- Financing instruments: Startups often use convertible loans, SAFE agreements and equity financing to raise capital.
- Convertible loan: Flexible loan that can later be converted into company shares, ideal for quick liquidity procurement.
- SAFE agreements: no interest and repayment, allows capital to be raised without immediate valuation.
- Equity financing: Fixed shareholder structure, requires notary and shareholder resolution, but offers long-term planning security.
- Special legal features: Founder's perspective and legal risks are crucial, especially compliance with German laws in 2025.
- Drafting contracts: Clean contracts are essential to avoid later conflicts and legal disadvantages.
- Insolvency law: Differences between the instruments in the event of insolvency should be known, as they may affect the liability of the managing director.
In the early stages, start-ups are faced with the question of how to raise the necessary capital without losing their flexibility or incurring unnecessary costs. Three central financing instruments have become established: 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 has its own legal requirements and risks. In the German legal framework 2025, it is crucial to know the differences precisely in order to select the appropriate instrument and structure it in a legally compliant manner. In the following, the three forms of financing are examined in terms of their contractual structure, typical areas of application, legal peculiarities and practical handling. The focus will be on German start-ups and German law – including current developments and (if available) court rulings – in order to provide founders with a well-founded overview. In the end, it becomes clear that the right legal advice is essential to avoid later conflicts and to put the financing on a secure footing.
Convertible loan – Flexible loan with conversion option
What is a convertible loan? A convertible loan is a loan that initially flows to a startup as debt capital, but grants the lender the right (or obligation) to convert the loan amount into company shares at a later date. The investor is therefore a creditor until the conversion; in the event of conversion, he becomes a shareholder. This instrument is particularly popular with start-ups because it can be agreed quickly and easily. Convertible loans are almost standard in practice, especially as bridge financing until the next major investment round. They allow capital to be injected without immediately determining a company valuation or initiating complex notarial processes. The actual participation of the investor is postponed to a later date – ideal if there is still uncertainty about the company value in the early phase.
Typical contract features: A well-drafted convertible loan agreement contains several core components:
- Loan amount and term: Agreement on the amount of the loan and the term. A fixed term (e.g. 12-24 months) is often agreed, within which a conversion event ideally occurs.
- Interest: Convertible loans usually have the same interest rate as normal loans. Moderate interest rates (e.g. 5-8% p.a.) are common, which correspond to the higher risk but are not too onerous. Interest is usually deferred and only accrues on maturity or conversion.
- Conversion clause: The key element is the conversion right or conversion obligation. The contract specifies the events upon which the conversion into shares takes place. Typically, the following applies: if a qualified equity financing round above a certain minimum amount takes place, the loan is automatically converted into new shares. The lender often does not have the right to choose, but is obliged to convert the loan into shares at pre-defined conditions. Alternatively, it may also be agreed that the investor may choose between conversion or repayment (depending on the negotiation situation) when the conversion event occurs.
- Calculation of the shares (discount/cap): In the event of conversion, it must be clear how many shares the investor will receive. The conversion price is usually determined by applying a discount to the price of the next financing round. For example, it could be agreed that the loan amount is converted into equity at a 20% discount to the valuation of the next round. Alternatively or additionally, valuation limits are often set: a cap (upper valuation limit) protects the investor from too high a valuation upon conversion, or a floor (minimum valuation) protects the founding team from excessive dilution at a very low valuation. These parameters are a matter of negotiation; in practice, discounts are often 10-30%, while caps are based on a plausible maximum valuation of the company’s current status.
- Repayment and maturity rules: In the event that no conversion event occurs during the term, the contract should regulate what happens. A final maturity date is often set on which the loan, including interest, must be repaid unless the investor chooses to convert. Some contracts instead agree on an automatic conversion at a defined price at the end of the term in order to avoid repayment (which the startup may not be able to afford). It is important that the contract makes clear specifications here to prevent uncertainty.
- Further investor rights and reservations of consent: Although the investor is not a shareholder prior to conversion, certain protective rights are often contractually granted to him. Rights to information (regular financial reports, inspection of books) and rights of consent to important business decisions are common. For example, the convertible loan agreement may stipulate that certain measures – e.g. the issue of further loans/SAFEs, fundamental changes to the articles of association or extraordinary expenses above a threshold value – require the consent of the convertible lender. These clauses protect the investor’s future share from dilution or loss of value without formally giving him voting rights. Also conceivable are privileges for the exit (e.g. a liquidation preference so that the lender is serviced primarily from the proceeds in the event of a sale) or most-favored-nation clauses that automatically grant the lender the benefits of better conditions if the startup later grants another investor more favorable conversion conditions.
- Subordination: An essential element – especially in Germany – is the qualified subordination of the investor’s loan claim. This means that the lender contractually agrees to be subordinated in the event of insolvency or over-indebtedness of the company, i.e. only after all other regular creditors. As a result of this step, the convertible loan does not count as a liability in the over-indebtedness test, but is treated economically as equity. This is vital for the startup’s survival: without subordination, a high convertible loan would appear as a liability on the balance sheet and could possibly trigger an obligation to file for insolvency due to over-indebtedness if there is no positive going concern forecast. Subordination prevents this and gives the startup financial breathing space. (For the investor, of course, this means that in an emergency he would only get something back at the very end – which is tantamount to a de facto loss, see below on insolvency classification).
