Startup Financing: Convertible Loans, SAFE, Equity | IT-Medienrecht

Early-Stage Financing for Start-ups: Convertible Loans, SAFE, and Equity Compared

In their early stages, start-ups face a critical question: how to raise essential capital without sacrificing flexibility or incurring excessive costs. Three central financing instruments have become established in this context: Convertible loans, SAFE agreements (“Simple Agreement for Future Equity”), and classic equity financing through a capital increase in exchange for shares. Each of these instruments comes with distinct legal requirements and risks.

For German start-ups navigating the legal framework of 2025, a precise understanding of these differences is crucial. This knowledge enables the selection of the most appropriate instrument and its legally compliant structuring. This article examines the three forms of financing based on their contractual structure, typical applications, legal peculiarities, and practical handling.

The focus is on German start-ups and German law, incorporating current developments and (if available) court rulings. This provides founders with a well-founded overview. Ultimately, it becomes clear that the right legal advice is indispensable to avoid future conflicts and to secure financing effectively.

Convertible Loan – Flexible Loan with Conversion Option

What is a Convertible Loan?

A convertible loan initially provides debt capital to a start-up. However, it grants the lender the right (or obligation) to convert the loan amount into company shares at a later date. Until conversion, the investor acts as a creditor; upon conversion, they become a shareholder. This instrument is particularly popular with start-ups due to its quick and easy implementation.

Convertible loans are almost standard practice, especially as bridge financing until the next major investment round. They allow capital injection without immediately determining a company valuation or initiating complex notarial processes. The investor’s actual participation is deferred, which is ideal when company valuation is uncertain in the early phase.

Typical Contract Features

A well-drafted convertible loan agreement typically contains several core components:

• Loan Amount and Term: The agreement specifies the loan amount and its term. A fixed term (e.g., 12-24 months) is common, aiming for a conversion event to occur within this period.
• Interest: Convertible loans usually bear interest, similar to normal loans. Moderate rates (e.g., 5-8% p.a.) are typical, reflecting the higher risk without being overly burdensome. Interest is often deferred and only accrues upon maturity or conversion.
• Conversion Clause: The conversion right or obligation is the key element. The contract defines the events triggering conversion into shares. Typically, if a qualified equity financing round above a certain minimum amount occurs, the loan is automatically converted into new shares. The lender may not have a choice, but is obliged to convert the loan under pre-defined conditions. Alternatively, the investor might choose between conversion or repayment when the event occurs, depending on negotiation.
• Calculation of Shares (Discount/Cap): The contract must clarify how many shares the investor receives upon conversion. The conversion price is usually determined by applying a discount to the price of the next financing round. For instance, the loan might convert into equity at a 20% discount to the next round's valuation. Additionally, valuation limits are common: a cap (upper valuation limit) protects the investor from too high a valuation upon conversion, while a floor (minimum valuation) protects the founding team from excessive dilution at a very low valuation. These parameters are negotiable. Discounts often range from 10-30%, and caps are based on a plausible maximum valuation for the company's current status.
• Repayment and Maturity Rules: If no conversion event occurs within the term, the contract should specify the outcome. A final maturity date is often set, by which the loan, including interest, must be repaid unless the investor chooses to convert. Some contracts stipulate an automatic conversion at a defined price at the end of the term to avoid repayment, which the start-up might not be able to afford. Clear specifications are vital to prevent uncertainty.
• Further Investor Rights and Consent Reservations: Even before conversion, investors often receive protective rights contractually. Rights to information (e.g., regular financial reports, book inspection) and rights of consent for significant business decisions are common. For example, the convertible loan agreement might require the convertible lender's consent for actions like issuing further loans/SAFEs, fundamental changes to the articles of association, or extraordinary expenses above a threshold. These clauses protect the investor’s future share from dilution or value loss without granting formal voting rights. Other conceivable privileges include exit preferences (e.g., a liquidation preference) or most-favored-nation clauses, automatically granting the lender better conditions if the start-up later offers more favorable conversion terms to another investor.
• Subordination: A crucial element, especially in Germany, is the qualified subordination of the investor’s loan claim. The lender contractually agrees to be subordinated in the event of insolvency or over-indebtedness. This means they are paid only after all other regular creditors. This step ensures that the convertible loan does not count as a liability in the over-indebtedness test, treating it economically as equity. This is vital for the start-up's survival: without subordination, a high convertible loan could trigger an obligation to file for insolvency due to over-indebtedness if no positive going concern forecast exists. Subordination prevents this, providing the start-up with financial breathing space. From the investor’s perspective, this means they would likely receive nothing in an emergency, effectively a de facto loss.

Legal Peculiarities and Pitfalls

Despite their apparent simplicity, convertible loans are not legally trivial. Correct form and coordination with company law are particularly important, as these areas present significant sources of error.

• Shareholder Approval: As a convertible loan ultimately leads to company shares, the shareholders’ meeting must be involved. For a GmbH, every capital increase requires a shareholder resolution with a 75% majority and notarization. However, a purely bilateral loan agreement between the investor and the company does not automatically bind the shareholders to the capital increase.

