Market Overview

2024 in review and trends

After a second year of recession in Germany, M&A activity and, accordingly, the number of acquisition financings remained relatively stable compared to 2023, but were significantly lower than the record deal numbers seen in the years before. The second half of 2024 saw a moderate upshift in M&A activity and related acquisition financings, which is continuing into 2025.

Several (macro)economic and geopolitical challenges and uncertainties – such as high energy, incidental wage and regulatory costs, the ongoing war in Ukraine and the massive trade and foreign policy shifts initiated by the new US administration – are leading to low productivity and weak economic growth in Germany and a general need for a fundamental recalibration of the German industrial model. This backdrop is impacting the German M&A market which, as a consequence, is still subject to high and continuous volatility. However, the German mid-market in particular has slowly started to adapt to an elevated interest rate environment and higher energy prices, while inflationary pressures have eased over the last year and interest rates have started to fall, although slower than expected.

Meanwhile, lenders have remained selective and focused on high-quality assets, attractive sectors and strong credit. Sectors such as software and technology as well as healthcare and life sciences have proven to be resilient, while transactions in the automotive, industrial products and manufacturing sectors – which are more heavily affected by the broader economic and political challenges – saw a decline in 2024.

Although narrowing, still significant gaps in the valuation expectations of sellers and buyers continued to drag down M&A activity in Germany in 2024, as in the previous year. In order to bridge the valuation gap and a concomitant financing gap, market participants often use vendor financing as an alternative form of financing.

Bank and private credit markets

The introduction of the UCITS V Implementation Act in March 2016 – which amended the German Capital Investment Code (Kapitalanlagegesetzbuch) and the German Banking Act (Kreditwesengesetz) to allow certain alternative investment funds to originate loans to German borrowers – has fundamentally changed the lending market in Germany. In particular, the mid-market segment of the German leveraged acquisition finance market has gradually shifted from a traditional bank market to a market dominated by alternative credit providers, who now consistently provide more than half the financings in this market segment. Direct lending typically offers certain advantages over traditional bank lending, such as no syndication risk, a more flexible and less restrictive covenant regime (including higher leverage ratios) and greater execution speed, albeit usually at a higher price. However, the differences have become somewhat blurred, with some alternative credit providers also setting up funds with senior lending strategies offering pricings comparable to bank financings, while some banks have also established direct lending funds to compete in the direct lending segment.

This trend, bolstering the private credit market at the expense of the bank market, is expected to continue, as many German banks tightened their lending guidelines in 2024 due to decreased risk tolerance and increased credit risk. A further tightening is expected in 2025 as a result of regulatory requirements, in particular the implementation of the reforms to Basel III, which will lead to an increase of risk-weighted assets. It remains to be seen how this will affect acquisition finance in the German small- and lower mid-cap segment, which is still dominated by the domestic banking sector and where long-standing relationships and trust in traditional banks have so far mostly kept direct lending alternatives at bay.

At the upper end of the market, syndicated bank lending is still the primary source for acquisition finance, although in a few instances alternative credit providers have demonstrated their ability to provide large ticket sizes, either together with other direct lenders or even as sole lenders.

Structures and Documentation

Senior/super senior financing and alternative/subordinated financing structures

Both bank financings and unitranche financings provided by debt funds are usually structured as senior financings with first lien security. Given that debt funds only provide term facilities, the general and working capital financing requirements of the target group are met either by a super senior revolving credit facility or by one or more bilateral revolving credit facilities in these acquisition financings.

The super senior revolving credit facility is typically documented as one of the facilities provided under the same facilities agreement as the unitranche financing, and is secured on a pari passu basis with the unitranche financing but is contractually afforded super senior status. This means that the super senior lender(s) will receive payment in priority to the senior lender(s) under the unitranche financing, pursuant to the enforcement proceeds waterfall provisions in the intercreditor agreement. Bilateral revolving credit facilities are documented and secured separately, usually on the bank’s own in-house form for bilateral revolving credit facility agreements and under the bank’s standard terms and conditions, and require appropriate carve-outs in the documentation and the security package for the unitranche financing.