Legal peculiarities and pitfalls: Despite their simplicity, convertible loans are not trivial in legal terms. The correct form and coordination with company law is particularly important, as there are major sources of error here:
- Shareholder approval: As a convertible loan is ultimately to result in company shares, the shareholders’ meeting must be involved. In the case of a GmbH, every capital increase requires a shareholders’ 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, there are two approaches to nevertheless ensure the conversion: (a) Either the existing shareholders adopt a resolution in advance authorizing the management to take up the convertible loan and later issue new shares for the conversion up to a certain amount. Such an authorization resolution (notarized) can be attached to the loan agreement as an annex and signals to the investor that the shareholders are on board. (b) Or you can choose a multilateral agreement to which all current shareholders are parties in addition to the startup. In this agreement, the shareholders contractually undertake to contribute to the necessary capital increase in the event of a conversion. Both ways ensure that the investor can actually exercise his conversion right without being thwarted by recalcitrant existing shareholders. (In startup practice, the first option is often preferred: a shareholder resolution in advance, as this is more common internationally than having all shareholders sign the loan agreement).
- Notarial form requirement: A much-discussed topic is whether convertible loan agreements must be concluded in notarized form in order to be effective. In principle, the following applies: Loan agreements in themselves do not require any form. However, as soon as an agreement contains obligations relating to a transfer or new issue of GmbH shares, the formal requirements of the GmbH Act may apply. § Section 15 GmbHG requires notarization for agreements on the transfer of shares (including binding transactions in this regard). And § 53 Para. 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 took the view that certain convertible loans require notarization. In the case, two convertible loans of a GmbH contained a conversion obligation in favor of a new investor in a future financing round as well as the obligation of the investor to then acquire new shares. The court considered this to be a takeover obligation on the part of a third party outside the company which, pursuant to Section 55 (1) GmbHG, requires at least notarization of the transferee’s signature. In addition, the OLG expressed doubts in the obiter dictum as to whether the entire agreement would not even have to be notarized because it effectively anticipated a future capital increase amending the articles of association in a binding manner. The consequence of this view: Without a notary, the convertible loan agreement would be void as to form (Section 125 BGB). The loans would then have been reclaimable – with the unpleasant consequence that the investor could demand his money back immediately as a normal loan, but would no longer have a conversion right. This would have completely destroyed 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 against the ruling (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 decision in the specific case, according to the BGH. The legal situation therefore remained unclear. The prevailing opinion of 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 actual warning and control function of the notary only takes effect when the actual capital increase takes place. Nevertheless, the current practical tip is: exercise caution! Start-ups and investors should draft convertible loan agreements extremely carefully and, in case of doubt, secure them formally. Specifically, it is advisable to at least have signatures notarized if conversion obligations are agreed. In addition, a separate notarized shareholders’ resolution (as mentioned above) can reduce the risk. Although many people deliberately choose not to have the contract fully notarized in order to save time and money, this should only be done after consulting a lawyer and being aware of the risks. In particular, if the contract contains other clauses under company law (e.g. obligation to join a shareholders’ agreement with drag-along obligations, i.e. future sales obligations), notarization may be required. A breach would render the relevant clause or even the entire contract null and void.
- Tax and accounting aspects: During implementation, care must be taken to ensure that the conversion is carried out in a technically clean manner. Conversion by means of a capital increase in return for a contribution in kind is common – however, not by contributing the loan as a classic contribution in kind (this would require a valuation and possibly an auditor), but by means of a structure: the investor acquires new shares at the 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. In this way, the loan is effectively transferred to equity without the need for complicated valuation reports. It is important that this only happens upon conversion – until then, the loan remains debt capital for accounting purposes (possibly with subordination, which means it can be excluded from the over-indebtedness test). It is also relevant for founders: Due to the tax regulations, the contract should make it clear that the addition of the SAFE or loan amount is not immediately considered equity, but is only transferred to the capital reserve upon conversion into shares. In this way, you avoid an interest-free loan possibly being interpreted as taxable income.
Typical areas of application: Convertible loans are ideal for obtaining liquidity quickly when a large financing round (e.g. Series A) is not yet ready to go ahead. They are frequently used:
- as bridge financing (bridge loan) to bridge the period until the next equity round,
- in seed phases, when business angels invest but all parties involved do not want to determine the valuation until a larger VC joins,
- or in the event of a crisis, when money is needed in the short term but valuation is currently difficult (e.g. because sales are still volatile).
The major advantage is flexibility: negotiations focus on a few key economic points (interest rate, discount, cap) and not on complex corporate law terms. In addition, the shareholder structure remains unchanged for the time being – the investor only officially appears as a shareholder upon conversion. This can be important, for example, in order not to jeopardize funding or to keep decision-making processes lean. In the event of success (next round comes about), the lender then becomes a co-shareholder almost seamlessly. If, contrary to expectations, there is no subsequent round, the loan may fall due depending on the agreement – therefore, from an investor’s point of view, at least a clear exit strategy in the contract is important (be it repayment or an alternative conversion clause at the end of the term).
