Behind seemingly straightforward statements, there are sometimes underlying dramas. In May, the ride-sharing service Clevershuttle released a statement with the headline, "Deutsche Bahn will no longer finance Clevershuttle." The German railway had been the majority owner of Clevershuttle, a shared taxi service founded in 2014, holding 86% of the shares. What was communicated so matter-of-factly meant insolvency for Clevershuttle - an unexpected turn of events. Co-founder Bruno Ginnuth emphasized that they had met and even exceeded their agreed-upon financial goals, saying, "The decision to end the partnership is all the more surprising."

Fraugster, a developer of anti-fraud software, also faced bankruptcy this year after a funding round failed. Since its founding in 2014, notable investors like Commerzventures and Earlybird had participated, and in 2018, Fraugster secured $14 million as part of a Series B financing round. Franka Emika, aiming to become the "Apple of robotics," had to file for insolvency in August following the collapse of a funding round due to disputes within the shareholder group.

These companies are not isolated cases. The Startupdetector database has already recorded more than 230 startup bankruptcies in 2023 after just three quarters, surpassing the total numbers for both 2022 and 2021.

The startup crisis is affecting not only newcomers to the market but also established players. "In recent months, we have seen an increasing number of insolvencies among startups that have previously received financing rounds, sometimes in the triple-digit millions," says Matthias Hofmann, an insolvency administrator, partner at the Pohlmann Hofmann law firm, and a board member of the Society for Restructuring TMA Germany.

Many young companies are suffering due to a significant reduction in investor engagement. According to the Startup Barometer by the auditing and consulting firm EY, the amount of venture capital almost halved in the first half of 2023 compared to the previous year. Startups raised just 3.1 billion euros during this period.

When investors are no longer as liberal with their funds, things can become critical, even if the balance sheets of young companies seem comfortable at first glance. "Some startups have double-digit million amounts in their accounts, are largely debt-free, and are still at risk of insolvency," says Joachim Ponseck, Partner in Restructuring & Insolvency at Baker McKenzie law firm. This includes young companies that have been in the market for several years and have significant revenues.

Many startups remain unprofitable even after years of operation. "If a company has 15 million euros in the bank but burns 2 million euros per month, trouble is foreseeable," Ponseck warns. Business leaders must be cautious and, in case of doubt, pull the plug in time, or they could face accusations of insolvency negligence.

While for large companies, the majority of insolvencies result from illiquidity because they cannot pay at least 10% of their outstanding bills, over-indebtedness plays a significant role as a cause of insolvency for startups. Over-indebtedness occurs when the debtor's assets no longer cover their liabilities, and the payment ability is not secure within the framework of the so-called going-concern forecast in the medium term. "If assumptions from financial planning don't materialize or significant investments are pending that cannot be covered by a new financing round, the going-concern forecast for a startup can quickly tip," explains Hofmann.

At the end of 2022, the forecast period for over-indebtedness was temporarily shortened to four months due to the limited visibility for companies caused by sharply rising energy prices. Starting from January 2024, they will need to set the forecast period back to twelve months. Some advisors are already encouraging their clients to plan beyond the twelve-month period.

The going-concern forecast, especially for startups, often depends on whether shareholders provide fresh capital or not. However, their commitments are not always legally binding. The most prominent case in dispute is the airline Air Berlin, which went bankrupt after Etihad terminated financial support despite a letter of comfort.

To minimize liability risks, Ponseck advises the responsible parties to always document financing commitments in writing, ideally in a "hard letter of comfort" or at least in a meeting protocol signed by all parties involved. "In this way, the managing director has something to rely on in the event of a serious situation," he says. However, he acknowledges that it's not guaranteed that a judge will accept it.

When it comes to raising crucial liquidity, valuations are currently the major sticking point. "New investors are generally still willing to invest in startups, but at significantly different valuations than the existing shareholders," observes Ponseck. Valuations for startups are typically based on future cash flows, which must be discounted at a significantly higher interest rate than one or two years ago. "This significantly reduces the net present value. As a result, many startups can no longer achieve valuations from the past."

In addition, some investors had significant pressure to invest in recent years and were quite generous with their investments. This has changed: "There are now opportunities for returns on capital elsewhere. Venture capital investors are more cautious than in the past years. This complicates financing rounds," notes insolvency administrator Hofmann.

For restructuring attorney Ponseck, in times of crisis, an existing shareholder is often the first point of contact. If liquidity is no longer forthcoming from there, a sale may be the only option to avoid insolvency. The conditions are not optimal: "Potential buyers are aware that their counterparts are under tremendous pressure to sell." Possible buyers can be direct competitors, as in the case of the delivery service Getir, which acquired the struggling competitor Gorillas at the end of 2022.

In a transaction shortly before insolvency, existing shareholders at best come out with minimal losses. They must write off the majority of their investments, after having invested time and passion in the young company for years. "These are often very emotional discussions," says Ponseck.

Struggling startups are challenging to sell in the M&A market for several reasons. "It takes a lot of persuasion to find an investor for a company that has received tens or hundreds of millions of euros in investment, has still not reached break-even, and whose existing shareholders are no longer putting in money," describes insolvency administrator Hofmann the challenge.

Once a provisional insolvency administrator takes over following the insolvency application, time pressure intensifies. During a maximum of three months in the provisional insolvency process, a startup can cover wages and salaries through insolvency benefits. This temporarily eliminates a major cost item. However, when the insolvency proceedings commence, the startup must bear all ongoing costs itself. While manufacturing companies can manage this for a few weeks to continue negotiations with potential investors, startups are on the brink. "Some are burning through millions monthly," explains Hofmann. If no solution is found in the provisional process, it typically means the end.

There's also a structural hurdle: Typically, startups have the highest chance of obtaining fresh liquidity from venture capital investors. However, most venture capital providers prefer to hold a minority stake. "The goal of the insolvency administrator is generally a complete sale to an investor," explains Hofmann. Failing this, individual assets can be sold—such as patents or technological developments. In a recent case, Hofmann sold the technology of the insolvent cooling technology company Efficient Energy to Vertiv a few weeks ago.

"In the ideal scenario, you find a company that is interested in the developments of the startup and the expertise of its employees, and as a strategic investor, takes over the entire operation," he says. In the past, other startups have also stepped in as saviors and acquired competitors. "However, this requires that they themselves have received enough fresh funding from their investors to sustain the higher cost structures over the long term," emphasizes Hofmann. In the current environment, many startups are likely already dealing with enough challenges of their own.