In order to economically incentivise banks to provide a super senior revolving credit facility in acquisition financings provided by debt funds, banks are sometimes also offered a super senior term facility in a so-called “first out/last out” structure. However, these structures have become less common recently as risk appetite has declined.

In certain situations, alternative or subordinated financing structures such as mezzanine, second lien or PIK financings are used as part of the overall acquisition financing. These alternative or subordinated financing structures may also consist of or comprise vendor finance, as described in more detail under Vendor Finance below.

Key documentation

Acquisition financings in Germany are typically documented by a facilities agreement, an intercreditor agreement or subordination agreement, and security agreements for each asset class over which security is being granted.

Given the international lender/investor base for this type of financing, facilities agreements and intercreditor agreements for acquisition financings in the mid-market segment are usually drafted in English and based on Loan Market Association (LMA) forms, adjusted to German law and further adapted to reflect the specifics of the transaction and the requirements of the target group’s business. In the case of sponsor-backed transactions, agreed sponsor precedents are also frequently used, which provide for more borrower-friendly terms than the customary LMA template. In line with this approach, the borrower’s counsel also usually drafts the facilities agreement and the intercreditor agreement in these transactions.

In the German small- and lower mid-cap segment, facilities agreements and intercreditor/subordination agreements are often in the German language and, while generally following the structure of LMA facilities agreements, are in abbreviated form. The documentation is usually drafted by the lender’s counsel in this segment.

The drafting dynamic may also shift in distressed or special situations where interested lenders will be fewer and therefore have a stronger bargaining position, to ensure that their counsel takes the lead on tighter and more prescriptive documentation.

Unless the acquisition financing is for a strategic buyer who obtains financing for the acquisition on the back of the consolidated balance sheet of the existing group, the closing security package of the acquisition financing for a German target usually consists of three items.

• Share pledges: a typical acquisition structure consists of two German limited liability companies where the holding company (“HoldCo”) grants a pledge over its shares in the acquisition company (“AcquiCo”), ensuring a single point of enforcement for the lenders at this level as the lenders’ most important security. As it is possible under German law to grant pledges over future rights, the AcquiCo will also grant a pledge over the shares in the target, which it will acquire upon completion of the acquisition.
• Account pledges: in addition, both the HoldCo and the AcquiCo have to grant pledges over their bank accounts, which require notice to the account bank(s) to be valid.
• Security assignment of receivables: the HoldCo and the AcquiCo also have to grant security over their receivables under shareholder/intra-group loans by way of security assignment, and the AcquiCo customarily has to assign its potential receivables against the vendor under the acquisition agreement, against due diligence report providers, and against insurers (in particular, under any warranty and indemnity insurance obtained for the acquisition, if applicable) as security.

The security package to be granted by the target group after completion of the acquisition depends on various factors, such as the lenders’ risk appetite, the potential default risks and the asset heaviness of the target group. It can range from just strategic security (ie, pledges over the shares in material subsidiaries, account pledges by material subsidiaries and security assignments of intra-group loans by material subsidiaries) to security over all (or substantially all) assets. German law does not provide for a security interest in the form of a floating or business charge creating security over all present and future assets of a business, as found in other jurisdictions. However, under German law, the individual security rights in the form of pledges, security assignments and transfers, as well as land charges and mortgages and the legal techniques developed in practice, achieve a similar result for secured lenders.

As Germany is a developed market for acquisition financings, German security agreements have relatively standardised terms, including customary protections by using so-called “limitation language” to avoid a breach of German capital maintenance rules when upstream or cross-stream guarantees and security are granted. Certain contractual techniques required in financings with multiple (or potentially multiple) lenders – such as parallel debt obligations to a security agent – are also well established. Therefore, the negotiation of the terms of security agreements is usually limited, and instead the focus of negotiation tends to be on the scope of the security package and general structural considerations at the outset.

Vendor Finance

As previously mentioned under 2024 in review and trends, one mechanism for bridging the gap between the purchase price expectations of sellers and buyers has been “vendor finance”. A vendor loan is provided by a seller by agreeing that the payment of a portion of the purchase price be deferred until a certain date or the occurrence of a certain event in the future, such as a refinancing of the buyer or the buyer’s exit of the target.