SAFE Agreement – “Simple Agreement for Future Equity”
What is a SAFE? The SAFE is originally a US concept, developed in 2013 by Y Combinator, and literally means a “simple agreement on future equity”. At its core, a SAFE is a special type of convertible loan with no term and no interest. The investor pays capital to the startup 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 runs for an indefinite period and only becomes relevant when certain defined events occur. Basically, the startup raises capital-like funds without giving 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 with some key differences:
- No maturity without an event: A SAFE does not provide for automatic conversion after a certain period of time. This means that if the trigger events provided for in the contract never occur, the SAFE remains in place – theoretically indefinitely. From the startup’s perspective, this is attractive because there is no need to plan for repayment “in advance”. For the investor, however, it means that their money is potentially tied up in the company for a very long time without any consideration (which is tantamount to a total loss if there is never a conversion).
- Conversion only with certain triggers: Typical trigger events in a SAFE are 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 the convertible, the agreed valuation discounts or caps apply so that the SAFE investor receives an advantageous entry price. In contrast to the loan, there is rarely an option: conversion is usually required as soon as the qualifying round takes place. If there is a company sale or IPO(liquidity event) instead, many SAFE contracts stipulate that there will be no further conversion. Instead, the investor can demand to be paid out – often in the amount invested (sometimes plus a bonus or interest compensation). This puts them in the same position as if they had already held shares and were now selling them. Important: If the payout amount is limited in the event of a sale and the company is only sold for a small amount, the SAFE investor may receive back less than he has invested (if the contract amount is reduced proportionately). In any case, it is subordinated to regular creditors. These rules are therefore similar to a type of silent partnership.
- No interest, no fixed coupons: a SAFE is interest-free. This means that there is no ongoing interest, which saves the startup liquidity. The “return” for the investor results exclusively from the discount or increase in value when the shares are later issued.
Drafting contracts under German law: Although the SAFE concept sounds simple, its implementation in the German legal framework poses a number of challenges. There is no legal definition of a SAFE – de facto you have to make do with existing legal figures. In most cases, a SAFE is contractually structured as a special type of subordinated loan, with the proviso that no repayment can be demanded, except in certain cases. Important points are
- 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. This means that if the startup fails or no qualifying event occurs over a longer period of time, the investor has no contractual right to reclaim their money. In extreme cases, the investment is lost completely. This is unusual in legal terms, as a loan without a repayment obligation is more akin to a transfer of equity. It is therefore important to clearly regulate this character – especially in order to clarify regulatory issues (e.g. a “repayment promise” could otherwise be considered a deposit transaction, which could trigger a BaFin license obligation for the startup). However, the lack of a fixed repayment claim and a qualified subordination ensures that there is no deposit business requiring a license – after all, the repayment is not unconditional and due at any time, but only subordinated and subject to conditions.
- Participation rights under the law of obligations: As SAFE investors are not initially shareholders, they have neither voting rights nor statutory rights to information like a GmbH shareholder. However, in order to secure their investment, contractual rights similar to a silent partnership are agreed in the SAFE contract. These often include information rights (similar to convertible loans, regular reports, inspection rights) and sometimes reservations of consent for capital-relevant decisions. For example, it could be stipulated that the startup may not enter into any further SAFE agreements or convertible loans above a certain amount, distribute dividends or issue new shares (except in the context of the qualified round) without the consent of the SAFE investor – all this in order not to dilute the SAFE investor’s future participation quota or undermine its right. However, SAFE investors are usually smaller early-stage investors, so excessive vetoes are uncommon; they are often content with MFN clauses (if another investor later receives a better offer, the SAFE will be amended accordingly). In any case, it is important to have clear rules so that the SAFE investor does not unintentionally exercise the rights of a full shareholder – this could possibly be seen as circumventing the statutory protection of the GmbH shares.
- Conversion and capital increase: As with convertible loans, an automatic conversion cannot take place without further ado under German GmbH law. A shareholder resolution is always required for a capital increase. The SAFE documentation must take this into account. In practical terms, this means that when the conversion event occurs (e.g. a new financing round), the GmbH must duly resolve and notarize the capital increase – unless it is a different legal form with prepared capital (in the case of an AG, for example, conditional capital or authorized capital could be used). As start-ups are usually limited liability companies, it is advisable to obtain the consent of the existing shareholders in advance. As with the convertible loan, this can be done by means of an anticipated shareholder resolution that permits the subsequent issue of the corresponding shares. This resolution can also cover multiple SAFEs (e.g. consent to conclude SAFEs up to a total amount of X). Alternatively, all shareholders could co-sign the SAFE – but this is unusual in international investor circles and is therefore rarely required. The resolution route is more elegant and should be notarized to ensure its 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, does not recognize an exactly corresponding concept of preferred stock. Although different classes of shares with different rights can be created in the GmbH, or profit participation rights can be used, all of this requires detailed provisions in the articles of association. A SAFE agreement in the German version may therefore have to refrain from promising genuine preferred shares. Instead, an assurance could be given that the investor will receive a position equivalent to that of the new VC investors in the event of conversion – in practice, the same preferential rights that are negotiated in the upcoming financing round could also be applied to the SAFE shares by contract or in the articles of association. Careful coordination is required here to ensure that the SAFE investor is not disadvantaged or favored without it being regulated in a legally tenable manner.
