A broad and primarily domestic consortium comprising both old and new investors – spearheaded by Innovation Park Artificial Intelligence (IPAI), Bosch Ventures, SAP, and Lidl and Kaufland owner Schwarz Group – has provided more than USD500 million in a Series B funding for Germany’s most prominent developer of generative AI, Aleph Alpha. While this represents the growth market’s most sizeable single fundraising event in Germany in 2023, there is still a considerable gap to the funding received by US competitors such as OpenAI (USD10 billion) or Anthropic (USD7 billion) during the same period.

Enpal, a German photovoltaic leasing firm, secured EUR215 million through a Series D funding round in January 2023. This raised the valuation of the Berlin-based company to approximately EUR2.2 billion. Other sectors with significant funding activity include biotech (ITM, Patient21), ESG (1Komma5), and defence/space (Helsing, Isar Aerospace).

One of the notable IPOs in Q4 2023 was German sandal manufacturer Birkenstock’s listing debut on the New York Stock Exchange on 11 October 2023. Previously acquired by L Catterton (the largest global private equity firm focused on consumer products) in 2021, Birkenstock’s market cap amounted to USD8.6 billion on the day of its IPO, in a transaction widely viewed as disappointing – given that the share price dipped more than 12% on the first day of trading.

The broader trend for challenged valuations is reflected in both financing round valuations and liquidity events. An uptick in start-up insolvencies, a reduction in the number of trade sales, and significantly fewer IPOs fit the picture of strained market conditions.

When comparing the venture capital (VC) market in 2023 to 2021’s more favourable conditions, the contrast is striking. Whereas 2021 boasted a record-breaking 1,426 VC financing rounds, the number for 2023 was down by almost a third (1,020 rounds) and the total funding amount declined by more than 50% (EUR15 billion in 2021 vs EUR7.3 billion in 2023). At the same time, numerous growth companies are facing liquidity constraints, driving some start-ups into insolvency in 2023 – for example, the digital forwarding start-up Instafreight and the fintechs Elinvar or Xpay, which have raised a combined sum of EUR175 million in equity financing in previous years. Moreover, VC firms are moving back the curve in the maturity cycle, increasing their allocations to early stage companies, such as Patient21 and DeepDrive.

Geographically, Berlin led with a total of 286 venture-backed financing rounds, significantly surpassing both Bavaria with 172 transactions and North Rhine-Westphalia with 113 transactions.

With Berlin start-ups raising some EUR2.4 billion, conditions are a far cry from the previous year’s total of EUR4.9 billion. Conversely, start-ups in Bavaria and Baden-Württemberg managed to expand their relative presence geographically – a potential shift towards a more equal distribution of VC funding within the country.

Alternative Financing Structures

The decline in valuations has entailed a surge in demand for alternative financing solutions. Start-ups and growth companies are now forced to contemplate non-dilutive financing options such as term loans or revenue-sharing concepts.

By way of example, the Berlin-based blockchain start-up Jolocom used a revenue-sharing concept for financing purposes. Similarly, venture capitalists’ focus has on many occasions been tied up by bridge rounds to bolster existing portfolio companies and to avert (to the extent possible) deep value depreciations. Investment rounds with reputable new lead investors were outside the norm.

Investor-Friendly Deal Terms

Additionally, reduced market activity compelled companies to concede to more investor-friendly deal terms. These include founder lock-ups, vesting, and liquidation preferences, as further outlined in 3.5 Investor Safeguards and 5.2 Securities).

Equity funding in German growth companies heavily favoured software and analytics in 2023, with start-ups in the sector securing some EUR2 billion. Unsurprisingly, this sector saw the highest number of financing rounds and exits in the past 12 months. In addition, e-commerce ventures secured a total of EUR633 million, highlighting the sector’s resilience and growth potential despite competitive challenges.

Amid the German energy transition fuelled by the Russo-Ukrainian conflict, growth companies in the energy/cleantech sector attracted EUR998 million in a relatively low number of financing rounds.

Although significant market focus continues to be directed towards the fintech/insurtech space, only EUR499 million has been raised therein. This indicates that businesses within this space are still encountering challenges when implementing their business models.

Lastly, climate tech start-ups attracted EUR154 million, underlining the growing focus of investors on combating climate change and promoting sustainability. Meanwhile, media and entertainment start-ups were only able to raise about 10% as much funding as they did in 2022.

Germany is home to some 110 active VC funds, whereas neighbouring Luxembourg is particularly popular with many sizeable Germany-focused VC investors, owing to its investor-friendly ecosystem, flexible corporate law and robust regulatory framework. When domiciled within Germany, the asset-managing GmbH & Co KG (a partnership with a limited liability company as the general partner (GP)) is a preferred structure, owing to its fiscal benefits – in particular, its tax transparency and exemption from trade tax obligations.

