Inbound investment to Germany – spotlight on three selected aspects

A. Convertible loan agreements: specific form to be observed?

1. Financial instruments

Convertible loans are popular financing instruments for SMEs in the start-up scene and for growth-oriented companies. They can be structured quickly and easily and offer a high degree of flexibility to both parties to the financing relationship. In particular, they help avoid lengthy discussions about company valuation, postponing these to the future. Convertible loans are prevalent when comprehensible data and criteria for company valuation are not sufficiently available due to the respective company phase (e.g., start-up or growth phase, reorganization, consolidation).

2. Legal nature

Under German law, a convertible loan is a contractual obligation based on a loan relationship. It comprises at least all the essential elements of a loan agreement, such as the parties‘ determination, loan amount, interest rate, collateral, cash repayment obligation and the maturity agreement. It can be supplemented by financial covenants of varying complexity.

The basic structure is then supplemented by a versatile conversion agreement, according to which the borrower, i.e., the company, can also deliver shares in the company to fulfil the loan repayment claim. This idea can be structured as a claim by the lender or the borrower, or a combination. The financing round conversion is almost always considered an extraordinary conversion event. This means the lender can convert the loan into shares if new investors are taken on or existing investments are expanded as part of a financing round. In this case, the valuation is determined by the financing round. The lender can then convert the loan receivable into shares at a discount to this valuation. The discount rewards the risk taken by the lender. Finally, provisions on subordination and an exit bonus are included to round off the financing purpose. The subordination also ensures that granting the convertible loan does not constitute a credit transaction requiring a licence within the meaning of banking supervisory law.

3. Formal aspects

To carry out the conversion, the borrower requires company shares that it can dispose of for transfer to the borrower. These can be shares already existing under company law or new shares to be created. New shares can only be created (besides the division of shares) through capital increase measures. To this end, authorized capital under company law can be used, or the company’s share capital needs to be increased.

The capital increase may constitute an amendment to the articles of association. In the case of a GmbH, the resolution must be notarized (§ 53 GmbHG – German limited liability company Act); in the case of a public limited company, a notarial record must be made of the corresponding resolution of the general meeting (Section 181 AktG – German stock corporation Act).

However, these forms only relate to the implementation channel. Conversion loan agreements were previously concluded in written form.

In an insolvency law matter, the Higher Regional Court of Zweibrücken, in its decision of 17.05.2022, file number 8 U 30/19, surprisingly ruled that a convertible loan agreement can only be effectively concluded with the involvement of a notary if the agreement already contains takeover declarations for the new company shares to be created by previously non-participating shareholders. The takeover declarations must be notarized (§ 55 GmbHG). In response to this ruling, a lively discussion has arisen in the notarial and legal literature regarding what form (notarization and/or certification) must be observed when making convertible loan agreements. The Federal Court of Justice has not yet ruled on this, so there is a lack of clarity from the highest court. In any case, the nullity of the contract must be avoided under all circumstances for all parties involved. A cure ex-post with effect ex tunc is not possible. The investor is threatened with the loss of (future) participation in the company. It is reduced to a claim for compensation by the principles of unjust enrichment. The company or its management faces difficulties in a crisis or insolvency, as a subordination about the concession claim would not have been agreed upon. In this case, the company may have recourse to claims against the management (Section 15b InsO) that could destroy the company’s existence. In addition to the notarization requirement under § 55 GmbHG, the opinion of the notarization obligation is also represented in the literature concerning § 15 para. 4 GmbHG.

As the theoretical approaches represented are diverse in nature, it is strongly recommended in practice that convertible loan agreements should not be drafted and agreed upon without advice from an expert in German company law. In case of doubt, the agreement should be notarized to avoid any nasty surprises later on.

B Tax law update – Growth Opportunities Act 2024

The so-called  Wachstumschancengesetz (Growth Opportunities Act) was promulgated in the Federal Law Gazette on March 27, 2024. Although it did not meet the high expectations that were set for this tax-driven economic development law at the beginning of the legislative process, some changes were made to promote investment in Germany as a business location.

I. Strengthening internal financing

The Growth Opportunities Act temporarily improves the possibility of internal financing for companies or investments through the following measures:

  • For movable fixed assets acquired or manufactured between 1.4.2024 and 1.1.2025, a declining balance depreciation of up to 20% and a straight-line depreciation for a maximum of 2 times will be introduced.
  • The economic effect of the special depreciation of investments in movable assets provided for in Section 7g EstG (German income tax Act) is doubled from 20% to 40%.
  • Introduction of a declining balance depreciation rate of 5% for residential buildings if construction begins after 30.9.2023 and before 1.10.2029 (or if the legally binding acquisition contract is concluded after 30.9.2023 and before 1.10.2029). This possibility represents significant support for investments in residential rental properties.
  • The application period for the regulation on additional special depreciation of a further 5% for rental housing provided for in Section 7b EStG has been extended and is favoured in the application conditions.

II. Corporation tax option for partnerships, Section 1a KStG (German corporate tax Act)

Corporations in Germany are taxed at a uniform rate of 15% corporation tax. In contrast, the income of partnerships is taxed transparently according to the level of taxation of the partners involved in the company and individually for each partner. Trade tax is also incurred separately at company level for both companies. As partners’ income in partnerships is taxed at a progressive tax rate of 14% to a maximum of 45%, the flat-rate corporation tax can now be applied to partnerships and registered civil law companies and not only to commercial partnerships, thereby deferring progressive taxation.

III. E-bill replaces paper invoices.

In addition to the aforementioned favourable regulations, another element of the Growth Opportunities Act that warrants a mention is the introduction of mandatory e-invoicing in the B2B sector in Germany from 01.01.2025. As from this date, companies will only be required to use invoices in a standardized data format for tax purposes. The era of paper invoices is coming to an end. Small and medium-sized companies are urgently advised to clarify the technical requirements beforehand.

C. Act on the Modernization of Partnership Law (MoPeG)

The Act on the Modernization of Partnership Law (MoPeG) came into force on 01.01.2024. It codifies decades of case law and the corresponding specialist literature, abolishes the joint and several ownership principles that have characterized partnership law for over a century, and finally introduces the legal capacity of civil law partnerships if they are entered into the newly created GbR register. The changes are substantial and far-reaching, so the MoPeG is being referred to as the reform of the century in partnership law.

While commercial partnerships were previously required to register in the commercial register, civil law partnerships (BGB-Gesellschaft or GbR) can now also register. A partnership must register if it acquires a registered right (e.g., a property). This creates clarity and security in legal transactions. By registering, registered GbRs (eGbRs) can now also be parties to a conversion process in accordance with the UmwG (German reorganization Act).

The above serves only as an informative introduction to the topic. As the effects of the reform on the articles of association of partnerships are manifold, and the tax consequences can be significant in individual cases, I recommend you seek expert advice to check whether the changes introduced by the MoPeG are relevant to your company.

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