In practice, two approaches ensure conversion:

1. The existing shareholders adopt a resolution in advance, authorizing management to take up the convertible loan and later issue new shares for conversion up to a certain amount. Such a notarized authorization signals shareholder buy-in to the investor.
2. A multilateral agreement is used, involving all current shareholders in addition to the start-up. In this agreement, shareholders contractually undertake to contribute to the necessary capital increase upon conversion.
Both methods ensure the investor can exercise their conversion right without obstruction from existing shareholders. In start-up practice, the first option – an advance shareholder resolution – is often preferred, as it aligns with international norms.
• Notarial Form Requirement: A frequently discussed topic is whether convertible loan agreements must be concluded in notarized form to be effective. Generally, loan agreements themselves do not require any specific form. However, if an agreement contains obligations related to a transfer or new issue of GmbH shares, the formal requirements of the GmbH Act may apply. Section 15 GmbHG mandates notarization for agreements on share transfers (including binding transactions). Moreover, Section 53 (2) GmbHG requires notarization for shareholder resolutions amending the articles of association, such as capital increases.

  A sensational ruling by the Higher Regional Court of Zweibrücken in May 2022 suggested that certain convertible loans require notarization. In that case, two convertible loans of a GmbH included a conversion obligation for a new investor in a future financing round, as well as the investor's obligation to acquire new shares. The court deemed this a takeover obligation from a third party outside the company, which, according to Section 55 (1) GmbHG, requires at least notarization of the transferee’s signature. Furthermore, the OLG expressed doubts in an obiter dictum whether the entire agreement might even need to be notarized, as it effectively anticipated a future capital increase that would amend the articles of association in a binding manner. Consequently, without notarization, the convertible loan agreement would be void as to form (Section 125 BGB). The loans would then have been reclaimable, meaning the investor could demand their money back as a normal loan, losing their conversion right. This would completely undermine the economic purpose of the convertible loan.

  This decision caused considerable uncertainty in the VC sector. Clarification by the highest court is still pending. In April 2023, the BGH dismissed an appeal against denial of leave to appeal (case no. II ZR 96/22), but did not rule on the merits of the case, as the question of form was not decisive for the specific decision. The legal situation therefore remains unclear. The prevailing opinion among many experts rejects the strict view of the Zweibrücken Higher Regional Court: a convertible loan is initially only a preliminary agreement to a later capital increase. The notary's warning and control function should only apply when the actual capital increase occurs. Nonetheless, the current practical tip is: exercise caution! Start-ups and investors should draft convertible loan agreements with extreme care and, if in doubt, secure them formally. Specifically, it is advisable to at least have signatures notarized if conversion obligations are agreed. A separate notarized shareholders’ resolution, as mentioned previously, can further reduce the risk. While many deliberately avoid full notarization to save time and money, this should only be done after consulting a lawyer and being aware of the risks. Particularly if the contract contains other company law clauses (e.g., obligation to join a shareholders’ agreement with drag-along obligations), notarization may be required. A breach could render the relevant clause or even the entire contract null and void. For further reading on legal documents, consider our article on binding effects and design of term sheets for startup investments.

• Tax and Accounting Aspects: During implementation, ensuring a technically clean conversion is essential. Conversion by means of a capital increase in return for a contribution in kind is common. However, this is not done by contributing the loan as a classic contribution in kind (which would require valuation and possibly an auditor). Instead, the investor acquires new shares at a minimum nominal value in cash (e.g., €1 per share) and offsets the loan repayment claim as a premium, which flows into the capital reserve. This effectively transfers the loan to equity without complicated valuation reports. Crucially, this only happens upon conversion; until then, the loan remains debt capital for accounting purposes (potentially with subordination, allowing its exclusion from the over-indebtedness test). It's also relevant for founders: due to tax regulations, the contract should clarify that the addition of the SAFE or loan amount is not immediately considered equity, but only transferred to the capital reserve upon conversion into shares. This prevents an interest-free loan from possibly being interpreted as taxable income.

Typical Areas of Application

Convertible loans are ideal for quickly obtaining liquidity when a large financing round (e.g., Series A) is not yet ready. They are frequently used:

• as bridge financing (bridge loan) to cover the period until the next equity round,
• in seed phases, when business angels invest but all parties wish to defer valuation until a larger VC joins, or
• in crisis situations, when immediate funds are needed but valuation is difficult (e.g., due to volatile sales).

The main advantage is flexibility: negotiations focus on a few key economic points (interest rate, discount, cap) rather than complex corporate law terms. Additionally, the shareholder structure remains unchanged for the time being, as the investor officially becomes a shareholder only upon conversion. This can be important, for instance, to avoid jeopardizing funding or to maintain lean decision-making processes. If successful (i.e., the next round materializes), the lender seamlessly becomes a co-shareholder. If, contrary to expectations, no subsequent round occurs, the loan may become due depending on the agreement. Therefore, from an investor’s perspective, a clear exit strategy (repayment or an alternative conversion clause at the end of the term) is crucial in the contract. For founders, avoiding common legal mistakes made by start-ups in these early stages is key.

SAFE Agreement – “Simple Agreement for Future Equity”

What is a SAFE?

The SAFE, short for “Simple Agreement for Future Equity,” originated in the US and was developed by Y Combinator in 2013. Essentially, a SAFE is a special type of convertible loan with no specified term and no interest. The investor provides capital to the start-up and, in return, receives the right to convert this capital into shares at a later date. However, unlike a classic convertible loan, there is no fixed repayment date and generally no interest claim. The SAFE remains in effect indefinitely and becomes relevant only upon the occurrence of certain defined events. This means the start-up raises capital-like funds without granting the investor any concrete claims other than the conversion right.