Structure

When structuring funds as a GmbH & Co KG, the separation of management and fund is mandatory. The initiators, together with the investors, participate as limited partners (LPs) without any obligations to make additional payments (Nachschusspflicht).

The GmbH serving as the fund’s GP is typically excluded from owning fund assets and its involvement in fund management activities is limited for tax purposes. Instead, fund management responsibilities (day-to-day administration) are assigned to a managing LP – a management limited liability company (Kapitalverwaltungsgesellschaft, or KVG) (the “Managing LP”).

Investors often receive co-decision rights through an investor advisory board, selected by the Managing LP from among significant investors. This advisory board typically oversees, among other things, deviations from predefined investment criteria and extensions to investment timelines.

An investment committee (IC) leads the decision-making process, using various approval methods such as unanimous voting or a points-based system to ensure alignment with the firm’s investment objectives. This makes the IC the actual investment manager of the fund.

Standard Documentation

Limited partnership agreements cover key areas such as capital contributions, profit distributions, investment strategies, time horizons such as investment and liquidation periods, and governance (including GP and Managing LP rights). The terms may be tailored to the specific needs of LPs through side letters, which qualify as amendments to the limited partnership agreement and therefore require the consent of all shareholders.

Management agreements define the roles, responsibilities, and compensation structure (eg, management fees) of the fund’s management team.

The German Standard Setting Institute (GESSI) – a collaborative initiative between Business Angels Germany e.V. and the German Startups Association (Bundesverband Deutsche Startups e.V.) – provides (registered) start-ups, business angels, and investors with expertly crafted templates that over convertible loans, term sheets, and financing round agreements, among other things.

The internationally established “2 and 20” fee model constitutes the default within the German VC industry.

Management Fees and Carried Interest

The management fee is an annual fee paid by the fund to the Managing LP for the purpose of covering administrative expenses and typically ranges from 2–2.5% of committed capital. It is charged every year that the fund is in operation.

Carried interest is the percentage of profits of an investment (typically 20%) allocable to the fund’s Managing LP. The Managing LP is entitled to carried interest once the fund has returned the invested capital and a minimum annually compounding interest rate (typically 6–8% per annum – the so-called hurdle rate) (“distribution waterfall”). However, if carried interest is paid on a deal-by-deal basis or the Managing LP is otherwise entitled to advances on the carried interest, LPs typically demand so-called claw-back provisions to address timing disparities/true-ups – pursuant to which, carry beneficiaries are required to reimburse LPs if the funds received by the Managing LP exceed targeted returns.

In Germany, the regulatory framework for funds (including VC funds) is established by the German Investment Code (Kapitalanlagegesetzbuch, or KAGB). For an entity to be recognised as an investment fund under the KAGB, it must meet certain structural criteria and be overseen by a licensed management company.

Investment funds in Germany are categorised into Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs), which encompass all non-UCITS investment entities. VC funds typically fall under the category of Special-AIFs, which typically are closed-end funds accessible only to professional and semi-professional investors, excluding retail investors.

The Managing LP (in the form of a KVG) requires authorisation from the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, or “BaFin”) to operate. The KAGB provides for simplified regulation for “small” AIF-KVGs managing Special-AIFs below certain asset management thresholds (which includes the fund structures relevant for VC investments). A “small” AIF-KVG manages Special-AIFs with assets not exceeding either EUR100million (including assets acquired through the use of leverage) or EUR500 million without leverage and if there are no redemption rights for investors within five years of making the first investment. VC-fund KVGs tend to qualify for the exemption, primarily owing to their non-reliance on leverage and their average fund size not exceeding the EUR100 million threshold (thus staying beneath the EUR500 million cap).

Such “small” AIF-KVGs are subject only to registration, reporting, and specific financial statement obligations, as well as audit requirements. Only AIFs structured as limited liability entities or partnerships, where the general partner possesses limited liability (eg, GmbH, AG, GmbH & Co KG), are eligible for management under this framework.

Government-Backed VC Funds

Government-backed VC funds receive significant public attention in Germany. The Growth Fund Germany (Wachstumsfonds Deutschland), which achieved its EUR1 billion target volume in 2023, is a fund-of-fund that invests in European VC funds that mainly invest in German later-stage start-ups. It is one of the largest German government-backed VC funds, with the government providing between EUR350 million, alongside institutional investors such as Allianz, Signal Iduna, Munich Re, and BlackRock. It is managed by KfW Capital, the investment subsidiary of the government-affiliated KfW development bank.

