile looking at those types of investments, which (still) do not fall within the scope of investment control. These include, in particular:
- Investments by German VC funds, and, in cross-sectoral procedures, European VC funds without attributable participation from third countries;
- Acquisition of voting rights below the 10% threshold (providing there is no atypical acquisition of control);
- Acquisition of additional voting rights above the thresholds to protect against the dilution of shareholding, to the extent that the voting rights after the acquisition do not exceed the percentage of voting rights before the acquisition;
- Acquisition of (additional) shares without voting rights.
The broadening of foreign investment control is likely to result in a significant rise in the number of transactions reviewed by the BMWi. Whether the current version of the draft law will actually be adopted remains doubtful. There is still considerable room for improvement, particularly in light of VC investments in start-ups. One could, for example, consider
- Exempting investments in start-ups– not from the notification obligation, but at least - from the closing prohibition;
- Introducing a materiality threshold for minor acquisitions of additional voting rights; or
- Introducing a general “de minimis threshold” for investments in start-ups (e.g. a threshold of at least EUR 1 million).
Dr Christian von Wistinghausen
Dr Patrick Alois Hübner
Rechtsanwalt, M.A. (China Studies)