- Subordination and insolvency: Although the SAFE does not have a fixed repayment claim, a qualified subordination is usually agreed as a precautionary measure. This seems paradoxical, but the background is as follows: As long as the SAFE is still classified as debt capital in the balance sheet before conversion (many people recognize it as a liability for lack of any other category), it could theoretically constitute over-indebtedness. Through the subordination, the investor makes a binding declaration that his claim (if there is one at all) is subordinated and will only be serviced after all regular creditors in the event of insolvency or liquidation. This means that the claim is excluded from the over-indebtedness test in accordance with Section 19 InsO. Furthermore, as mentioned above, subordination prevents BaFin from considering the transaction to be a deposit-taking business requiring a license, as the capital is not unconditionally repayable. In short: Subordination is also a must-have in SAFE in order to be on the safe side from a regulatory and insolvency law perspective. This changes little for the investor – they have not agreed any priority over other creditors anyway, the subordination only confirms their equity-like status.
- Choice of law and foreign templates: Since SAFEs originate from the USA, US investors sometimes insist on using the well-known 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 because many things are mandatorily subject to German corporate law (e.g. the capital increase). Therefore, German law should always be agreed as applicable in the SAFE. The US templates must be translated and adapted in terms of content (e.g. deletion of automatic conversion without a resolution, adaptation of the exit provisions, deletion of exotic clauses such as tax characterization as “common stock” in advance). All of this requires detailed legal work – simply taking the PDF from the Internet and inserting names would be grossly negligent.
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 are a burden on the company. Liquidity remains in the startup until either a successful round occurs (then the conversion does not interfere because new capital comes in) or the startup fails (then there is nothing to repay anyway). The often cited fact that no immediate valuation is required also sounds attractive. However, it is important to note that an implicit valuation is actually agreed through the discount and cap. Founders sometimes tend to accept caps that are too generous, which means that in the event of conversion, they surrender far more shares than intended – a kind of hidden anticipation of the valuation. Caution is therefore advised here.
From an investor’s point of view, SAFE is double-edged: on the one hand, there is no interest and no specific maturity date – the investor cannot put the startup in distress even if he wanted to. On the other hand, they bear a high risk, as their capital is completely lost in the worst-case scenario. There is a lack of the “pressure” that a bullet loan exerts to either seek a new round or repay it. Accordingly, SAFEs are often accompanied by investor confidence – there is a strong belief in the success of the startup. SAFEs are therefore less attractive for professional VC investors, as they like to see clear deadlines and obligations. SAFEs are more often used by business angels, accelerators or foreign early-stage investors who are familiar with the model from the USA. For larger sums or longer periods, many investors prefer a more structured solution (convertible with interest/maturity or equity). Another disadvantage for investors is that they have no shareholder rights between investment and conversion. This means that 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 who raise SAFE capital should therefore 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 startup practice, convertible loans have long been predominant; however, SAFEs are gaining in popularity. Especially since around 2020/21, SAFE-like constructs have been increasingly seen, often inspired by US investors. There are even models that have been adapted by local law firms. Nevertheless, there is as yet no published German case law on SAFEs. This means that many of the assumptions (such as the effectiveness of certain clauses) are still theoretical. The parties involved are operating in a certain gray area, which is, however, filled by analogous application of the rules for convertible loans and subordinated loans. In the insolvency of a startup, a SAFE is effectively treated like a subordinated shareholder contribution – an insolvency administrator would probably classify the SAFE investor in a similar way to a silent partner, who would only get their turn after all creditors (if there is anything left at all). For founders, the uncertainty in the application of the law can be a minor disadvantage; this makes it all the more important for contracts to be properly drafted by experienced lawyers so that clear agreements are in place in the event of a dispute.
Capital increase in exchange for shares – classic equity financing
The third instrument of early-stage financing is the direct raising of equity by issuing new company shares. In this case, the investor does not invest as a lender, but becomes a direct shareholder. In the German context, this usually means a capital increase in a GmbH (or UG) in return for a contribution from the investor. This procedure differs fundamentally from convertible loans and SAFE, as it formally follows company law and the investor becomes a co-owner with all rights and obligations from the very first moment.
Legal requirements and procedure: A capital increase in a GmbH is formally complex and strictly regulated by law. The most important steps and requirements are
- Shareholder resolution and notary: First of all, the existing shareholders must approve a capital increase. A resolution to increase the share capital and issue new shares requires a qualified majority (usually 3/4 of the votes cast) and must be notarized (Section 53 (2) GmbHG). The participation quota of each new share and, if applicable, new share classes are determined in this resolution. The notary records the resolution and thus ensures that all legal requirements are met.
- Acquisition of shares by the investor: The investor (transferee) must subscribe to the new shares. Pursuant 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 he is taking over the new shares named in the resolution and paying in the corresponding contributions.
- Payment and share capital increase: The investor pays in the agreed amount. In the case of a cash foundation, at least the part of the amount corresponding to the share capital must be paid into the company’s account (usually 100% in the case of a cash capital increase; in the case of a contribution in kind, a different procedure would be necessary, including valuation). Amounts in excess of the nominal value go into the capital reserve (premium). An example: An investor pays € 500,000 for 20% of the shares in a GmbH with a share capital of € 25,000. The share capital could then be increased by € 5,000 (new nominal amount), for example, and the remaining € 495,000 is a premium. The nominal amount flows into the share capital, the premium into the reserves. This reflects the value of the company without unnecessarily inflating the share capital.
