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Frequently Asked Questions

Germany: What are the most material terms I should pay attention to when negotiating a Convertible Loan Agreement?

Convertible loans are a very important financing tool in German startup land, especially in the early stages, since they are fast and usually cheaper to implement when it comes to time and costs. However, the importance of negotiating good terms for a convertible loan agreement should not be underestimated.

When negotiating a convertible loan agreement, the following aspects should be discussed and negotiated (this also being a good time for involving your lawyers):

  • Loan amount(s)
  • Distribution of the loan: Pay-out in one or several tranches. In case the payments are linked to the achievement of milestones, the milestones should on the one hand be worded in such a way that they can be objectively verified and on the other hand do not deprive the startup borrower of the necessary flexibility in the further development of the business.
  • Loan utilization and purpose: Shall there be specifications and limitations for the use of the loan amount? The lender will often try to limit the risk of a distribution or other payout of funds to the existing shareholders.
  • Interest: How will the loan interest be structured (interest rate, calculation method and, as the case may be, provisions regarding the capitalization of interest)? Shall interest accrue in any case or only if the loan is not converted within a certain period after being granted? Note that from an economic (dilution) perspective the discount and, in particular, the cap on the conversion price (if any) are usually more important than the interest rate.
  • Security: Usually, the loan under the convertible loan agreement is unsecured.
  • Term of the loan (maturity): Is the term appropriate considering the purpose of the loan (merely a bridge loan or loan with longer term financing character)?
  • Subordination: In any case, the convertible loan agreement should contain a properly worded qualified subordination clause (to avoid cases of insolvency).
  • Conversion event: The loan agreement should precisely specify when the lender shall be entitled or even obliged to convert the loan. A convertible loan typically converts upon the next (qualified) financing round, the expiration of the term of the convertible loan (maturity date conversion) and, sometimes, an exit before the expiration of the term. A financing round is deemed "qualified" if a certain agreed threshold of fresh money to be invested is reached.
  • Conversion mechanism: The loan agreement should precisely specify which conversion amount may be converted at which conversion price. This constitutes the basis for the determination of the number of new shares to be issued to the lender and usually differs according to the relevant conversion event.
  • Information and other governance rights of the lender: While limited information rights are oftentimes granted to lenders, governance rights are a rare exception.

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