- Convertible loans are a form of start-up financing in which loans are converted into equity.
- Investors are given the option of conversion at a fixed price or discount.
- Legally, this is a contract under the law of obligations with a repayment obligation.
- Tax planning is important, as interest is deductible as a business expense.
- The advantages for start-ups are flexibility and faster processing.
- Investors benefit from discounted shares and interest payments.
- Complexity and uncertainty in the valuation are challenges with convertible loans.
A convertible loan, also known as a convertible note, is a form of start-up financing in which investors grant the company a loan that can later be converted into equity. This conversion typically takes place during the next financing round or an exit event at a predetermined conversion price or discount. Convertible loans are a popular financing instrument in the German start-up scene, particularly in the early stages of a company’s development.
Legal classification and design
In legal terms, this is initially a contract under the law of obligations, which imposes a repayment obligation on the borrower. The special feature lies in the lender’s option to demand conversion into company shares instead of repayment. In Germany, convertible loans are permitted under company law, provided that the requirements for a capital increase are met. Various parameters must be taken into account when drafting convertible loan agreements, including the conversion price or discount, conversion events, term, interest rate and collateral.
Tax aspects
In terms of tax law, convertible loans can give rise to complex issues, particularly with regard to the treatment of the loan and the conversion. The interest payments are generally deductible as operating expenses for the company. Income may be realized upon conversion if the value of the shares granted exceeds the nominal amount of the loan. Careful tax planning and advice is therefore essential.
Advantages and disadvantages
Advantages for start-ups:
1. avoidance of immediate valuation
2. flexibility in the design
3. faster and simpler processing compared to equity financing
Advantages for investors:
1. Possibility of obtaining shares at a later date at a reduced price
2. Interest payments as compensation for the risk
3. Priority position over equity investors in the event of insolvency
Disadvantages and challenges:
1. Complexity of the legal and tax structure
2. Potential dilution of existing shareholders upon conversion
3. Uncertainty regarding the future valuation of the company
Practical implementation
The following aspects should be taken into account when implementing convertible loans in Germany:
1. clear definition of the conversion conditions and events
2. determination of an appropriate interest rate and discount
3. consideration of scenarios such as insolvency or early repayment
4. compliance with company law regulations, in particular for the GmbH
5. coordination with existing shareholders and consideration of their interests
Conclusion
Convertible loans are a flexible and effective instrument for financing start-ups in Germany. They offer advantages for both companies and investors, but require careful legal and tax structuring. The use of convertible loans can expand a startup’s financing options and bridge the gap between pure debt and equity financing. Due to the complexity and potential pitfalls, expert legal and tax advice is essential when drafting convertible loan agreements.
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