- Amendment to the articles of association: The capital increase usually 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. As a rule, the notary also registers the capital increase and shareholder change with the commercial register, which is relevant for the effectiveness vis-à-vis third parties. The process is only completed 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 act of the capital increase, the founders, existing shareholders and the new investor usually conclude a participation agreement or shareholders’ agreement. This sets out the investor’s rights in more detail, which go beyond the law. Typical provisions include, for example Voting rights agreements (such as veto rights of the investor in important decisions, approval catalog), drag-along/tag-along clauses(regulations for the exit: the investor can force the founders to co-sell or vice versa), pre-emption rights in the event of share sales, non-disposal obligations (lock-up for founders’ shares), liquidation preferences (if implementable in the GmbH, e.g. via preferential rights in profit distribution) and anti-dilution clauses in the event of later more favorable capital rounds. This agreement can be drawn up privately, but must be coordinated with the articles of association. If it contains binding clauses on the future transfer of shares (e.g. drag-along with an obligation to sell), these special clauses are again subject to notarization in accordance with § 15 GmbHG. In practice, either the entire participation agreement is notarized (which increases effort and costs), or binding share transfer obligations are limited to the notarized articles of association. For example, a preferential profit distribution or liquidation preference can be anchored directly in the articles of association, which have to be notarized anyway – this way, the desired effect is formally effective. In any case, equity financing means that extensive legal documentation is required to regulate all aspects of the new ownership structure.
Advantages and disadvantages of direct equity financing:
- Advantages: For the investor, the acquisition of real shares is often the goal of all efforts – they become co-owners with full voting rights, can exercise influence in the company (e.g. agree a seat on the advisory board/supervisory board) and participate directly in increases in value and profits. From the startup’s perspective, an equity investor provides long-term planning security: the capital is real equity that does not have to be repaid. The uncertainty of a future conversion or maturity is eliminated – the “cup” of repayment passes the GmbH by. In addition, a committed investor often brings know-how, a network and prestige. The cooperation can be more intensive because the investor as a shareholder is motivated to increase the value of the company (not just to get his loan back with interest). In many cases, larger venture capital investors demand real shares anyway, as this is the only way they can effectively implement all the necessary investor protection rights (voting rights, voting agreements, etc.).
- Disadvantages: The classic capital increase is more time-consuming and cost-intensive. Every step – from negotiating the company valuation and due diligence of the investor to drawing up the contracts and going to the notary – costs resources. Notary fees are linked to the transaction value according to the scale of fees, which can easily add up to a few thousand euros for larger investments. Legal advice costs are also higher because the contracts are more complex (articles of association, investment agreement, ancillary agreements if necessary). For founders, taking on a new shareholder immediately also means giving up co-determination rights and often accepting certain restrictions. In addition, a company valuation must be found, which can be difficult and conflict-prone, especially in the early stages – if you value too high, you scare away investors; too low, you dilute your own shares considerably. All in all, equity financing is a big step that requires careful consideration and preparation.
Typical areas of application: Due to the disadvantages mentioned above, an immediate capital increase is often only chosen for larger financing rounds when a lead investor joins and wants to invest several million euros (classic Series A and later). In such cases, the company has usually already matured somewhat: there are more reliable figures that justify a valuation, and the investor wants considerable influence and clear conditions – this is only possible with real shares. Strategic investors (e.g. a corporate investor from industry) or public investment companies also often invest directly in equity, as they are reluctant to take detours (loans). In the early stages (pre-seed, small seed rounds), on the other hand, many founders shy away from formal capital increases – here they prefer to resort to convertible loans or SAFEs to save time and avoid the tedious notary procedure until the business model has been validated. Nevertheless, if friends and family provide capital, for example, they may be taken on as shareholders (direct participation), as the sums involved are small and there is a personal basis of trust. So every startup has to weigh things up: Is the added value of a real shareholder (including the capital, but also know-how) worth the effort, or is it better to go with a more flexible instrument and postpone the “big shot” until later?
Comparison of instruments depending on the financing situation
Not every instrument is suitable for every situation. Founders should weigh up the advantages and disadvantages depending on the phase and requirements:
- Quick bridging without valuation: If liquidity is at stake in the short term or a smaller amount needs to be collected in order to reach the next milestone, convertible loans or SAFE are usually the better choice. Both allow capital to be raised in days rather than weeks – the contract can be kept lean in terms of content and concluded without a notary. In addition, you avoid a company valuation at this early stage, which may already be outdated in a few months. A convertible loan is ideal, especially if you are already talking to interested VC investors about a larger round but need cash immediately: it bridges the gap and is easily converted in the next round. A SAFE can also be used, especially if the conditions are very founder-friendly (no interest, no maturity date). However, founders should only borrow amounts that they can afford in the worst-case scenario – because SAFE investors may be disappointed later if the conversion takes a long time. From an investor’s point of view, a convertible loan with a fixed term is sometimes preferable, as it disciplines the startup to initiate the next round in good time or to find a solution (otherwise it would have to repay). In practice, many SAFE-like agreements are therefore provided with a long “longstop” period, around 18-24 months, after which a conversion or a discussion about repayment should take place – even if there is no nominal end date.
