Convertible loans in startup financing: legal considerations and current developments

Introduction

Convertible loans, also known as convertible loans, are a key instrument in startup financing. They enable young companies to raise capital without immediately ceding equity shares. A central aspect of convertible loans is the possibility for investors to convert their loan into company shares under fixed conditions. This instrument is attractive not only because of its flexibility in raising capital, but also because it forms a bridge to future financing rounds. Convertible loans can bind investors to a startup at an early stage, which can be an advantage for later, qualified investment rounds. This early commitment can be strategically important for start-ups in order to build long-term, stable investment relationships.

Basics of the convertible loan

A convertible loan is a loan that can be converted into company shares under fixed conditions. This process is usually carried out by contributing the loan repayment claim to the company’s capital reserves, which results in a capital increase. The specific conditions for the conversion are varied and may include, for example, the achievement of certain company targets, a further financing round or a specific date. During conversion, the value of the loan is converted into shares in the company’s equity, whereby the conversion ratio – i.e. the ratio of the loan amount to the company shares – plays a decisive role.

This conversion option offers advantages for both the startup and the investor. This usually means a lower immediate financial burden for the startup, as the loan is repaid in the form of company shares. For the investor, it offers the opportunity to participate directly in the growth and success of the company. In addition, this type of financing can be more attractive for start-ups than traditional equity or debt financing, as it is less dilutive and at the same time creates a stronger bond between investor and company.

However, it is important to note that the structure of a convertible loan can be complex and must be carefully planned to protect the interests of both parties and meet legal requirements. In particular, the determination of the conversion ratio and the associated valuation issues are key aspects that should be clearly defined in advance.

Legal aspects and the importance of formal requirements for convertible loans

The legal structure of convertible loans is of central importance, particularly with regard to compliance with the formal requirements. These regulations primarily concern the question of whether and to what extent notarization or signature certification is required. The need for such formalities depends heavily on the specific structure of the loan agreement and the resulting obligations. This includes aspects such as the terms of the conversion, the rights and obligations of the parties involved and any effects on the company’s shareholder structure.

In its ruling of May 17, 2022 (Ref. 8 U 30/19), the Higher Regional Court of Zweibrücken made an important decision that has far-reaching implications for practice. The court found that a notarized signature may be required, especially if the convertible loan agreement provides for an obligation to convert and new shares are to be transferred to the lender in the course of this conversion. This decision contradicts earlier rulings and the prevailing opinion in the literature, which do not consider such certification to be necessary. The judgment of the Higher Regional Court of Zweibrücken emphasizes the importance of precise legal examination and documentation in the drafting of convertible loan agreements and shows that compliance with the formal requirements can be decisive for the validity of such agreements.

The consequences of this decision are particularly important for start-ups and their investors. They underline the need for careful legal advice and contract drafting in order to minimize the risks of the contract being null and void due to formal defects. This is all the more true as the legal framework and requirements for convertible loans are complex and subject to constant change. Startups should therefore work with experienced legal advisors to ensure that their financing agreements not only make economic sense, but are also legally sound.

Conclusion and practical consequences

The ruling of the Higher Regional Court of Zweibrücken emphasizes the importance of careful legal examination and professional contract drafting in the case of convertible loans. This ruling shows that special attention must be paid to compliance with the formal requirements when structuring such financing instruments in order to avoid the risk of the contract being null and void due to formal defects.

The complexity and legal intricacies of convertible loans make it clear that there is much more involved in drawing up a contract than just minor details or minimal wording. Experienced lawyers, who also act in an advisory capacity, can use their expertise and experience to draft contracts in such a way that potential problems and obstacles are effectively avoided.

Cooperation with a specialized lawyer is therefore essential. It is not just a question of form, but a strategic decision that can contribute significantly to the success and stability of financial agreements. In an area such as startup financing, where the legal framework is complex, sound legal expertise is essential in order to take full advantage of convertible loans while avoiding legal pitfalls.

Author: Marian Härtel

Marian Härtel ist Rechtsanwalt und Fachanwalt für IT-Recht mit einer über 25-jährigen Erfahrung als Unternehmer und Berater in den Bereichen Games, E-Sport, Blockchain, SaaS und Künstliche Intelligenz. Seine Beratungsschwerpunkte umfassen neben dem IT-Recht insbesondere das Urheberrecht, Medienrecht sowie Wettbewerbsrecht. Er betreut schwerpunktmäßig Start-ups, Agenturen und Influencer, die er in strategischen Fragen, komplexen Vertragsangelegenheiten sowie bei Investitionsprojekten begleitet. Dabei zeichnet sich seine Beratung durch einen interdisziplinären Ansatz aus, der juristische Expertise und langjährige unternehmerische Erfahrung miteinander verbindet. Ziel seiner Tätigkeit ist stets, Mandanten praxisorientierte Lösungen anzubieten und rechtlich fundierte Unterstützung bei der Umsetzung innovativer Geschäftsmodelle zu gewährleisten.