Purposes of vendor finance

Vendor finance can serve several purposes.

• Quality assurance: as a form of re-investment by the seller, the seller continues to maintain “skin in the game”, thereby signalling to a buyer confidence in the quality of the asset being sold.
• Re-investment instrument: by accepting a vendor loan, the buyer can also offer the seller the opportunity to remain invested in the business, to earn an attractive return and to be ultimately paid by the business, whose risk profile the seller is familiar with, through a relatively straightforward instrument that can serve as an alternative to a roll-over or equity re-investment of the seller.
• Bridge financing: as bridge financing, a vendor loan can enable an expedited consummation of an acquisition while the buyer is obtaining acquisition finance in the bank or private credit markets.
• Closing the financing gap: in the current market environment, vendor finance is also increasingly being used to close any gap in the financing available to buyers to fund the purchase price the seller is asking for.

Regulatory considerations

In Germany, the granting of loans is, in principle, subject to a banking licence requirement. However, several exceptions typically apply to vendor loans.

• According to the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin), a seller who provides credit for its own sales by deferring the purchase price does not conduct lending business, even if the parties agree that interest will accrue on the deferred purchase price. Only if the claim for payment of the deferred purchase price is rescheduled as a loan by the seller and the purchaser can lending business be conducted in a form that is relevant from a banking regulatory perspective.
• Also exempted from banking licence requirements are loans that are more equity-like and subject to qualified subordination provisions. Such subordination provisions do not only provide for a subordination of the loan in the insolvency or liquidation of the borrower but also prohibit the lender from requesting payment if and to the extent payment would give cause to the commencement of insolvency proceedings over the assets of the borrower. Often, vendor loan agreements contain qualified subordination provisions, given that they are usually structured as subordinated financing.

Customary terms of vendor finance, and structural considerations

While there are no standardised terms for vendor loan agreements, the requirements of a senior acquisition financing of the buyer have certain customary implications for the structure and the terms of vendor loan arrangements in situations where vendor finance is not provided as a bridge to third-party acquisition financing.

Subordination

As acquisition financing obtained in the bank or private credit markets is structured as senior financing, vendor finance will always be subordinated in these circumstances. Subordination is usually achieved through an intercreditor agreement or subordination agreement with the lenders under the senior financing. If the amount of the vendor loan is relatively small, the lenders under the senior financing may also agree to rely only on qualified subordination provisions or on subordination provisions in the form of a contract for the benefit of third parties, pursuant to Section 328 paragraph 1 of the German Civil Code (Bürgerliches Gesetzbuch) in the vendor loan agreement itself.

However, in more complex financing structures where robust enforcement mechanisms are prioritised, senior lenders will also strive for a structural subordination of vendor finance through a “debt push-up” of the vendor loan to a holding entity in the buyer’s acquisition structure. This is usually achieved by the holding entity assuming the payment obligation of the buyer, and by the seller consenting to such assumption of debt and the corresponding release of the buyer from its payment obligation.

No security

In contrast to circumstances where vendor finance is used as bridge financing, a vendor loan is usually unsecured, because substantially all of the assets of the buyer and the target group are being used to secure the senior ranking acquisition financing. Second lien security for the benefit of the seller is usually not accepted, as this would prevent the granting of further prior-ranking security required for further add-on financings or in the event of a restructuring of the senior financing. Only in acquisition structures where the vendor loan is pushed up to a holding entity in the buyer’s acquisition structure may first-ranking security over shares be granted at a level not interfering with the senior financing, and subject to certain restrictions on enforcement and standstill periods in the intercreditor agreement with the senior lenders.

Limited covenants

Vendor loan arrangements usually contain no or only limited covenants, even for more sizeable vendor loans, and in particular where they are part of a more complex financing structure with senior acquisition financing obtained by the buyer in the bank or private credit markets. Here, the seller typically piggybacks on the senior acquisition financing and relies on the protection provided by the covenants agreed between the buyer and the senior lenders, given that interests are largely aligned on the side of all the lenders to the acquisition structure.