- Seed financing with an uncertain valuation: Particularly in the early seed phase, when the product and market are not yet fully valid, convertible loans/SAFEs are a good way to get investors on board without having to negotiate shares straight away. This keeps transaction costs low and prevents founders from giving up too much equity if the initial valuation is too low. You buy yourself time until more reliable key figures allow for a fairer valuation. Many well-known start-ups in Germany have structured their very first angel investments via convertible loans – fast, uncomplicated and everyone concentrates on developing the business, not on contract negotiations.
- Larger round with lead investor (Series A/B): As soon as an institutional investor (VC fund, corporate VC, etc.) and a larger amount of capital (~€1 million and upwards) come into play, there is hardly any way around a classic capital increase. 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 the valuation is highly controversial – even then, a VC would rather use a convertible with a cap, which then converts in a larger co-round. Series A is usually the time when all convertible loans and SAFEs issued to date are consolidated and converted. This means that the startup should keep an eye on how the sum of these conversions will affect the new investment structure. In large financing rounds, the existing shareholders and new investors have to come to the table anyway, so you can clear the air right away: a complex but complete reorganization of the shareholder structure. Advantage: There are no more pending claims, everything is converted into equity, which future investors welcome (a “tidy” cap table). Disadvantage: Founders often only experience the full dilution of accumulated convertible loans/SAFEs here, which sometimes leads to nasty surprises if caps have previously been overlooked or interest has accumulated. This makes transparency and prior consultation all the more important.
- Bridge financing in times of crisis: In economically difficult phases (e.g. the investor for the next round backs out or an external shock occurs), existing shareholders or new investors can help quickly via convertible loans. A SAFE would make less sense here because it would be unclear when/if a conversion would even take place – in crisis situations, a short time horizon and possibly stricter conditions (e.g. reduced cap, higher interest rate) are usually set to reflect the risk. Public aid programs (such as in the coronavirus era) have also used convertible loans because they can be structured flexibly and are compatible with subsequent investor entries.
- Number of investors and structure: If you only have one investor, you can theoretically use any instrument. However, as soon as many small investors are to be involved (e.g. crowdinvesting or family & friends rounds), the equity solution becomes impractical, as you don’t want to take on dozens of new shareholders. In this case, convertible loans are often used to bundle the group of small investors and possibly add them to the list of shareholders at a later date via a trustee or a vehicle. In crowdinvesting, subordinated loans are often used in legal terms – similar to SAFE – to avoid the obligation to publish a prospectus and to avoid creating thousands of mini-shareholders. It is therefore important for founders to plan: Who is investing and how many? How long should the group of people stay on board? The more diverse and short-term, the more likely loans/SAFE; the more targeted and long-term an investor, the more likely equity.
In summary, convertible loans are ideal for gaining time and saving transaction costs in the early stages, while equity financing is indispensable when it comes to larger sums and formal investments. SAFE agreements occupy an intermediate position – they are particularly founder-friendly and subordinated to investors, but are particularly suitable for very early, trust-based investments and must be adapted carefully in Germany.
Insolvency law classification of the instruments
A critical aspect that is often overlooked when making financing decisions is the different treatment in the event of insolvency. For managing directors in particular, it is important to know the balance sheet and insolvency effects in order to prevent liability risks (keyword: delay in filing for insolvency).
- Convertible loan: Until conversion, the convertible loan is considered debt capital (liability) of the startup. Without special agreements, the lender would have to be treated as a normal creditor in the event of insolvency. However, a qualified subordination is agreed in almost all convertible loans. This means that the investor’s claim is subordinated in insolvency proceedings (Section 39 InsO) and, in particular, is not taken into account in the over-indebtedness test (Section 19 InsO). In practical terms, this means that as long as the company still has prospects of continuing as a going concern, the loan amount does not have to be assessed as a “mountain of debt” – the obligation to file for insolvency can therefore often be averted by a subordination, provided there is no insolvency. Should insolvency nevertheless occur, the convertible loan lender is at the back of the queue: Only when all senior creditors (banks, suppliers, etc.) have been satisfied in full would it be the convertible lender’s turn – which usually means that it goes away empty-handed. Without subordination, the lender would have a normal claim in the event of insolvency and could be registered in the insolvency table; if applicable, it would have received a quota. However, start-ups are usually worthless in the event of insolvency, so the quota would usually be zero here too. Important for managing directors: If a convertible loan without subordination has been agreed and over-indebtedness occurs, an application for insolvency must be filed in good time – the instrument itself then does not trigger any protection. In addition, no further repayments may be made to the lender when the company is insolvent, otherwise there is a risk of managing director liability under Section 15b InsO (formerly Section 64 GmbHG). The above-mentioned ruling by the Higher Regional Court of Zweibrücken shows the background to this: the insolvency administrator had argued that the convertible loans were formally invalid and could therefore be reclaimed at any time – meaning that the GmbH was overindebted and repayments to the lenders in the crisis were inadmissible. This dispute makes it clear that only a clean structure (including subordination and correct form) protects against additional problems in the event of insolvency.