Another government-backed investment vehicle is Coparion, with the government having invested EUR275 million through the European Recovery Programme (ERP) Special Fund (mandated by the German Federal Ministry for Economic Affairs and Climate Action (Bundesministerium für Wirtschaft und Klimaschutz, or BMWK)) and the KfW bank. Coparion focuses on Series A, B and C financing rounds with a respective financing volume of between EUR500,000 and EUR3 million, investing up to a total of EUR10 million per start-up. Coparion invests as a co-investor under the same conditions and usually with the same volume as a private investor (eg, a business angel or VC fund).

Furthermore, there is High-Tech-Gründerfonds. Unlike Coparion, it independently provides seed financing and is financed not only by the BMWK and KfW bank but also by a consortium of German private corporations. It manages approximately EUR1.4 billion across its four funds and focuses on tech start-ups with substantial growth potential.

Impact Investing and Corporate VC

Impact investing is gaining prominence within Germany’s VC landscape, with a notable emphasis on decarbonization. Cleantech/energy is a key area for impact funds. Examples include BonVenture in Munich, which supports social enterprises and start-ups across sectors like education and renewable energy across Germany and Europe. Furthermore the World Fund, headquartered in Berlin, invests in energy, food, manufacturing, buildings and mobility start-ups while Berlin-based Planet A focuses on green-tech start-ups.

Corporate VC plays a prominent role in Germany’s investment landscape and DAX-listed companies like Allianz X, SAP Sapphire and Deutsche Börse VC entertain notable, sector-focused VC programs.

Fund-of-Funds

A discernible trend towards increased fragmentation in private markets investments ‒ particularly within VC funds ‒ has led to a notable recent upswing in fund-of-funds activity. This development derives from an increasing number of investors focusing on niche industries or emerging technologies, thereby fostering a broader diversification across the VC landscape. The largest fund-of-funds operator in Germany is KfW Capital, with a volume of EUR1 billion. KfW Capital invests across all phases and sectors in VC and venture debt funds with a focus on Germany.

Legal due diligence is usually conducted by the lead investor and includes a review of the company’s capitalisation table and key corporate documents. The process focuses on material terms and encompasses tax considerations, prior financing arrangements, contractual foundations for revenues, liabilities, employment terms, ongoing legal disputes, and IP rights. Financial due diligence centers on validating the completeness and accuracy of the company’s assumptions underlying its business plan, books and records, and financial statements. Business due diligence explores the overarching economic outlook of the target company, examining market trends, industry dynamics, growth opportunities, and revenue forecasts.

Typically, the founders assume personal liability for the representations and warranties made in transaction agreements. This liability is generally limited to the lower of:

• the amount invested in the financing round; and
• a cap equal to one to three times their annual salary.

Representations tend to be subject to further restrictions such as “tipping baskets”. Unless an entire data room is deemed disclosed against the representations and warranties (which is market standard in German M&A practice), the company will table exceptions in a disclosure schedule, underpinning the critical role of management in the due diligence process.

Timeline

It typically takes between three and six months to raise a Series B round and the timeline is affected by factors such as complexity of the business model, revenue potential, investor interest, legal set-up and macroeconomic conditions. In general, a preparation and planning phase (centered around Key Performance Indicators and financial information) and the negotiation of financing terms result in the entry into a non-binding term sheet or memorandum of understanding (MoU). Investors will conduct due diligence while, concurrently, long-form documentation (eg, subscription and shareholders agreements) is negotiated.

Relationship Between the Parties

The existing investors’ role in a new financing round is typically limited in that they do not actively participate in nor necessarily benefit from the results of the due diligence. That said, all investors’ consents are typically required in order to amend the shareholders’ agreement, which is the central document in most financing transactions.

In terms of process, existing (and, in early-stage financings, even all) investors may share legal counsel to streamline and accelerate negotiations. In more sizeable rounds, however, it is also standard market practice to carefully review the need/desire for separate legal counsel in light of prospectively (diverging) interests. Cost of counsel is less frequently charged to the company than is the case in many jurisdictions.

Governance discussions typically evolve around exit rights and reserved matters/veto rights for commercially relevant measures, such as capital increases or amendments to the articles of association (AoAs). With deviations from the “one share, one vote” principle practically rarely relevant, the statutory default super-majority requirement of 75% for significant measures such as a new financing round typically serves as an inflection point for numerous discussions.

Apart from common stock, typically earmarked for founders and initial investors, the following instruments are frequently observed in German VC transactions.

