Article by Valter Võhma, attorney-at-law at TRINITI Estonia specialised in advising the start-up sector and fundraising transactions. TRINITI is a pan-Baltic law firm that helps entrepreneurs to change the world.
The land of unicorns
Estonia is located on the coast of the Baltic Sea neighbouring Finland, Sweden, Latvia and Russia. With the population of approximately 1,33 million, it is one of the most digitally advanced countries in the world. Estonia is the birthplace of multiple unicorns like Skype, Playtech, Wise, Bolt, Pipedrive, Zego and ID.me making it the country with most unicorns per capita in Europe.*
Estonian start-up ecosystem
In the mid-2021 Estonia had more than 1200 start-ups, with the total employ account of around 7000 people employed locally. The top five sectors for Estonian start-ups by employment taxes paid are (a) fintech, (b) transport & logistics, (c) business software, services & HR, (d) cyber tech and (e) communication, with the average gross salary being around EUR 2700. The aggregate turnover of Estonian start-ups in the first half of 2021 was EUR 558M, which is approximately 49% increase compared to the same period in 2020. In the first half of 2021 the total investments made into Estonian start-ups amounted to around EUR 223,4M (for 2020, the figure was EUR 142,7M). With Bolt receiving EUR 600M, it is predicted that by the end of the year total investments made into Estonian start-ups will reach EUR 1B.** Bolt’s latest investment round is remarkable as Bolt is headquartered in Estonia. This clearly shows that raising big money no longer requires Estonian start-ups to flip to their topco US, UK or other similar jurisdiction and that investors have trust in the Estonian business and legal environment.
Startup investing in Estonia has developed a lot over the last decade. From a very few players on the market and limited funds available, Estonia now has a healthy ecosystem supporting start-ups from pre-seed and seed rounds (mostly accelerators, business angels and smaller family offices/VCs) up to B and C rounds (larger VCs and PE).
There are variety of accelerators and incubation centres in Estonia helping founders to transform their ideas into businesses. For example, Startup Wise Guys, Prototron, Startup Incubator Tehnopol, Startup Lab, etc. Some of them also offer start-ups investments and participate in the following investment rounds together with business angels and VCs.
Estonia has a very active business angels’ network EstBAN. For smaller VCs investing in very early stages (pre-seed and seed) it might make sense to get in touch with EstBAN, as they have all the knowledge about local and nearby teams that are fundraising. Angels also actively syndicate to reduce the costs and the names in the CAP table, so partnering up with a syndicate could be a practical way for an early-stage VC in getting into a pre-seed or seed round. A good statistical summary, prepared by Change Ventures, on the funding characteristics in the Baltics on pre-seed, seed and A rounds can be found at: https://www.changeventures.com/baltic-startup-funding-report.
The VC market is very active in Estonia. In addition to the VCs, entrepreneurs who have exited from their companies, both from new and old economy, have given raise to multiple family office type of investment vehicles that are able to participate in bigger deals together with VCs. This mix has considerably increased the amount of financing available in the ecosystem. VCs in Estonia usually start with minimum of around 200K-300K tickets and can go up to about couple of million, or more if needed, per investment round. Investments bigger than that usually come from foreign investors.
There are variety of events in Estonia dedicated to showcase the Estonian start-up scene. The StartupDay in Tartu and Latitude59 in Tallinn are the biggest events of the year. There are also number of sector specific events, for example the biggest greentech event in the region, GreenEST Summit in Tallinn. These events bring together start-ups, investors, and other market players all over the world, foremost from the Baltics and the Nordics.
In general, legal principles related to investment process and shareholder relations in Estonia are similar to the rest of the world, but there are certain aspects that might be worth considering.
Free document package: Startup Estonia and the Estonian Private Equity and Venture Capital Association have prepared a free document package for early-stage investing (seed rounds, early VC rounds) with the purpose to harmonize investment processes and to bring down legal costs related to it. The template package is extensive, ranging from day-to-day documents like IP assignment agreement, employment agreement to SAFE, convertible loan, investment agreement, shareholders’ agreement and even a calculation sheet for the CAP table. The templates are available at https://startupestonia.ee/resources and are widely used. Therefore, in majority of cases it makes sense in early stage for a foreign VC to use these templates as the base for making the investment instead of using the VC’s own template. The legal cost for amending the templates (basically taking out bits which are not necessary and adding bits where needed) is usually considerably lower compared to modifying a foreign VC’s own templates to suite Estonian laws.
Shares: in Estonia, in case of a private limited company (OÜ or osaühing in Estonian) (almost all start-ups are registered in the form of a private limited company) each shareholder owns one share of the same class. The differentiation on the size of the stake is based on the nominal value of the shares. For example, if a private limited company with a share capital of EUR 10 000 in nominal value has 2 founders holding both 40% each and 2 investors holding both 10% each, then the company has total of 4 shares. Each of the founders hold one share with the nominal value of EUR 4000 and each of the investors hold one share with the nominal value of EUR 1000. The investors, as a rule, get preferred shares and the founders have common shares. It is common to create multiple classes of shares already with the very first pre-seed or seed equity round.
Governing bodies / committees: most Estonian start-ups operate only with a management board and do not have a supervisory board. The members of the management board are the de facto managers of the company who represent the company in all transactions and can sign on behalf of the company. As a default setting, each member of the management board can represent the company solely. It is possible to have joint representation rights, but this is very rare. Having a supervisory board is not mandatory for private limited companies, although possible. In case of early-stage start-ups, having a supervisory board usually is just not practical, as it adds a layer/cost and the same economic result can be achieved by contractual means (with having the relevant veto provisions in place for the management board, etc.). In case of more developed start-ups, supervisory boards are a bit more common and it might make sense to have it, if this is commercially required. As regards to committees (for example salary committees, option committees, etc.), they are not used in Estonia as the relevant items are decided either by the management board, the supervisory board (if existing) or the shareholders. This sort of a very thin corporate governance might seem a bit unconventional for foreign investors used to a layered corporate set-ups, but there are ways how to achieve the same commercial result by contractual means without the need to have the supervisory board, committees, etc. The leaner the set-up, the easier and cost-effective it is for the founders to manage and build the company.
Notarisation: issuing shares of a private limited company does not require notarisation. For example, in case of an equity investment, the only thing an investor needs to do for subscribing the share(s) is to transfer the funds to the company’s bank account. After the funds have landed, the company will file an application to the commercial register and the new share capital is registered. In case of converting a convertible instrument, instead of paying the funds, an investor is obligated to sign a set-off agreement with the company according to which the investor’s claim against the company to repay the loan is set-off against the company’s claim against the investor to pay for the share(s) issued.
Regardless of the above, it is important to bear in mind that in case of private limited companies, the sale of shares is a notarised transaction. It is possible to waive the notarisation requirement in the articles, provided that the company’s share capital is at least EUR 10 000 (in nominal value). Based on the above it is recommended to have the target’s share capital least EUR 10 000 post closing to enable transfer of shares without notarisation.
Signing requirements: in case an investment round includes foreign investors/shareholders, it is customary to sign the investment agreement and the shareholders’ agreement by electronical signature (for example DocuSign) or similar signature.