- 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 the event of insolvency (except possibly in the event of a previously defined liquidation event). However, many SAFE contracts contain a clause that grants the investor a claim to repayment of the amount invested in the event of liquidation or insolvency – albeit subordinated to the other creditors. This means that if the startup is liquidated, the SAFE investor should be able to demand his capital investment (after the normal creditors have been satisfied), but only up to the amount of what is left over – often nothing is left over, so the SAFE investor is left empty-handed. Qualified subordination (which, as mentioned, is also recommended in the SAFE context) makes it clear that this restitution claim really only comes at the very end and does not count for over-indebtedness issues. This means for the obligation to file for insolvency: A SAFE that is correctly structured as a subordinated loan is not a burden on the over-indebtedness balance sheet and can therefore help to avoid arithmetical over-indebtedness. Conversely, however, the SAFE investor cannot put pressure on the management due to over-indebtedness, as its capital is treated as equity. However, this does not change anything in the event of insolvency (liquidity shortage) – only fresh money or cost reduction will help. To summarize: In the event of 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: The situation is clear here: 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 not paid until all creditors have received 100% – a situation that practically never occurs. The investment is therefore lost. However, this total loss corresponds to the typical risk of an equity investor (high risk, high reward). On a positive note: Equity can never cause insolvency-triggering over-indebtedness in the sense of accounting law, as it is by definition not debt capital. On the contrary, a capital increase can be a means of averting impending insolvency (by increasing equity). For the managing directors, the problem of having to manage loan liabilities is eliminated – there is simply no repayment obligation towards the investor. However, other obligations come into play here: e.g. the share capital may not be paid out to shareholders (otherwise a breach of capital maintenance rules), and in a crisis, shareholder loans could be subordinated in accordance with section 39 InsO and repayments to shareholders could be contestable in accordance with section 135 InsO. However, these issues relate more to existing shareholder loans. Unlike a lender, a pure equity investor cannot sue to get his money back – he is fully dependent on the company’s success.
Interim conclusion: From an insolvency perspective, SAFE and (subordinated) convertible loans are much more gentle on the startup than normal loans. They act as liable capital that cushions losses. From an investor’s perspective, you should be aware of the order of priority: Until conversion, you only have real security with a convertible loan if you could theoretically act as a normal creditor – which you voluntarily give up through subordination. With SAFE, you have hardly any rights in insolvency proceedings from the outset. Ultimately, SAFE investors and convertible lenders (with subordination) hardly differ from equity investors: if the company goes bankrupt, the investment is gone in almost all cases. The big difference lies in the time before insolvency: a non-subordinated convertible loan could theoretically generate pressure or make claims earlier, where SAFE and equity would still have to stand still. In this respect, SAFE and subordinated convertible loans act as a buffer for start-ups in a crisis – they prolong the breathing space, as these investors cannot immediately run for cover when things get tight.
Comparison of notary and transaction costs
Cost and effort are also important considerations when choosing a financing instrument – especially for tight startup budgets:
- Convertible loan and SAFE – a cost-effective start: The initial costs for a convertible loan or SAFE are relatively low. There are no notary fees 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: although a lawyer should be consulted here in order to have a solid contract, the scope (and therefore the costs) are significantly lower than for a fully negotiated participation agreement. Convertible loan agreements are often based on tried and tested models that can be adapted with a manageable amount of effort. Despite warnings, some founders even use free online templates. But be careful: as explained above, seemingly small clauses can have a major impact (up to and including nullity). The savings in legal costs should therefore be weighed against the risk. Overall, however, SAFE and Convertible enable fast and streamlined processing: it can take just a few days from agreement on the conditions to payment, as there are no formal hurdles.
- Capital increase – formal process with fees: The classic equity round inevitably entails notary fees. These are set by law in Germany (GNotKG) and are based on the value of the transaction, i.e. roughly the amount of the investment. For an investment of €1 million, for example, notary and registration costs could be in the region of €1,500-3,000 (depending on expenditure, drafting costs, etc.). In addition, every shareholder resolution in the GmbH that involves changes to the articles of association often has to be notarized. In the context of a VC round, this sometimes involves several documents: the capital increase itself, amendments to the articles of association (new share classes, possibly changes to managing director approvals), and sometimes also approvals or waivers (e.g. waiver of subscription rights of existing shareholders if the investor receives exclusive shares). Each of these points is recorded in the minutes of the notarial meeting. In addition, there are legal fees for negotiating and drafting the participation agreement and the new articles of association – depending on the complexity and rounds of negotiations, these costs can be higher than the notary. From the founders’ perspective, this is a considerable upfront investment: part of the capital raised is immediately spent on incidental transaction costs. However, large investors understandably insist on legally compliant implementation, so there is no way around these expenses.
- Dealing with follow-up costs: It is important to understand that convertible loans and SAFEs do not cancel the formal costs , but postpone them. If conversion takes place at a later date, the notarized capital increase must then be carried out, with similar costs. However, this can often be combined: For example, in a Series A round, not only is fresh capital subscribed in exchange for new shares, but all convertible loans/SAFEs are also converted at the same time by resolution. The notary can notarize this in one go. The fixed costs are thus spread over a larger transaction. It is much more convenient for the startup to bear the costs later, when it has more capital thanks to the new round, than in an early phase. If – worst case scenario – no successful round follows and the startup fails, you even save yourself the costs altogether (because the company is then simply liquidated without ever having completed the conversion). Of course, this is not a pleasant scenario, but it shows that SAFE/convertible are pay-as-you-go models, while equity financing generates upfront costs.