• Convertible loans serve as the primary “pre-seed” type of funding instrument in the German VC market. SAFE (Simple Agreement for Future Equity) agreements (a financing instrument popularised by incubator Y Combinator in the USA) do not offer investors any significant advantages over convertible loans and encounter legal challenges such as uncertainty associated with the issuance of “naked warrants” in a German stock corporation (Aktiengesellschaft, or AG)/European company (Societas Europaea, or SE) and unviability of an “automatic” conversion ‒ given that capital increases are not actioned by the management but require the explicit consent of the company’s shareholders, manifested through a formal resolution that cannot be addressed in a straightforward manner. However, as founders may favour SAFE agreements over convertibles owing to the absence of repayment claims, accruing interest, etc, practical needs may ultimately outweigh current lingering legal uncertainty.
• Convertible loan agreements do not require notarisation if they are concluded not only by the lender and the company – represented by a managing director ‒ but also by the shareholders. In contrast, if the convertible loan agreements have been concluded only by the lender and the company (but without the shareholders), then these agreements require a notarised shareholders’ resolution authorising the managing director, as well as the corresponding registration of this authorisation resolution with the Commercial Register. This requirement arises in case lenders are subject to mandatory conversion conditions or must comply with shareholders’ agreements setting out according obligations (eg, drag-along rights).
• Preferred stock is a form of equity that includes specific rights or privileges not afforded to common stockholders. In Germany, (non-participating) liquidation preferences and weighted-average anti-dilution provisions are mostly negotiated as a means of downside protection, while cumulative dividends are typically not addressed.
• Multiple voting shares (so-called “founders’ shares/dual-class shares”) are equity shares with voting rights of up to 10:1, which were introduced by the Future Financing Act (Zukunftsfinanzierungsgesetz). They are intended to help founders retain their influence on the company despite raising capital.
• Virtual (employee) stock option plans (VSOPs), which embody cash-settled and contingent claims of the holder against the company, are widely utilised in the German market. They are considered more simple and flexible (and may entail tax benefits) when compared with physically settled stock options or shares held in escrow/subject to reverse vesting conditions. Restricted Stock Unit (RSU) agreements, performance shares and other instruments are less frequently encountered – although German corporate law permits significant flexibility in a GmbH.

Although there are no universally accepted standard documents for financing rounds in Germany, the most frequently observed core documents include the following.

• Investment-and-shareholders’ agreement (Beteiligungs-und-Gesellschaftervereinbarung) – both agreements are either combined or concluded as two separate contracts. The investment agreement outlines the investment amount and corresponding ownership percentage for each investor in the financing round. It specifies the form and timing of fund disbursement to the company; additionally, milestone agreements may be established, linking the release of investment tranches to the achievement of specific goals by the company. Typically, the shareholders’ agreement covers governance matters (eg, board composition, shareholder majorities and exit rights (tag- and drag-along rights)). The investment-and-shareholders’ agreement, in addition to the obligation to carry out a capital increase, regularly includes provisions to share assignments, pre-emption rights, co-sale rights and obligations or vesting regulations; therefore, it necessitates notarisation, particularly in the case of start-ups operating as an Entrepreneurial Company (with limited liability) (Unternehmergesellschaft (haftungsbeschränkt), or UG) or GmbH.
• Articles of association – the independent regulatory content of the AoAs is limited. As all essential agreements between founding shareholders and VC investors are typically addressed in the investment-and-shareholders’ agreement, they remain a mandatory component of VC investment documentation. The AoAs are renegotiated and adopted in each financing round to align with the investor’s participation and to ensure consistency with the shareholders’ agreement. The resolution of the shareholders’ meeting to amend the AoAs must also be notarised.
• Corporate resolutions, which are necessary for capital increases and the exclusion of existing shareholders’ subscription rights, are resolved by the company and need to be notarised (Section 55 of the Act on Limited Liability Companies (Gesetz betreffend die Gesellschaften mit beschränkter Haftung, or GmbHG). The resolution requires a majority of 75% of the shareholders for a GmbH (75% of the capital represented for an AG).
• Ancillary documentation includes non-disclosure agreements and term sheets/MoUs. Typical contents of a term sheet are agreements on the investment amount, the valuation of the start-up, and investor rights (eg, veto rights and liquidation preference).

Statutory subscription rights entitle existing shareholders (by default) to subscribe for a pro rata number of newly issued shares in any capital increase. Additional anti-dilution protection ‒ notably, in a down-round scenario – is implemented by providing (additional) subscription/pre-emption rights within the shareholders’ agreement.

