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Table of Contents
Related Content
The Germany content consists of this summary page, and separate pages for Preferred Shares in a German Limited Liability Company (“GmbH”), Silent Partnership in a Corporation, and Debt.
Executive Summary1
In the German (debt/equity) market there is no classical “revenue-based finance” in the sense of a (customary) shareholders’/finance arrangement under which the investor has a priority right to receive repayment/distributions up to an agreed portion of “gross revenues” or “free cash flow”, until an agreed return on the investment is reached. However, the following three options come closest thereto: (1) preferred shares in a German Limited Liability Company (“GmbH”), (2) a silent partnership in a German corporation (GmbH or a stock corporation (“AG”)) or (3) a loan to a GmbH, AG or a limited partnership by shares (Kommanditgesellschaft auf Aktien (“KG aA”)) in combination with a warrant against the company’s/borrower’s shareholder(s) to call for shares (or, alternatively, to opt for a cash settlement) upon a specific trigger event.
Preferred Shares in a GmbH entitle the holder of such shares to a preferred treatment in regards of the priority of distribution of profits among the shareholders, i.e., the other (ordinary) shareholders accept that the investor has a right to repayment by way of distributions of profit (based on the revenue of the GmbH) and that such right needs to be discharged prior to other (ordinary) shareholders receiving their portion of the (remaining) amount to be distributed. Distributions and redemptions are limited by capital maintenance provisions applicable under German law to ensure that the GmbH’s funds in the amount of its registered share capital (Stammkapital) are not diminished by any profit distributions.
A silent partnership in a German corporation is an undisclosed civil law partnership. It can be designed with or without membership rights. In both scenarios, the investor participates in the corporation’s profit. In the typical case of a silent partnership, membership rights are excluded, and the investor solely participates in the corporation’s profit, for which reason the silent partnership is considered a debt instrument. The atypical silent partnership includes membership rights and/or entitles to participate in hidden reserves. Therefore, for tax and insolvency purposes, it is categorized as an equity instrument.
The combination of a loan to a GmbH, AG or KG aA combined with a warrant against its shareholder(s) combines a debt and an equity instrument. The warrant to call for shares or, alternatively, to opt for a cash settlement is mostly designed in the form of a right to demand release of proceeds. Usually, the warrant is designed without any membership rights or equivalent influence in order to avoid subordination in an insolvency scenario.
In any of the three options contestations by an insolvency administrator of repayments/distributions made to the investor needs to be considered on a case-by-case basis in the light of German insolvency law. For the instruments qualifying as equity or the investor qualifying as a shareholder or as shareholder like – which can only be assessed on a case-by-case basis -, investor’s claims are subordinated pursuant to German insolvency law.
Withholding tax on payments received by the investor is triggered in case of preferred shares. In case of the other instruments, it needs to be assessed on a case-by-case basis (details below).
Preferred Shares in a German Limited Liability Company (“GmbH”)1
Investment Structure Summary
The following proposal for the structuring of a revenue-based financing investment aims at achieving the economic objective, i.e., the contribution of capital by the investor into the capital reserves of the GmbH in exchange for equity in the GmbH which grants the investor a right to repayment of its investment (including a premium) by way of distributions based on the revenue of the GmbH. This would be achieved through the investor receiving preferred shares in the GmbH (Gesellschaft mit beschränkter Haftung). Such preferred shares provide for Guaranteed Dividends (as defined below), but do not entitle the investor to any voting rights or, essentially, other rights as a shareholder of the GmbH.
GmbHs allow for a dualistic share structure, comprising preferred shares and ordinary shares. Preferred shares can be structured in such a way that they do not grant any voting rights. As a compensation for the loss of voting rights, preferred shares can provide for certain preference rights regarding their return on the investment.
a) Generally, the distributable profits of a GmbH (the “Distributable Profits”) need to be determined by the shareholders’ meeting and the distribution of such profits will usually be resolved upon annually. Revenue-based financing requires the GmbH to make payments to the investor periodically based on the relevant revenue of the GmbH generated during a specific period which may be shorter than the financial year of the GmbH. To accommodate such a need for multiple disbursements within a year, the GmbH needs to pay interim dividends. Any such interim dividend is to be understood as a pre-payment on the expected Distributable Profits at the end of a financial year.
b) To avoid any obligation of the investor to pay back interim dividends that exceeded the actual Distributable Profits, the interim dividends should be structured as so-called “Guaranteed Dividends”. Guaranteed Dividends allow for regular payments by the GmbH which do not necessarily have to be covered by Distributable Profits. If provided for in the articles of association, the Guaranteed Dividends can be variable in the amount, e.g., can be based on certain business benchmarks of the GmbH. The amount of Guaranteed Dividends to which the investor is entitled due to its contribution of capital can be capped at a total amount of distributions in the amount of the investment (including the premium). Once the cap has been reached, the preferred shares can be redeemed by the Company or given back by the investor without any further consideration.
The basis of assessment and applicable caps (if any) regarding the amounts of such Guaranteed Dividends are subject to negotiation of the parties and statutory limitations (i.e., principle of capital maintenance, not harming the existence of the GmbH and breach of fiduciary duties towards minority shareholders). To prevent any uncertainties regarding the terms for (re-)payments under the Guaranteed Dividends, the articles of association of the GmbH should clearly (i) stipulate the basis of assessment, e.g., monthly revenues or expected profits, and (ii) exclude any repayment claims of the GmbH in case the Guaranteed Dividends disbursed to the investor in a financial year exceed the Distributable Profits generated by the GmbH in such year.
Category
Equity
Category for tax purposes
Preferred shares are generally considered equity instruments also for German tax purposes.