Mechanism and Conversion Events

The contractual terms of a SAFE are similar to those of a convertible loan but feature some key distinctions:

• No Maturity Without an Event: A SAFE does not provide for automatic conversion after a specific period. This implies that if the trigger events defined in the contract never occur, the SAFE theoretically remains in place indefinitely. From the start-up’s perspective, this is appealing as there is no need to pre-plan for repayment. For the investor, however, it means their money could be tied up in the company for a very long time without any immediate return, potentially resulting in a total loss if conversion never happens.
• Conversion Only with Certain Triggers: Typical trigger events for a SAFE include a major equity financing round (similar to a convertible loan) and an exit event. If a new financing round occurs – often defined as an investment of at least €1 million by external investors, for example – the SAFE is automatically converted into shares. As with convertibles, the agreed valuation discounts or caps apply, providing the SAFE investor with an advantageous entry price. Unlike convertible loans, an option is rare here; conversion is usually required once the qualifying round takes place. If a company sale or IPO (liquidity event) occurs instead, many SAFE contracts stipulate no further conversion. Instead, the investor can demand to be paid out – often for the amount invested (sometimes with a bonus or interest compensation). This places them in a position similar to having already held shares and selling them. Important: If the payout amount is limited in a sale, and the company sells for a small sum, the SAFE investor might receive less than invested if the contract amount is proportionately reduced. In any case, it is subordinated to regular creditors. These rules resemble a type of silent partnership.
• No Interest, No Fixed Coupons: A SAFE is interest-free. This means no ongoing interest payments, preserving the start-up's liquidity. The “return” for the investor stems exclusively from the discount or value increase when shares are issued later.

Drafting Contracts Under German Law

While the SAFE concept appears simple, its implementation within the German legal framework poses challenges. There is no specific legal definition for a SAFE. Therefore, existing legal figures must be adapted. Most often, a SAFE is contractually structured as a special type of subordinated loan, with the caveat that repayment cannot be demanded, except in specific scenarios. Important considerations include:

• No Repayment Claim: Unlike a normal loan, a typical SAFE does not entitle the investor to repayment of their capital as long as no conversion or liquidity event occurs. If the start-up fails or no qualifying event happens over a long period, the investor has no contractual right to reclaim their money. In extreme cases, the investment is entirely lost. Legally, this is unusual, as a loan without a repayment obligation resembles a transfer of equity. Clearly regulating this characteristic is crucial, especially to address regulatory issues. For example, a “repayment promise” could otherwise be considered a deposit transaction, potentially triggering a BaFin license obligation for the start-up. However, the lack of a fixed repayment claim and qualified subordination generally prevents it from being deemed a license-requiring deposit business.
• Participation Rights Under the Law of Obligations: As SAFE investors are not initially shareholders, they lack voting rights or statutory information rights like a GmbH shareholder. To protect their investment, however, contractual rights similar to a silent partnership are agreed upon in the SAFE contract. These often include information rights (e.g., regular reports, inspection rights, similar to convertible loans) and sometimes reservations of consent for capital-relevant decisions. For instance, the start-up might be prevented from entering further SAFE agreements or convertible loans above a certain amount, distributing dividends, or issuing new shares (outside the qualifying round) without the SAFE investor’s consent. This prevents dilution of the SAFE investor’s future participation or undermining their rights. However, SAFE investors are typically smaller early-stage investors, so excessive veto rights are uncommon. They often content themselves with MFN clauses (if another investor later receives a better offer, the SAFE is adjusted accordingly). Clear rules are essential to ensure the SAFE investor does not unintentionally exercise the rights of a full shareholder, which could be seen as circumventing statutory protection of GmbH shares.
• Conversion and Capital Increase: Similar to convertible loans, automatic conversion is not straightforward under German GmbH law. A shareholder resolution is always required for a capital increase. The SAFE documentation must reflect this. Practically, when a conversion event occurs (e.g., a new financing round), the GmbH must duly resolve and notarize the capital increase. This is unless a different legal form with prepared capital is used (e.g., conditional capital for an AG). Since start-ups are usually limited liability companies, it is advisable to obtain the consent of existing shareholders in advance. As with convertible loans, this can be done via an anticipated shareholder resolution permitting the subsequent issue of corresponding shares. This resolution can cover multiple SAFEs (e.g., consent for SAFEs up to a total amount of X). Alternatively, all shareholders could co-sign the SAFE, though this is uncommon in international investor circles. The resolution route is more elegant and should be notarized for effectiveness.
• Preferred Shares and German GmbH: SAFE templates from the USA often assume the issue of preferred shares (e.g., with preferential rights on exit). German GmbH law, however, lacks an exact equivalent concept of preferred stock. While different classes of shares with varying rights can be created in a GmbH, or profit participation rights used, all this requires detailed provisions in the articles of association. A German SAFE agreement might therefore need to forgo promising genuine preferred shares. Instead, an assurance could be given that the investor will receive an equivalent position to new VC investors upon conversion. In practice, the same preferential rights negotiated in the upcoming financing round could be applied to the SAFE shares by contract or in the articles of association. Careful coordination is needed to ensure the SAFE investor is not disadvantaged or favored without a legally sound regulation.
• Subordination and Insolvency: Although a SAFE lacks a fixed repayment claim, qualified subordination is usually agreed as a precautionary measure. This seems paradoxical but ensures that as long as the SAFE is still classified as debt capital on the balance sheet before conversion (often recognized as a liability for lack of another category), it could theoretically contribute to over-indebtedness. Through subordination, the investor makes a binding declaration that their claim (if any) is subordinated and will only be serviced after all regular creditors in the event of insolvency or liquidation. This means the claim is excluded from the over-indebtedness test according to Section 19 InsO. Furthermore, as mentioned, subordination prevents BaFin from classifying the transaction as a deposit-taking business requiring a license, as the capital is not unconditionally repayable. In short: Subordination is also a must-have in SAFE agreements for regulatory and insolvency law certainty. This changes little for the investor; they haven't agreed to any priority over other creditors anyway. The subordination merely confirms their equity-like status.
• Choice of Law and Foreign Templates: Since SAFEs originated in the USA, US investors sometimes insist on using the familiar Y Combinator template. Caution is advised here: A choice of law in favor of US law for a German GmbH will generally not be permissible or will be highly problematic, as many aspects are mandatorily subject to German corporate law (e.g., capital increase). Therefore, German law should always be agreed upon as applicable in a SAFE. US templates must be translated and adapted in terms of content (e.g., deletion of automatic conversion without a resolution, adaptation of exit provisions, deletion of exotic clauses like tax characterization as “common stock” in advance). All of this requires detailed legal work. Simply adopting a PDF from the internet without adaptation would be grossly negligent. This also ties into the general advice of using AI-generated contracts with caution.