Around 50% of investors require anti-dilution clauses in early-stage investments. The most common form of anti-dilution protection is the weighted-average method, which calculates the subscription price in a subsequent down round as an average of the financing round the existing investor actually participated in and the valuation implied in the down round. Full-ratchet clauses, on the other hand, effectively ensure that investors maintain a relative shareholding equal to their initial investment value – irrespective of the valuation underlying the down round. Full ratchet protection tends to be “off market” and can only be secured in rare (distressed) circumstances. So-called “pay-to-play clauses”, which incentivise existing investors to participate in a new financing (down) round by granting them the economic rights, privileges, and obligations they agree to during the previous financing round, are less commonly used in Germany than is the case in the US market.

Liquidation preferences have evolved to become market standard and determine the order of payout in a liquidation event (or a deemed liquidation event, which typically includes exit scenarios). They entitle investors to receive a certain multiple (although the German market standard is 1x) of their investment or a specified preference amount before other shareholders receive any distributions. Remaining funds/assets are distributed proportionally ‒ ie, on a pro rata basis. This preference can be structured as participating in the “second step” pro rata distribution or non-participating, with the former being more frequently encountered as a compromise. Unlike the participating liquidation preference, the non-participating liquidation preference is not limited to hedging against the negative scenario of an exit below the expected value, but rather also serves to secure the investor a premium on his investment. Both participating and non-participating liquidation preference holders always have the option to receive the value on a per share “as converted basis” so that, in an upside scenario, pro rata allocation is the norm.

As start-ups are typically structured as GmbHs, the shareholders’ meeting holds the authority to issue binding directives to the company’s managing directors. The GmbH comes with no other statutorily mandatory bodies other than the shareholders’ meeting and its managing directors. On the other hand, certain transactions will require the approval of the shareholders’ meeting prior to execution ‒ whether by law, AoAs or, most notably, shareholders’ agreements. These reserved matters typically include amendments of the AoAs, alteration of the rights attached to or issuance of new shares/instruments, significant corporate transactions, and changes in the capital structure of the company.

Shareholders’ agreements often see rights to regular reporting that go beyond statutory information and inspection rights.

Fundamental guarantees granted to investors relating to existence, title, the absence of encumbrances and conflicts, etc, are all but ubiquitous in German market practice, In addition, business-related representations ‒ most notably, concerning the company’s financial statements/status and adequacy of IP assets – are increasingly frequent, particularly in late-stage financings. However, warranties do not extend to the entirety of the business plan, as inherent risks remain with the investor as part of a VC investment’s nature.

Investors generally confirm that:

• they are authorised to enter into the investment agreement and fulfil the associated obligations;
• they are accredited investors; and
• the execution and fulfilment of the agreement does not conflict with other obligations.

Additionally, a venture often commits to specific operational covenants, which may include obligations to:

• maintain adequate insurance coverage;
• comply with specific accounting principles; and
• adhere to predetermined financial ratios or liquidity levels.

They are often sought to address investors’ diligence findings.

By statutory default, legal consequences of a breach of representations and warranties amount to the restoration of the breached “contractual guarantee” and the payment of damages if restoration is impossible (in rem restitution, or Naturalrestitution). However, in many cases, immediate claims for monetary damages are excluded. The liability concept in an investment agreement will typically be limited to a cap and, besides the company, founders/key employees may stand behind the representations – typically within the confines of adequacy. Upon breach of a covenant, injunctions become relevant as an effective course of action against the defaulting contractual party. This which is the most relevant legal remedy relating to a shareholders’ agreement.

Among the most relevant government programmes directed at enhancing investments in German early-stage companies are the “INVEST – Venture Capital Grant”, the “Venture Tech Growth Financing” programme, and the ERP-EIF Facility.

INVEST – Venture Capital Grant

The BMWK supports investments by private investors in young innovative companies through grants for investors (acquisition grant of 25% of the invested amount for business angels). The investments can be made by natural persons or via an investment company. Natural persons can receive an exit grant if they sell their shares. The grant amounts to a flat rate of 25% of the capital gains realised and thus approximately covers the tax burden associated with the divestiture. The maximum eligible investment amount per investor is EUR500,000 per year. Per company, the upper limit is a maximum of EUR3 million per year for eligible investments.

To apply, start-ups may submit an online application to the Federal Office for Economic Affairs and Export Control (Bundesamt für Wirtschaft und Ausfuhrkontrolle, or BAFA), providing details such as evidence of innovation and company size, age, and legal structure. Upon approval of eligibility, BAFA issues an according certificate. The investor can then apply for funding via BAFA, prior to application of shares in the start-up or subscription for convertible bonds.