For the borrower and for the senior lenders, it would also not be prudent to accept a separate extensive covenant regime in the subordinated vendor loan arrangements, which may not only increase the administrative burden on the borrower but may also render futile any waiver, consent or amendment requests to which the senior lenders consent if the seller refuses to consent thereto as well. In particular, this would put restructuring efforts at risk by giving a subordinated lender leverage over the buyer and the senior lenders. Separate covenants in a vendor loan agreement are therefore usually limited to covenants ensuring the priority of the vendor loan over shareholder loans in the acquisition structure, preventing dividend and other payments or value transfers by the borrower and the target group to the sponsor and its affiliates, and so-called “anti-layering covenants”, prohibiting the incurrence of further subordinated debt layered between the senior acquisition financing and the subordinated vendor loan.

Pay-in-kind (PIK) interest

The subordination of vendor finance has implications for the payment of interest on vendor loans. Usually, the terms of the senior acquisition financing will restrict the borrower’s ability to make debt service payments on vendor loans. Due to these restrictions, and also to provide for risk-adjusted pricing for granted vendor finance, vendor loan agreements frequently provide for PIK arrangements, pursuant to which accrued interest is capitalised and added to the principal of the vendor loan. However, these arrangements need to be structured in such a way as to comply with the prohibition of compound interest in Section 248 paragraph 1 of the German Civil Code (Bürgerliches Gesetzbuch), which does not allow an automatic capitalisation of accrued interest but requires an agreement after the accrued interest has become due. In practice, this is resolved by a PIK toggle provision in the vendor loan agreement, which can be exercised (and needs to be exercised if payment in cash is not possible) by the borrower at its sole discretion once accrued interest has become due.

Unrestricted voluntary prepayments

Unlike acquisition finance obtained in the private credit market, call protections that prohibit a prepayment of a vendor loan or make its prepayment subject to a prepayment fee or penalty, in order to ensure a specific minimum return for the seller on the financing provided, are not commonly encountered features in vendor finance arrangements. The purchaser is typically entitled to prepay a vendor loan, in whole or in part, at any time without any prepayment fee or penalty. In certain cases, the purchaser is even incentivised to achieve an early refinancing of the financing structure (including the vendor loan) through incremental increases of the applicable interest rate over the term of the vendor loan.

While vendor finance will continue to be used as an instrument of acquisition finance because of the various objectives it can achieve, it remains to be seen whether a continued narrowing of the gap between the purchase price expectations of sellers and buyers will also result in vendor finance featuring less frequently in acquisition financings for German targets.

Conclusion and Outlook

From Q2/2025, Germany has a new governing coalition between conservative Christian Democrats and centre-left Social Democrats, which prematurely replaced the hapless coalition between Social Democrats, Greens and pro-business Free Democrats that had been marred by infighting. In response to major geopolitical shifts, Germany also recently loosened its constitutional “debt brake” (which had led to crippling underinvestment in defence and infrastructure) to allow for, in principle, unlimited defence spending as well as major spending on infrastructure.

It is not yet known how the new governing coalition and the expected massive increase in public spending will affect the general economic climate in Germany, and its effect on inflation and the interest rate environment remains unclear – all factors that also impact M&A activity. Even if the expected changes in the general political framework have a positive impact, unrelenting geopolitical volatility continues to present serious headwinds to the German industrial model.

Nevertheless, there are signs of an increase in M&A and acquisition financing activity. The industry has long awaited a surge in deal making, and this expectation now finally seems likely to materialise in 2025. Market participants have somewhat adapted to certain challenges of past years (such as the higher interest rate environment), and some further interest rate cuts are expected, all leading to a narrowing of the valuation gap between sellers and buyers that has impacted M&A activity since the sudden increase of interest rates in 2022.

While the focus of investors and lenders on certain sectors is expected to continue, an increase of acquisitions of distressed assets from sectors and businesses hardest hit by the (macro)economic shifts and the ongoing economic uncertainty also seems possible.