Advantages and Disadvantages of a SAFE

From a founder’s perspective, a SAFE offers several advantages: It is fast and flexible, like a convertible loan, but even more founder-friendly because neither interest nor fixed repayments burden the company. Liquidity remains with the start-up until either a successful round occurs (then conversion is not an issue, as new capital comes in) or the start-up fails (then there's nothing to repay anyway). The often-cited benefit of no immediate valuation sounds attractive. However, it's important to note that an implicit valuation is indeed agreed through the discount and cap. Founders sometimes accept caps that are too generous, which means they surrender far more shares than intended upon conversion – a hidden anticipation of the valuation. Caution is therefore advised.

From an investor’s point of view, SAFE is a double-edged sword: on the one hand, there is no interest and no specific maturity date. The investor cannot put the start-up in distress, even if they wanted to. On the other hand, they bear a high risk, as their capital can be completely lost in the worst-case scenario. There is no “pressure” that a bullet loan exerts to either seek a new round or repay it. Accordingly, SAFEs are often accompanied by investor confidence – a strong belief in the start-up’s success. SAFEs are therefore less attractive for professional VC investors, who prefer clear deadlines and obligations. SAFEs are more commonly used by business angels, accelerators, or foreign early-stage investors familiar with the model from the USA. For larger sums or longer periods, many investors prefer a more structured solution (e.g., a convertible loan with interest/maturity or equity). Another disadvantage for investors is that they have no shareholder rights between investment and conversion. This means they initially have no say and no seat at the table, unlike an investor who immediately subscribes shares and, for example, receives an advisory board position. Founders raising SAFE capital should be aware that this investor tends to remain in the background until conversion, which can be positive, but also develops less of a bond with the company.

Practice in Germany

In German start-up practice, convertible loans have long been predominant. However, SAFEs are gaining popularity. Especially since around 2020/21, SAFE-like constructs have been increasingly observed, often inspired by US investors. There are even models adapted by local law firms. Nevertheless, there is as yet no published German case law on SAFEs. This implies that many assumptions (e.g., the effectiveness of certain clauses) remain theoretical. The parties involved operate in a certain gray area, which is, however, informed by the analogous application of rules for convertible loans and subordinated loans. In the insolvency of a start-up, a SAFE is effectively treated like a subordinated shareholder contribution. An insolvency administrator would likely classify the SAFE investor similarly to a silent partner, who would only be paid after all creditors (if anything remains). For founders, the uncertainty in legal application can be a minor disadvantage, making it even more important for contracts to be properly drafted by experienced lawyers to ensure clear agreements in the event of a dispute.

Capital Increase in Exchange for Shares – Classic Equity Financing

The third instrument for early-stage financing is the direct raising of equity by issuing new company shares. In this scenario, the investor does not act as a lender but becomes a direct shareholder. In the German context, this typically involves a capital increase in a GmbH (or UG) in exchange for an investor's contribution. This process differs fundamentally from convertible loans and SAFEs, as it strictly adheres to company law, and the investor becomes a co-owner with all rights and obligations from the outset. For a comprehensive overview of investment options, see our article on types of investment contracts.

Legal Requirements and Procedure

A capital increase in a GmbH is formally complex and strictly regulated by law. The most important steps and requirements include:

• Shareholder Resolution and Notary: First, existing shareholders must approve a capital increase. A resolution to increase share capital and issue new shares requires a qualified majority (usually 3/4 of votes cast) and must be notarized (Section 53 (2) GmbHG). The participation quota for each new share and, if applicable, new share classes are determined in this resolution. The notary records the resolution, ensuring all legal requirements are met.
• Acquisition of Shares by the Investor: The investor (transferee) must subscribe to the new shares. According to Section 55 (1) GmbHG, the takeover declaration for new shares must either be notarized or at least the signature must be notarized. In practice, this is often combined directly in the notarial deed of resolution: the investor declares before the notary that they are taking over the new shares specified in the resolution and paying in the corresponding contributions.
• Payment and Share Capital Increase: The investor pays the agreed amount. For a cash foundation, at least the portion corresponding to the share capital must be paid into the company’s account (usually 100% for a cash capital increase; for a contribution in kind, a different procedure, including valuation, would be necessary). Amounts exceeding the nominal value go into the capital reserve (premium). For example: An investor pays €500,000 for 20% of shares in a GmbH with share capital of €25,000. The share capital could then be increased by €5,000 (new nominal amount), and the remaining €495,000 is a premium. The nominal amount flows into the share capital, the premium into reserves. This reflects the company’s value without unnecessarily inflating the share capital. For more details, consult our article on the share capital of a GmbH.
• Amendment to the Articles of Association: The capital increase typically requires an amendment to the articles of association (share capital, list of shareholders with new shares). This amendment is also notarized by the notary (often in the same process) and later filed with the commercial register. Generally, the notary also registers the capital increase and shareholder change with the commercial register, which is crucial for effectiveness against third parties. The process is complete only when the capital increase is entered in the commercial register. Until then, the resolution is pending, and the contribution is typically held in a trust account.
• Ancillary Agreements – Participation Agreement: Parallel to the formal capital increase, founders, existing shareholders, and the new investor usually conclude a participation agreement or shareholders’ agreement. This document specifies the investor’s rights beyond statutory provisions. Typical clauses include:
  • Voting rights agreements (e.g., investor veto rights in key decisions, approval catalog).
  • Drag-along/tag-along clauses (regulations for exit: the investor can force founders to co-sell, or vice-versa).
  • Pre-emption rights in case of share sales.
  • Non-disposal obligations (lock-up for founders’ shares).
  • Liquidation preferences (if implementable in GmbHs, e.g., via preferential profit distribution).
  • Anti-dilution clauses in the event of later, more favorable capital rounds.
  This agreement can be drawn up privately but must be consistent with the articles of association. If it contains binding clauses on future share transfers (e.g., drag-along with a sales obligation), these specific clauses require notarization under Section 15 GmbHG. In practice, either the entire participation agreement is notarized (increasing effort and costs), or binding share transfer obligations are limited to the notarized articles of association. For instance, a preferential profit distribution or liquidation preference can be directly embedded in the articles of association, which are notarized anyway, thus ensuring formal effectiveness. Ultimately, equity financing necessitates extensive legal documentation to regulate all aspects of the new ownership structure.

Advantages and Disadvantages of Direct Equity Financing

• Advantages: For the investor, acquiring real shares is often the ultimate goal. They become co-owners with full voting rights, can exert influence within the company (e.g., securing an advisory board position), and directly participate in value appreciation and profits. From the start-up’s perspective, an equity investor provides long-term planning security: the capital is real equity that does not require repayment. The uncertainty of future conversion or maturity is eliminated, removing the burden of repayment. Moreover, a committed investor often brings know-how, network, and prestige. The cooperation can be more intensive because the investor, as a shareholder, is motivated to increase the company’s value. In many cases, larger venture capital investors demand real shares anyway, as this is the only way to effectively implement all necessary investor protection rights (e.g., voting rights, voting agreements). This approach strengthens the foundation for future growth and can be a key part of legal preparation for the first investment round.
• Disadvantages: Classic capital increases are more time-consuming and costly. Every step – from negotiating company valuation and investor due diligence to drafting contracts and notarization – consumes resources. Notary fees in Germany (GNotKG) are legally set and based on transaction value, easily reaching several thousand euros for larger investments. Legal advice costs are also higher due to the complexity of contracts (articles of association, investment agreement, ancillary agreements). From the founders’ perspective, this is a significant upfront investment, with a portion of the raised capital immediately spent on incidental transaction costs. However, large investors understandably insist on legally compliant implementation, making these expenses unavoidable. Furthermore, taking on a new shareholder means relinquishing co-determination rights and often accepting certain restrictions. A company valuation must also be established, which can be challenging and conflict-prone in early stages: valuing too high deters investors, while valuing too low significantly dilutes existing shares. Overall, equity financing is a major step requiring careful consideration and preparation.

Typical Areas of Application

Due to the aforementioned disadvantages, an immediate capital increase is often chosen only for larger financing rounds when a lead investor joins and plans to invest several million euros (classic Series A and later). In such cases, the company is typically more mature, with more reliable figures supporting a valuation. The investor seeks substantial influence and clear conditions, which only real shares can provide. Strategic investors (e.g., corporate investors) or public investment companies also often invest directly in equity, preferring to avoid indirect routes like loans. In early stages (pre-seed, small seed rounds), many founders avoid formal capital increases, opting instead for convertible loans or SAFEs to save time and bypass tedious notary procedures until the business model is validated. Nevertheless, if friends and family provide capital, they may be included as direct shareholders, as sums are small, and a personal basis of trust exists. Each start-up must weigh: Is the added value of a real shareholder (including capital and know-how) worth the effort, or is a more flexible instrument preferable, postponing the “big shot” until later?

Comparison of Early-Stage Financing Instruments Depending on the Situation

Not every instrument suits every situation. Founders should weigh advantages and disadvantages based on their phase and requirements:

• Quick Bridging Without Valuation: If short-term liquidity is needed or a smaller amount is required to reach the next milestone, convertible loans or SAFEs are usually the better choice. Both enable capital raising in days rather than weeks. Contracts can be lean and concluded without a notary. Moreover, you avoid a company valuation at this early stage, which might be outdated in a few months. A convertible loan is ideal, especially if discussions with VC investors for a larger round are ongoing but immediate cash is needed: it bridges the gap and converts easily in the next round. A SAFE can also be used, especially if conditions are very founder-friendly (no interest, no maturity date). However, founders should only borrow amounts they can afford in the worst-case scenario, as SAFE investors may be disappointed later if conversion takes a long time. From an investor’s perspective, a convertible loan with a fixed term is sometimes preferable, as it disciplines the start-up to initiate the next round promptly or find a solution (otherwise, repayment would be due). In practice, many SAFE-like agreements include a long “longstop” period, typically 18-24 months, after which conversion or a discussion about repayment should occur, even without a nominal end date.
• Seed Financing with Uncertain Valuation: Particularly in the early seed phase, when product and market validation are still incomplete, convertible loans/SAFEs are an excellent way to bring investors on board without immediately negotiating shares. This keeps transaction costs low and prevents founders from giving up too much equity if the initial valuation is too low. It buys time until more reliable key figures allow for a fairer valuation. Many well-known German start-ups structured their first angel investments via convertible loans: fast, uncomplicated, allowing everyone to focus on business development rather than contract negotiations.
• Larger Round with Lead Investor (Series A/B): Once an institutional investor (VC fund, corporate VC) and a larger amount of capital (~€1 million and upwards) are involved, a classic capital increase is almost inevitable. The investor will insist on receiving real shares and rights anchored in the articles of association. Convertible loans are more of an emergency solution here if valuation is highly controversial. Even then, a VC would prefer a convertible with a cap, converting in a larger co-round. Series A is typically when all previously issued convertible loans and SAFEs are consolidated and converted. The start-up must consider how the sum of these conversions will impact the new investment structure. In large financing rounds, existing shareholders and new investors must convene anyway, allowing for a comprehensive reorganization of the shareholder structure. Advantage: No more pending claims; everything converts to equity, which future investors appreciate (a “tidy” cap table). Disadvantage: Founders often experience the full dilution from accumulated convertible loans/SAFEs at this stage, sometimes leading to unpleasant surprises if caps were previously overlooked or interest accrued. Transparency and prior consultation are thus paramount. You can also explore the binding effect and design of term sheets in this context.
• Bridge Financing in Times of Crisis: In economically challenging phases (e.g., if the investor for the next round withdraws or an external shock occurs), existing shareholders or new investors can provide quick help via convertible loans. A SAFE would be less suitable here, as it would be unclear when/if conversion would occur. In crisis situations, a shorter time horizon and potentially stricter conditions (e.g., reduced cap, higher interest rate) are usually set to reflect the increased risk. Public aid programs (such as during the coronavirus era) have also utilized convertible loans due to their flexible structure and compatibility with subsequent investor entries.
• Number of Investors and Structure: For a single investor, any instrument is theoretically viable. However, if many small investors are to be involved (e.g., crowdinvesting or family & friends rounds), the equity solution becomes impractical, as managing numerous new shareholders is undesirable. In such cases, convertible loans are often used to bundle small investors and potentially add them to the shareholder list later via a trustee or vehicle. In crowdinvesting, legally, subordinated loans – similar to SAFEs – are frequently employed to avoid the obligation to publish a prospectus and to prevent creating thousands of mini-shareholders. Founders must plan: Who is investing and how many? How long should the group remain involved? The more diverse and short-term the involvement, the more likely loans/SAFEs are suitable; for targeted, long-term investors, equity is generally preferred. This strategic decision is part of taking on investors in a startup.

In summary, convertible loans are ideal for gaining time and saving transaction costs in the early stages, while equity financing is indispensable for larger sums and formal investments. SAFE agreements occupy an intermediate position; they are particularly founder-friendly and investor-subordinated but are best suited for very early, trust-based investments and require careful adaptation in Germany.

Insolvency Law Classification of the Instruments

A critical aspect often overlooked in financing decisions is the differing treatment in the event of insolvency. For managing directors, understanding the balance sheet and insolvency effects is crucial to prevent liability risks (e.g., delayed insolvency filing).

• Convertible Loan: Until conversion, a convertible loan is considered debt capital (liability) of the start-up. Without specific agreements, the lender would be treated as a normal creditor in insolvency. However, a qualified subordination is included in almost all convertible loans. This means the investor’s claim is subordinated in insolvency proceedings (Section 39 InsO) and, importantly, is not considered in the over-indebtedness test (Section 19 InsO). Practically, if the company has ongoing prospects, the loan amount isn't assessed as a “mountain of debt.” Subordination can often avert the obligation to file for insolvency, provided there is no illiquidity. Should insolvency still occur, the convertible loan lender is at the back of the queue: only after all senior creditors (banks, suppliers, etc.) are fully satisfied would the convertible lender be paid, usually resulting in nothing. Without subordination, the lender would have a normal claim and could register it in the insolvency table, potentially receiving a quota. However, start-ups are typically worthless in insolvency, so the quota would usually be zero. Important for managing directors: if a convertible loan without subordination was agreed and over-indebtedness occurs, an insolvency application must be filed promptly – the instrument itself offers no protection. Additionally, no further repayments may be made to the lender if the company is insolvent, risking managing director liability under Section 15b InsO (formerly Section 64 GmbHG). The Zweibrücken Higher Regional Court ruling highlights this: the insolvency administrator argued the convertible loans were formally invalid and reclaimable, meaning the GmbH was over-indebted, and repayments during the crisis were inadmissible. This dispute underscores that only a clean structure (including subordination and correct form) protects against additional problems in insolvency. The StaRUG regulations also bring new obligations for start-ups in this regard.
• SAFE: A SAFE is treated economically as an equity substitute. As there is no fixed repayment claim, from the investor’s perspective, there is actually no claim that could be filed in insolvency proceedings (except potentially in a previously defined liquidation event). However, many SAFE contracts include a clause granting the investor a claim to repayment of the invested amount in the event of liquidation or insolvency – albeit subordinated to other creditors. This means that if the start-up is liquidated, the SAFE investor should be able to claim their capital (after normal creditors are satisfied), but only up to what remains, which is often nothing. Qualified subordination (recommended in the SAFE context) clarifies that this restitution claim comes very last and doesn't count for over-indebtedness. For the obligation to file for insolvency: a correctly structured SAFE as a subordinated loan does not burden the over-indebtedness balance sheet and can help avoid arithmetical over-indebtedness. Conversely, the SAFE investor cannot pressure management due to over-indebtedness, as their capital is treated as equity. However, this doesn't change anything in the event of illiquidity; only fresh money or cost reduction helps. In summary: in insolvency, a SAFE is very close to equity; the money is usually lost, and there is no creditor status as with a normal loan.
• Direct Equity Investment: Here, the situation is clear: an investor who is already a shareholder has no claim in insolvency proceedings, but at most a share in the liquidation residue. In insolvency, shareholders are generally paid only after all creditors receive 100%, a situation that almost never occurs. The investment is therefore lost. This total loss corresponds to the typical risk of an equity investor (high risk, high reward). Positively, equity can never cause insolvency-triggering over-indebtedness in the accounting sense, as it is by definition not debt capital. On the contrary, a capital increase can avert impending insolvency by increasing equity. For managing directors, the problem of managing loan liabilities is eliminated; there is no repayment obligation to the investor. However, other obligations arise: e.g., share capital cannot be paid out to shareholders (breach of capital maintenance rules), and in a crisis, shareholder loans could be subordinated under Section 39 InsO, and repayments to shareholders contestable under Section 135 InsO. These issues primarily relate to existing shareholder loans. Unlike a lender, a pure equity investor cannot sue to reclaim their money; they are entirely dependent on the company’s success.