Venture Tech Growth Financing

The KfW’s “Venture Tech Growth Financing” programme supports emerging technology-oriented companies through funding provided by the German federal government (through the KfW banking group). The programme is part of the Tech Growth Fund initiative. Financing is exclusively facilitated through collaboration with professional, private credit, or venture debt providers. KfW participates under identical terms as the corresponding private lender, sharing the risk, which usually ranges between EUR0.5 to EUR125 million. The standard risk-sharing ratio between KfW and private lenders stands at 50:50.

ERP-EIF Facility

The ERP-EIF Facility is a partnership between the German federal government and the European Investment Fund (EIF), aimed at bolstering venture and growth capital financing – in particular, for high-tech growth companies in Germany. The facility’s funding has been successively increased and currently reaches a volume of up to EUR4.6 billion. With more than 4,000 investments in SMEs across Europe via its backed funds, the ERP-EIF Facility constitutes a significant component of the broader pan-European VC landscape.

Direct Investment

Shares held by individual shareholders as non-business assets (Privatvermögen)

Capital gains from the sale and other dispositions of shares that an individual shareholder holds as non-business assets (generally, participations below 1%) are generally subject to a 25% flat tax (plus 5.5% solidarity surcharge thereon, resulting in an aggregate withholding tax rate of 26.375% plus church tax, if applicable). Losses from the sale of such shares can only be used to offset capital gains from the disposal of shares during the same year or in subsequent years. The amount of the taxable capital gain from the sale is the difference between the proceeds from the sale and the cost of acquisition of the shares (including sale-related expenses).

Shares held as business assets (Betriebsvermögen)

In respect of gains on the disposal and other disposition of shares held by an individual or corporation as business assets, the taxation generally depends on whether the shareholder is a corporation, an individual or a partnership.

• For corporations, capital gains from the sale of shares are ‒ as a general rule and currently irrespective of any holding period or percentage level of participation – effectively 95% exempt from corporate income tax (including solidarity surcharge) and trade tax plus solidarity surcharge.
• For individuals, 60% of capital gains from the sale of shares are taxed at the individual income tax rate plus 5.5% solidarity surcharge (plus church tax, if applicable) on such income tax if the shares are held as business assets by an individual who is subject to unlimited tax liability in Germany.
• If the shareholder is a partnership, the individual income tax or corporate income tax is not levied at the level of the partnership, but at the level of the respective partner. The taxation of each partner depends on whether the partner is a corporation or an individual. Thus, (corporate) income tax (including solidarity surcharge) and – if applicable – church tax will be assessed and levied only at the level of the partners. Trade tax, however, is assessed and levied at the level of the partnership if the shares are attributable to a permanent establishment of a commercial business of the partnership in Germany. Generally, 60% of a capital gain attributable to an individual partner and 5% of a capital gain attributable to a corporate partner are taxable.

Foreign tax residents

Capital gains from the disposal by a shareholder who is not tax-resident in Germany are generally only taxable in Germany if the selling shareholder holds the shares through a permanent establishment or fixed place of business or as business assets for which a permanent representative is appointed in Germany. In such a case, the foregoing description for German tax-resident shareholders who hold their shares as business assets applies accordingly.

Interposition of funds

Typically, investments in growth and start-up companies are made in funds structured as partnerships, which tend to be tax-transparent structures in case of the fulfilment of certain criteria. Simply put, merely managing one’s own assets ‒ regardless of size ‒ is not considered a commercial activity. However, details are heavily disputed in practice and whether or not a tax transparency of the fund can be achieved requires a case-by-case analysis. If this is the case, owing to the tax transparency of the fund, the above-mentioned considerations regarding a direct investment in a portfolio company apply accordingly – ie, from the perspective of the investor, there is no difference compared to a direct investment. By contrast, if the fund qualifies as trading (gewerblich), the fund is subject to trade tax; the trade tax paid by the fund and attributable to the individual’s general profit share is completely or partially credited against the shareholder’s individual income tax in accordance with such lump-sum method.

Carried Interest

Carried interest received by VC/private equity fund initiators (typically, managing LPs) is, in the case of a tax-transparent fund, subject to the partial income method ‒ ie, only 60% is subject to tax at the marginal income tax rate of the carried interest participant. Political attempts to abolish this tax advantage for carried interest resulting from tax-transparent funds have been effectively resisted. It should, however, be noted that the tax treatment of the carried interest received by the initiators of a trading fund is heavily disputed.