Governance Rights
Under German law, the voting rights of shareholders that hold preferred shares can be excluded. Certain shareholder rights however cannot be excluded, inter alia, (i) a right to information and a right of inspection, and (ii) certain mandatory rights regarding resolutions specifically affecting such shareholder (e.g., regarding a change of preference rights with respect to its preference shares).
If the investor shall be granted voting, veto and/or other participation rights, etc., upon agreement with the shareholders of the GmbH, such rights can be granted to the investor by way of the articles of association and/or shareholders’ agreement (as applicable).
Investor Qualification Requirements
No specific requirements apply to a revenue-based financing.
Certain customary regulatory filing requirements may apply in case the investor and/or the investment qualifies for such requirements (e.g., antitrust or foreign investment control procedures).
Currency Considerations
The investment can be made in Euro or in any foreign currency. However, capital contributions in a foreign currency can only discharge the payment obligation of the investor if such contribution in another currency equals the corresponding registered Euro amount, deducting any costs incurred due to the payment in a currency other than Euro.
Collateral
Collateral is not required as the preferred shares will be issued to the investor as consideration for its investment.
Priority Payment Rights
As described above, the preferred shares provide for a Guaranteed Dividend for the benefit of the investor. The investor will receive such payments periodically. The Guaranteed Dividends should generally relate to the (anticipated) Distributable Profits of the GmbH but can be expressed in a certain percentage of the gross revenue/free cash flow/net income generated by the GmbH in a specific period.
Distribution and Redemption Limitations
Distributions in connection with Guaranteed Dividends to the investor are limited by the principle of capital maintenance. The compliance with such principle shall ensure that a GmbH has funds equal to its registered share capital (Stammkapital) at its free disposal at all times. Any payment of Guaranteed Dividends can therefore only be made from free capital, i.e., distributable profits and distributable reserves. The abovementioned requirements cannot be modified or waived in the GmbH’s articles of association. Thus, the Guaranteed Dividends can be based on a certain portion of the revenue generated, but such distributions must always be covered by free capital or free reserves.
Legal limitations to pricing or total return
Customary statutory limitations (principle of capital maintenance, violation of bonos mores, fiduciary duties, bad faith and rules of equality that apply vis-à-vis the minority shareholder) may apply and are subject to the specific circumstances of each individual case. Please also refer to the limitations noted above.
Status in Insolvency Proceedings
In case of insolvency, the previous payments of Guaranteed Dividends might be contested by the insolvency administrator according to the rules of the German Insolvency Code (details are very fact-specific and the outcome is uncertain; certain contestation periods might apply). If the administrator is successful, this would result in a repayment obligation of the investor. In addition, membership rights of shareholders generally do not constitute insolvency claims. Shareholders are only eligible to receive proceeds from the liquidation of the insolvency estate in the last rank after satisfaction of all liabilities. Thus, claims of the investor as a holder of preferred shares are, particularly, subordinate to any claims resulting from debt instruments.
Limitation of Liability
The liability of a GmbH is restricted to the GmbH’s assets. Therefore, shareholders of a GmbH are excluded from any liability vis-à-vis the GmbH’s creditors. Vis-à-vis the GmbH, the shareholders are liable for the fulfilment of their capital contribution obligations.
Further liability may arise in certain special circumstances, e.g., in connection with unlawful distributions by the GmbH to the respective shareholder or any liability of the shareholder for willful misconduct, fraud or tort.
Transfer Restrictions
Transfer Restrictions: In principle, shares in a GmbH are freely transferable. However, the articles of association of a GmbH may provide for certain transfer restrictions (Vinkulierungsklauseln). In particular, the transfer of the shares can be subject to the GmbH’s and/or the shareholders’ meeting’s approval. Further, the entrance of the new investor in a shareholders’ agreement regarding the GmbH requires the consent of the other shareholders due to the novation/restatement of such shareholders’ agreement.
Critical Tax Considerations
Distributions on the preferred shares are not tax deductible at the level of the GmbH.
Furthermore, such distributions are generally subject to a 26.375% withholding tax, i.e., the GmbH has to make a respective withholding from any payments “on” the preference shares. Please note that this also applies to a “repayment” of the “principal” amount (i.e., the amount contributed for the subscription of the preferred shares). Certain exceptions apply, e.g., if and to the extent the distribution is made out of the so-called capital contribution account (steuerliches Einlagekonto), which is, however, only the case if the GmbH does not have any distributable profits as of the end of the year preceding the distribution (i.e., any distributable profits are distributed first).
The taxation of the distributions in the hands of the investor depends on a on a number of different factors, including the investors tax residence and the eligibility of the investor under an applicable double taxation treaty. This is also true for a potential withholding tax refund from the German tax authorities. However, without going into details, please note that German domestic law generally imposes strict substance requirements for such a refund so that the withheld tax might become final and could become a cost item for the investor.
Please note that the above is a high-level summary of certain key aspects only. The specific tax consequences always need to be reviewed by taking into consideration all relevant details of the individual case.
- Note: Under German corporate law, besides the GmbH and certain partnerships, the stock corporation (Aktiengesellschaft) is another form of entity which may be a possible target for such revenue-based financing. The following presentation focuses only on the GmbH as, due to strict statutory requirements and limitations regarding the stock corporation, guaranteed dividends cannot be granted with regard to preferred shares in a stock corporation and, therefore, the structuring proposal as described herein is not applicable. Any dividends to be disbursed by the stock corporation must be based on the profit generated by the stock corporation and the disbursement of such profits must have been formally resolved upon by the shareholders’ meeting. Therefore, the structuring of revenue-based financing with regard to stock corporations should be structured by way of a silent partnership. For further details, please refer to the investment structure described below under B.). ↩︎