Interim Conclusion: Insolvency Implications

From an insolvency perspective, SAFEs and (subordinated) convertible loans are significantly less burdensome for the start-up than normal loans. They act as liable capital that cushions losses. From an investor’s perspective, one must be aware of the order of priority: until conversion, real security with a convertible loan exists only if one could theoretically act as a normal creditor, which is voluntarily relinquished through subordination. With a SAFE, one has hardly any rights in insolvency proceedings from the outset. Ultimately, SAFE investors and convertible lenders (with subordination) differ little from equity investors: if the company goes bankrupt, the investment is lost in almost all cases. The significant difference lies in the period before insolvency: a non-subordinated convertible loan could theoretically create pressure or make claims earlier, where SAFE and equity would still be static. In this respect, SAFEs and subordinated convertible loans act as a buffer for start-ups in a crisis; they prolong the breathing space, as these investors cannot immediately seek cover when things get tough.

Comparison of Notary and Transaction Costs

Cost and effort are crucial considerations when choosing a financing instrument, especially for tight start-up budgets:

• Convertible Loan and SAFE – A Cost-Effective Start: The initial costs for a convertible loan or SAFE are relatively low. No notary fees are incurred initially, as the contract can be concluded without any formal requirements (private deed). There are also no registration fees, as there is no immediate change in the commercial register. The main costs lie in the preparation of the contract: while legal consultation is advisable for a solid contract, the scope (and thus costs) are significantly lower than for a fully negotiated participation agreement. Convertible loan agreements often rely on proven models that can be adapted with manageable effort. Despite warnings, some founders even use free online templates. However, caution is advised: as explained, seemingly minor clauses can have a major impact, potentially leading to nullity. Savings in legal costs should always be weighed against the risks. Overall, SAFEs and convertible loans enable fast and streamlined processing: from agreement on conditions to payment, it can take just a few days due to minimal formal hurdles.
• Capital Increase – Formal Process with Fees: A classic equity round inevitably incurs notary fees. In Germany, these are legally mandated (GNotKG) and based on the transaction value. For an investment of €1 million, notary and registration costs could range from €1,500-€3,000, depending on expenditure and drafting. Additionally, every shareholder resolution in a GmbH involving articles of association changes often requires notarization. In a VC round, this sometimes involves several documents: the capital increase itself, articles of association amendments (new share classes, potential changes to managing director approvals), and sometimes approvals or waivers (e.g., waiver of subscription rights by existing shareholders if the investor receives exclusive shares). Each point is recorded in the notarial meeting minutes. Moreover, legal fees for negotiating and drafting the participation agreement and new articles of association can be higher than notary fees, depending on complexity and negotiation rounds. From the founders’ perspective, this represents a considerable upfront investment, with a portion of the raised capital immediately spent on incidental transaction costs. However, large investors understandably insist on legally compliant implementation, making these expenses unavoidable.
• Dealing with Follow-up Costs: It's crucial to understand that convertible loans and SAFEs do not eliminate formal costs but defer them. If conversion occurs later, the notarized capital increase must then be carried out, incurring similar costs. However, this can often be combined: for example, in a Series A round, fresh capital is subscribed for new shares, and all convertible loans/SAFEs are simultaneously converted by resolution. The notary can handle this in one go. Fixed costs are thus spread over a larger transaction. It is more convenient for the start-up to bear costs later, when it has more capital from the new round, rather than in an early phase. If – worst case scenario – no successful round follows and the start-up fails, these costs are saved entirely (as the company is liquidated without conversion). While not a pleasant scenario, it illustrates that SAFE/convertible are pay-as-you-go models, whereas equity financing entails upfront costs.
• Transaction Duration: The time factor should not be underestimated. A notary appointment requires coordination (often several weeks in advance, unless an urgency fee is paid) and prior completion of all documents. It then takes days to weeks for the commercial register entry to be finalized, only then providing investors with legal certainty regarding their shareholder status. In contrast, a convertible loan can be closed virtually overnight if both sides agree: cash flow via online transfer, done. For a young company in financial difficulty, this time difference can be vital for survival.
• Avoiding the Notarization Requirement? As discussed in the section on convertible loans, some actors deliberately try to avoid notarial form to save costs. Such shortcuts are risky. Instead, one might consider digital notary appointments (online notarizations have been possible in certain cases since 2022) to at least minimize travel expenses. Structures like incorporating a UG into an AG can also be considered to facilitate working with authorized capital later, though this extends beyond early-stage concerns to later scaling.

