The Ecosystem: deep-tech is not holding its breath for multiple vote share structures

Work is underway on an EU directive to make multiple-vote share structures that allow the founders of start-ups to retain control when raising funds on public markets an option in all member states. The argument is that this will reduce reluctance to list and increase access to capital.

“Entrepreneurs should have access to capital without fear of losing control of their company,” said Swedish justice minister Gunnar Strömmer, announcing the EU Council’s negotiating position in April. “Multiple-vote share structures can help to make access to markets more attractive and we are determined to make this option available for all European SMEs as soon as possible across the whole internal market.”

But Europe’s deep tech ecosystems are not crying out for this change. Voting rights can already be customised through conventional shareholder agreements, and in European countries where multiple-vote share structures are allowed they are seldom used by deep tech start-ups.

“We certainly don’t see a lot of them, even though Finnish legislation would already allow for such structures,” said Pontus Stråhlman, partner at Helsinki-based Voima Ventures, which specialises in deep tech ventures in the Nordics and Baltics. “It’s very seldom that the votes per share have ever counted for anything in our start-ups.”

Patrik Sobocki, senior investment director at the Industrifonden venture capital fund in Stockholm agrees. “If you look at the listed environment [in Sweden] it’s very common, as a power play for minority shareholders, but when it comes to our environment of deep tech companies it’s very rare. I can’t recall a case where we had differentiated voting on shares.”

This is even the case when companies mature and go public. “We’ve listed a number of companies over the years, and I can’t say share ownership has been the main challenge for founders,” said Sobocki.

A likely explanation for this is that there are other ways of addressing questions of control over a start-up company, for example through shareholder agreements or company bylaws. These set out the rules on how the company is managed, and can accommodate provisions that give specific powers one or another shareholder.

“We do use different classes of shares, with different governance powers, and it is very common that we leverage on this kind of structure,” said Nicola Redi, managing partner at Obloo, a venture fund based in Milan.

Working though company bylaws in this way is effective and prepares the start-up for what is to come. “If you assign specific powers to different classes of shares, which are usually linked to the different classes of investors joining the start-up later on, it makes the life of a start-up easier, because everything is more transparent,” Redi said.

For early stage start-ups, the goal is usually to assign additional rights to investors rather than protect founders. “In the early stage, investors are usually in the minority, but still want to have some veto rights, for example over extraordinary corporate finance decisions, or taking on extra debt, or assigning intellectual property,” said Redi. “And that can be written into the investors’ class of shares.”

This approach can even cover issues inked to the day-to-day management of the company. “Most often we don’t have rights to decide upon budgets, but we have a veto right,” said Stråhlman. “That means that any kind of deviation from the ordinary business is something that investors have a disproportionally large say in.”

Downside protection

According to Sobocki, the balance of power in these agreements often follows the mood of the market. “During hypes, you tend to see more founder-friendly share clause conditions, and in tougher times it’s a buyer’s market and you tend to see more downside protection built in.”

The spread of US practices in Europe is also playing a role. “So, for example, you introduce preferred share clauses with different conditions even earlier on the funding journey than maybe we saw 10 years ago,” Sobocki said.

Venture capital firms naturally argue that their desire for at least some control is reasonable, since they are supplying start-ups with money. “It would feel strange if we didn’t have any say in how that money is spent and how fast it is burned,” said Stråhlman.

He is confident that the agreements used in Finland are not unbalanced. “We use shareholder templates that have been created in collaboration with university entrepreneurship societies, and I assume that they would not publish shareholder agreement templates that are extremely unfair to them.”

Others emphasise the partnership between founders and early stage investors. “Especially in deep tech, founders are primarily researchers who have turned into entrepreneurs, and early on they may not be acquainted with how companies are run,” said Redi.

In this context, a requirement that investors be involved in negotiations and sign-off on strategic decisions can avoid mistakes being made. “That is just a matter of experience, so in the early stages it is very important, even just from a legal point of view, that we support founders in running their own companies,” he said.

And there is no negative feedback from the companies. “We use these structures, they are plain vanilla, and our founders are not complaining at all about the use of different classes of shares.”

Unintended consequences

Multiple-vote shares that benefit founders therefore seem to be a poor fit for early-stage companies. “I find it a bit old-fashioned to think that a company would be better off creating a structure where the original founders can cement their power, and have the new money that is sharing in risk-taking merely profiting from the upside,” said Stråhlman.

