Conver­ti­ble loans have always been popu­lar as a way to avoid diffi­cult valua­tion discus­sions in the early stages of a busi­ness or to bridge short-term finan­cing needs until a larger round of finan­cing is available. In times of high valua­tion vola­ti­lity and diffi­cult exter­nal circum­s­tances, it is ther­e­fore not surpri­sing that compa­nies very much like to seek inter­nal and also exter­nal finan­cing via conver­ti­ble loans in order to save tran­sac­tion costs on the one hand, but also to try to avoid exter­nal signs of current valua­tion restraint on the other. Conver­ti­ble loans are desi­gned to be conver­ted in full into equity at a later date, i.e. they contain the right or obli­ga­tion to subscribe for shares in the Company in return for the claims arising from the loan in the event of a capi­tal increase.

This distin­gu­is­hes them from venture debt, which is loan finan­cing for young compa­nies that are not yet able to obtain finan­cing from a bank in the early stages due to a lack of colla­te­ral. In contrast to conver­ti­ble loans, venture debt does not dilute exis­ting share­hol­ders much, if at all. Hardly, because many of the venture debt contracts include a so-called warrant , which conta­ins a conver­sion right for part of the loan or is at least econo­mic­ally mode­led on a conver­ti­ble loan. Venture debt contracts are often chosen by compa­nies that expect shar­ply rising valua­tions above the inte­rest rate on the venture debt.

Accor­ding to the correct view, conver­ti­ble loans do not have to be nota­ri­zed. At least not if they are concluded with all share­hol­ders. Any conver­sion obli­ga­tion is then struc­tu­red as a pure voting obli­ga­tion of the share­hol­ders, which is possi­ble without any forma­li­ties. Conver­ti­ble loans with a conver­sion obli­ga­tion concluded purely bila­te­rally with the Company are curr­ently under discus­sion as being subject to nota­riza­tion or even authen­ti­ca­tion. We ther­e­fore advise the former design variant.

Despite the avai­la­bi­lity of sample contracts on the web, profes­sio­nal support is recom­men­ded when conclu­ding conver­ti­ble loans. Not only must the conver­sion mecha­nism be neatly regu­la­ted. Situa­tions in which the loan is to be conver­ted, such as whether only one side is to be entit­led or both, or even whether there are to be conver­sion obli­ga­ti­ons, also require clear regu­la­tion in order to avoid dispu­tes. In addi­tion, conver­ti­ble loans can include agree­ments that are other­wise more typi­cal of equity finan­cing rounds, such as infor­ma­tion or even veto rights.

If the contract does not contain any provi­sion on the sale of the company, it conti­nues to run in prin­ci­ple. Howe­ver, this is usually not in the inte­rest of the parties. Ther­e­fore, this case should be clearly regu­la­ted. A right of termi­na­tion with repay­ment, also with a bonus, a so-called exit kicker, can be conside­red. Howe­ver, prior conver­sion would also be possi­ble, in which case it must be clari­fied at what valua­tion. Usually, the inves­tor will want to parti­ci­pate in a successful exit, so either a discount or a maxi­mum valua­tion is set. In this way, the inves­tor can secure the same oppor­tu­nity as if he had parti­ci­pa­ted in the company’s equity from the outset.

About Björn Weidehaas

Björn Weide­haas advi­ses family offices, funds, busi­ness angels and start-ups holi­sti­cally during the finan­cing phases as well as compa­nies during restruc­tu­rings and in insol­vency law. As a busi­ness graduate, he under­stands the complex econo­mic inte­rests of his clients.

weidehaas@lutzabel.com