On 15 December 2023, the Future Financing Act came into effect. The objective of this legislative measure is to facilitate access to capital markets and equity financing for start-ups, growth companies and SMEs, in particular. This is to be achieved through digitisation, deregulation, and internationalisation in the areas of capital market law, corporate law, and tax law.

The reintroduction of dual-class shares signifies a significant shift driven by the international competition among capital markets. With several European countries now permitting multiple voting shares in public companies, the new legislation seeks to dissuade German start-ups from opting for foreign legal structures solely for this reason. This enables founders to maintain control over the company, even after selling shares to investors or undergoing an IPO. Corporations are now permitted to issue registered shares with multiple voting rights (regardless of size or whether they are publicly traded). Multiple voting shares constitute a distinct class and are not a specialised form of preference shares. The multiple voting rights must not exceed ten times the voting rights of “ordinary” shares. Unanimous shareholder consent is required to establish multiple voting shares, rendering their introduction at existing public companies more or less impracticable. The tenure of multiple voting rights terminates ten years after the company’s IPO or inclusion in the regulated unofficial market (the so-called sunset clause). This timeframe can be prolonged by up to ten years via a resolution passed by a three-quarters majority of shareholders. Multiple voting shares cannot be issued when utilising authorised capital.

The expansion of the allowable amount for a capital increase with simplified exclusion of pre-emption rights as stipulated in the Future Financing Act will wield significant practical implications. Pre-emption rights may be waived for a capital increase against cash contributions, especially if the issue price is notably below the stock market price. Previously, the volume for capital increases with simplified exclusion of pre-emptive rights was capped at 10% of share capital; this limit has now been elevated to 20%. Capital increases with simplified exclusion of pre-emption rights will be more attractive to issuers as legal recourse is significantly limited. Resolutions for such increases cannot be contested based on unreasonably low issue prices. Shareholders excluded from pre-emption rights are not entitled to cash compensation under the German Stock Corporation Act (Aktiengesetz, or AktG).

The Future Financing Act also raises certain volume limits for conditional capital. Conditional capital increases to finance stock options for management and employees can now be conducted up to 20% (previously 10%) of the share capital. This change is expected to impact start-ups where a significant portion of compensation is provided in shares. Additionally, under the new rules, conditional capital used to issue shares for a merger with another company ‒ an option seldom exercised ‒ can now amount to 60% instead of the previous maximum of 50% of the existing share capital. However, the limit of 50% of share capital for conditional capital created for issuing convertible bonds (which is generally the primary purpose) remains unchanged.

The Future Financing Act brings a comprehensive overhaul to the legal protection mechanism for shareholders concerning capital measures approved by the general meeting. Previously, challenges to resolutions increasing the company’s capital (with subscription rights excluded, based on objections regarding the issue price or minimum price) were viable. Owing to the uncertainty of court rulings, such challenges posed risks of delays or non-implementation of capital increase resolutions. Under the new version of Section 255 of the AktG, resolutions can no longer be contested on the basis that a shareholder sought to obtain special benefits or on the basis of unreasonably low share contribution values. The Future Financing Act replaces the previous legal protections of avoidance and/or nullity actions with compensation claims awarded in appraisal proceedings for valuation-related objections, which significantly enhances transaction security for capital increases.

German Growth Opportunities Act (Wachstumschancengesetz)

In addition to the Future Financing Act, the government aims to create incentives for more innovation and investment in new technologies through the German Growth Opportunities Act, in order to enhance the competitiveness of Germany as a business location. This act was passed by the Bundestag and Bundesrat on 22 March 2024 and includes a total relief volume of EUR3.2 billion. Companies will benefit particularly from:

• expanded tax incentives for research;
• improved depreciation options;
• tax incentives for new residential construction;
• enhancements to tax loss deductions; and
• the introduction of electronic invoicing.

Founder/employee arrangements remain highly customised, taking into account various factors such as the negotiating power of the founding team, the complexity of the required structure, the specific incentives the company intends to offer, tax considerations for employees, and the intricacy of implementation.

The initial founders typically hold physical shares without restrictions on voting or other membership rights. Generally, no transfer restrictions apply insofar.

Regarding additional hires, there are several options for committing employees to the venture – for example, options to acquire company shares (“stock options”), participation via a VSOP, an employee stock ownership plan (ESOP) or so-called hurdle shares.

With the distribution of stock options, employees receive the option to acquire company shares at a predefined exercise or strike price, provided certain conditions are met. Transfer restrictions may attach to the shares that are granted as part of a physical settlement.

Under ESOPs, the ownership of company shares is transferred to the employee. To ensure that the company is protected against fraudulent use or transfers, the power of disposal (Vinkulierung) and the rights of membership are regularly restricted. In general, vesting conditions (so-called reverse vesting) are part of ESOPs.