- Transaction duration: The time factor should not be underestimated. A notary appointment requires coordination (often several weeks in advance, unless you pay for urgency) and the completion of all documents in advance. Then it takes another few days to weeks for the entry in the commercial register to be completed – only then do investors have legal certainty about 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 difficulties, 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 the notarial form in order to save costs. Such shortcuts are risky. Instead, you can consider using digital notary appointments (online notarizations have been possible in certain cases since 2022) to at least minimize travel expenses. You can also choose structures such as incorporating a UG into an AG to make it easier to work with authorized capital later on – but this goes beyond early-stage issues and relates more to later scaling.
Conclusion on costs: For small financing amounts, it is usually not worth making a big “investment fuss”. Convertible loans/SAFEs score points here thanks to low initial costs and fast processing. For large amounts, the notary costs are relativized in percentage terms 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/SAFE to finance the development, then, if sufficient progress is made, a concentrated capital increase in which a collective conversion takes place and new money is raised – this means that the notarial procedure is only required once, but all early-stage investors are integrated.
Drafting clean contracts – why legal advice is essential
No matter which instrument you choose: The contract should be drafted with the utmost care. Early-stage financing is time-critical, but hastily signed contracts can cost the startup dearly later on. Here are a few reasons why legal advice is worth its weight in gold:
- Effectiveness and form: As we have seen, various formal traps lurk with convertible loans/SAFEs. What use is the best financing if the contract is void afterwards and the investor can suddenly assert a normal repayment claim? A sample contract found on the internet may superficially fit the bill, but in a specific case – for example with individual clauses or in combination with a shareholder agreement – it may trigger other requirements. The OLG Zweibrücken decision in 2022 was a wake-up call: standard clauses from US models or misunderstood templates can be fatal in Germany. Founders should therefore never blindly adopt clauses whose scope they do not understand. It is better to rely on tried and tested standards in Germany (many law firms have templates that are 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 has to be filed before conversion? How are convertible loans/SAFE treated in the event of a partial exit (sale of a business unit)? Can the startup take on further debt even though the SAFE is running? Such points should be clearly regulated in order to avoid disputes later on. Discussions often arise years after financing because contracts have gaps or allow for different interpretations. For example, the calculation of the conversion rate: if discount and cap are combined, how exactly is this calculated? Is the interest also converted? And what happens if the next round is to take place in tranches or if conversion is to be partial? Detailed questions of this kind can be complex. With proper contract work, you lay the foundation for the conversion or investment to run smoothly later on without the parties’ lawyers having to renegotiate at every step.
- Balance of interests: A startup financing agreement should be fair – it must protect the legitimate interests of the investor, but must not unnecessarily gag the founders. Without experienced advice, founders run the risk of, for example, giving excessive rights to investors in a SAFE (such as vetoes that could block any future financing) or setting unfavorable caps. Conversely, an investor must ensure that he is not in a worse position in the convertible loan than future investors. This can be achieved through most-favored-nation clauses or cap regulations. Balancing such points requires negotiating skills and knowledge of the market: What is usual in 2025? What conditions are “in line with the market”? Lawyers who regularly advise start-ups and investors know this and can help to structure a deal that is acceptable to both sides – so that there is no resentment in the next round because an early investor was disproportionately favored or disadvantaged.
- Taking current developments into account: The legal field is in flux. New court rulings (such as the one on convertible loans mentioned above) 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 run the risk of acting with outdated knowledge. One example: For a long time, it was assumed that convertible loans were always form-free – until the courts called this into question. Similarly, a court could at some point classify a SAFE as an atypical silent partnership or declare any clause invalid. Professional advice ensures that all relevant precedents and laws are taken into account at the time the contract is concluded. Where there is uncertainty, you will play it safe (e.g. go to a notary after all or adapt clauses).
- Subsequent investor due diligence: Investors review the cap table and existing contracts in every major financing round. If it turns out that a previous convertible loan or SAFE has technical errors, this can jeopardize the deal or at least cause delays and renegotiations. In the worst case, old contracts have to be cured or renegotiated while the fresh money is supposed to be flowing in. Such risks can be avoided by having a solid initial structure. What’s more, a structured contract that is ready to be signed also makes an impression on the other party (investor or founder) and creates trust. It shows that you are acting professionally and thinking about the future.
In conclusion, it can be said that early-stage financing instruments are powerful tools for helping start-ups to succeed in a flexible manner. Convertible loans and SAFEs enable quick access to capital, while classic equity financing involves investors in the long term. Each has its place – if used correctly. For German start-ups in 2025, this means dealing with the legal intricacies or enlisting competent help. Tailor-made contract drafting prevents legal disadvantages and conflicts that can become expensive in retrospect. Start-ups should not be put off by the supposed “paperwork”: The effort required for legal certainty is worthwhile in order to actually be able to make full use of the hard-won financing. If in doubt, it’s better to ask a lawyer early on than to argue in court later – that way the focus stays where it belongs, namely on the further development of the company and the next big milestone.