Conclusion on Costs

For small financing amounts, a significant “investment fuss” is usually unwarranted. Convertible loans/SAFEs excel here due to low initial costs and fast processing. For large amounts, notary costs become proportionally less significant, and the advantages of direct equity come to the fore. From a cost perspective, a combination strategy can be ideal: early-stage financing via convertible loans/SAFEs to fund development, followed by a concentrated capital increase once sufficient progress is made, enabling collective conversion and new capital raising. This ensures the notarial procedure is only required once, integrating all early-stage investors. This strategy also aligns with best practices for legal aspects of equity deals.

Drafting Clean Contracts – Why Legal Advice is Essential

Regardless of the instrument chosen: The contract must be drafted with utmost care. Early-stage financing is time-critical, but hastily signed contracts can prove costly for the start-up later. Here are some reasons why legal advice is invaluable:

• Effectiveness and Form: As discussed, various formal pitfalls exist with convertible loans/SAFEs. What good is optimal financing if the contract is void afterward, allowing the investor to suddenly demand normal repayment? A sample contract found online might superficially fit, but in a specific case – e.g., with individual clauses or combined with a shareholder agreement – it could trigger other requirements. The OLG Zweibrücken decision in 2022 served as a wake-up call: standard clauses from US models or misunderstood templates can be fatal in Germany. Founders should never blindly adopt clauses whose scope they don't fully understand. It is better to rely on proven German standards; many law firms offer templates adapted to local case law, including information on form and procedure.
• Conflict Avoidance Through Clarity: A good contract anticipates what-if scenarios. For example: What happens if an insolvency petition must be filed before conversion? How are convertible loans/SAFEs treated in a partial exit (sale of a business unit)? Can the start-up incur further debt even with a SAFE in place? Such points need clear regulation to prevent future disputes. Discussions often arise years after financing due to gaps or ambiguous interpretations in contracts. For instance, the exact calculation of the conversion rate if discount and cap are combined, whether interest is also converted, and what happens if the next round occurs in tranches or if conversion is partial. These detailed questions can be complex. Proper contract work ensures the conversion or investment proceeds smoothly later, without lawyers having to renegotiate every step. This minimizes the risk of conflict cases.
• Balance of Interests: A start-up financing agreement should be fair: it must protect the investor's legitimate interests without unnecessarily restricting the founders. Without experienced advice, founders risk granting excessive rights to investors in a SAFE (e.g., vetoes that could block future financing) or setting unfavorable caps. Conversely, an investor must ensure they are not in a worse position in a convertible loan than future investors. This can be achieved through most-favored-nation clauses or cap regulations. Balancing such points requires negotiating skills and market knowledge: What is customary in 2025? Which conditions are “in line with the market”? Lawyers regularly advising start-ups and investors possess this knowledge and can help structure a deal acceptable to both sides, preventing resentment in the next round due to disproportionately favored or disadvantaged early investors.
• Taking Current Developments into Account: The legal field is dynamic. New court rulings (like the convertible loan one mentioned) or legal changes (e.g., simplification of online notarization, possible future introduction of preferential shares in the GmbH, or changes in insolvency law) can have a major impact. Without legal advice, founders risk acting on outdated knowledge. For instance, convertible loans were long assumed to be form-free until courts challenged this. Similarly, a court could classify a SAFE as an atypical silent partnership or declare a clause invalid. Professional advice ensures all relevant precedents and laws are considered at the time the contract is concluded. Where uncertainty exists, one errs on the side of caution (e.g., opting for notarization or adapting clauses).
• Subsequent Investor Due Diligence: Investors review the cap table and existing contracts in every major financing round. If a previous convertible loan or SAFE contains technical errors, this can jeopardize the deal or at least cause delays and renegotiations. In the worst case, old contracts must be rectified or renegotiated while fresh money is expected to flow in. Solid initial structuring avoids such risks. Furthermore, a structured, ready-to-sign contract impresses the other party (investor or founder) and builds trust. It signals professionalism and forward-thinking. This proactive approach is vital for an effective confidentiality strategy.

Conclusion

In conclusion, early-stage financing instruments are powerful tools for helping start-ups succeed flexibly. Convertible loans and SAFEs provide quick access to capital, while classic equity financing involves investors long-term. Each instrument has its place, if used correctly. For German start-ups in 2025, this means diligently addressing legal intricacies or enlisting competent assistance. Tailor-made contract drafting prevents legal disadvantages and conflicts that can become expensive in retrospect. Start-ups should not be deterred by perceived “paperwork”: The effort required for legal certainty is worthwhile to fully utilize hard-won financing. When in doubt, it’s better to consult a lawyer early than to litigate later; this ensures the focus remains on company development and achieving the next major milestone.