If multiple-vote share structures were to be taken up more widely, there may inevitably be consequences. “Founders may well enjoy the kind of structure where they retain control, but I think that the end result will be that investors, who are now used to having control, will need to be compensated by getting an extra upside,“ said Stråhlman.

Sobocki feels that greater education of founders is required about the process they are embarking on, particularly if they have big ambitions. “Not all founders are aware of the dilution effect that happens when you really want to take an idea from the lab bench to a global, scalable company,” he said.

This is likely to be even more pronounced if the company is looking for the high investment necessary to pass the $1 billion valuation milestone. “A founder may own 20%, 30% or even 50% of the company today, but it is unrealistic to have that ownership if the company becomes a unicorn,” said Sobocki. “For us, it’s natural that founders experience a substantial dilution, and we work on a number of ways to compensate for that and incentivise founders further.”

This not to say that the Commission’s urge to harmonise the law on share structures is not laudable. “If a company has international ambitions, it’s only natural that the financing should aim be international, and therefore harmonisation is a good idea,“ said Stråhlman. But he thinks the Commission may have set its sights too low. “I fear that this is not trying to harmonise with the current [international] standard, but creating something specifically for the EU. And I’m not sure that, in the current start-up ecosystem, this is a smart way of doing things.”

While there are doubts about how effective this intervention on share structures will be, there is generally a lot of support in the venture community for the measures the Commission has taken to channel funding for deep tech startups, for example through the European Innovation Council (EIC) and the European Investment Bank (EIB).

Even so, Sobocki thinks that more could be done for deep tech start-ups once they clear the early stages. “I think we have a fair amount of venture firms who can pick up the first growth, but when it comes to larger rounds – from  €30 million up to €100 million – that’s where it gets tough,” he said. The EIC now has a remit to match up to €30 million, but there is scope to go further, for example with regional EIC-type funds that could work across ecosystem to boost the scale-up phase.

Redi meanwhile thinks that a more strategic intervention would be to look at acquisitions, which are a much more significant exit route for deep tech start-ups than public listings. The problem is that non-EU corporations make most of the running. “The EU is investing a lot of money in growing start-ups that are eventually acquired by non-European companies,” he said. “So, let’s try to figure out how we can increase the number of acquisitions through European corporations.”

That may require some kind of support through the EIB, in order to persuade European corporations to open their wallets. “It would be fantastic if we could help big corporations in Europe understand that they can acquire technology and become competitive though the acquisition of start-ups,” Redi said. “But they have to be willing to pay the going rate, because every start-up, in the interest of its  own investors, has to sell to the best acquirer.”

Elsewhere in the Ecosystem…

• Start-ups working with virtual worlds and Web 4.0 should be able to test new technologies, products and services in regulatory sandboxes, according to the EU strategy for the sector, published last week. The European Commission says it will work closely with national governments to identify specific topics where testing should be prioritised, such as the tokenisation of virtual assets, and to ensure a coordinated approach within the EU. Regulatory sandboxes are also underway or planned for companies working in financial services, blockchain and artificial intelligence.
• Dutch start-up Rocsys has secured a €18 million loan from the European Investment Bank to finance the development and deployment of its autonomous charging systems for electronic vehicles. Founded in 2019, the company’s technology is based on biomechanical soft robotics for exoskeletons initially developed at Delft University. The technology can be retrofitted on any standard electric vehicle connector and charging equipment, and so does not depend on changing any charging hardware.
• US genome sequencer manufacturer Illumina has been fined approximately €432 million by the European Commission for pushing through a merger with its former spin-out, liquid biopsy specialist Grail, without regulatory approval. Grail has been fined €1,000. The merger went ahead in 2021 despite an ongoing investigation into the possibility that it would stifle innovation and reduce choice in the emerging market circulating tumour DNA blood tests. The Illumina fine, calculated at 10% of its turnover, is the maximum the Commission can impose. The Grail fine is symbolic, but marks the first time such a fine has been imposed on a target company.
• Aphea.Bio, a 2017 spin-off from Flemish life sciences research institute VIB and its partner universities in Ghent and Leuven, raised  € 70 million in a series C funding. The money will allow the company to carry out further R&D on biological agents for use in agriculture, scale-up product launches, expand market reach and commercialise product offerings. The round was led by Innovation Industries, joined by Korys Investments and supported by the Bill and Melinda Gates Foundation.