VSOPs provide the advantage that no membership/governance rights attach. VSOPs embody the right for a (deferred or contingent) cash payment if an exit event occurs. The payment amount is based on the (increase in the) company value.

In addition, the employees can acquire hurdle shares ‒ ie, company shares with a “negative liquidation preference” ensuring that employees only participate in future value increases.

Through participation programs like ESOP/VSOP, employees financially engage in the start-up’s success via physical or virtual equity incentives. The exercise of the right is typically subject to several conditions (eg, duration of employment or acquisition of the company).

Non-compete and non-solicitation agreements are widespread as part of shareholders’ agreements. This is to safeguard the company’s interests and prevent founders and key employees from engaging in competitive activities or soliciting customers, employees, or business partners upon leaving the company.

Vesting conditions ensure that employees have only access to their shares after a certain period of time. This vesting period is typically between two and five years, with a one-year cliff vesting period. If employees depart before the end of the vesting period, they cannot exercise the unvested part of their stock option and do not receive payments from the unvested part of their VSOPs. Vesting conditions can be used for all of the previously mentioned instruments.

Additionally, employee participation programmes such as ESOP/VSOP or hurdle shares may include “good leaver”/“bad leaver” clauses, which allow the company to reclaim equity granted to an employee if they leave the venture (typically, a reverse vesting call option at nominal value). Bad leaver qualifications tend to be limited to gross misconduct or criminal activity, as well as voluntarily terminations on the part of the employee – making Germany an instrument-holder-friendly jurisdiction.

In practice, reverse vesting ‒ ie, the granting of a call option over the shares obtained in favour of the venture or the other shareholders ‒ is often agreed upon for founder vesting. The founders are initially allocated their full shares and, at the end of the vesting period, all shares become vested and secured. However, premature departure from the company during the vesting period results in the loss of the unvested portion, which is potentially compensated for only partly or discounted. The decision between a VSOP agreement with vesting or an allocation with reverse vesting should always be analysed from a tax perspective.

Tax-effective structuring of incentive schemes targets:

the avoidance of dry income events for an employee; and

the receipt of capital gains tax treatment for any future increase in company valuation at a preferred tax rate of 25% (plus 5.5% solidarity surcharge thereon, resulting in an aggregate tax rate of 26.375% plus church tax, if applicable) (“Capital Gains Tax”).

ESOP

Almost all ESOP agreements stipulate that employees can acquire shares free of charge or at a discounted price, which leads to a non-cash benefit (geldwerter Vorteil) and is therefore subject to income tax. As a result, employees are required to pay taxes on a non-cash sum, potentially resulting in significant additional tax payments of up to 45% (plus 5.5% solidarity surcharge thereon, resulting in an aggregate tax rate of 47.475% plus church tax, if applicable) in income tax on the benefit (“dry income”). Any capital gains from the increase of the value of the granted shareholding after the acquisition are subject to Capital Gains Tax.

Stock Options

In case of stock options, a financial benefit in the form of a discount is only considered to accrue to the option holder as and when they exercise the option and acquire underlying shares at a discounted rate; only at this point is the monetary benefit realised and subject to taxation. Unless the time of exercise coincided with a liquidity event (eg, due to an accelerated vesting provision under the terms of the option arrangement), the dry income problem also exists for stock options at the time of exercise ‒ ie, it is merely postponed.

VSOP

VSOPs do not entail dry income events, as they are taxed upon the actual cash payment to the employee. However, VSOPs trigger full taxation at a rate of up to 47.475% in income tax/solidary surcharge (plus church tax, if applicable), without offering any option to allocate at least part of the future increase in company value to Capital Gains Taxation.

Hurdle Shares

In order to overcome the disadvantages of the above instruments, hurdle shares have become increasingly popular in the German market. The envisaged tax treatment of hurdle shares is that the employee can acquire the shares for free/at a significant discount due to the negative liquidation preference attached to the shares. Notwithstanding the inherent “option value” of hurdle shares, the negative liquidation preference is designed to result in a low/no value of the shares granted to the employee and thereby ideally avoid a dry income taxation. Any future increase of the company’s valuation is meant to permit Capital Gains Tax treatment. In this context, taxpayers often try to obtain a binding ruling for the desired tax treatment of hurdle shares ‒ although this has become increasingly difficult in the recent past.

Tax Revisions to ESOP Schemes (Physical Shares Subject to Reverse Vesting Provisions)

German tax law basically offers two benefits for the grant of physical company shares ‒ ie, tax benefits only applicable to ESOPs, stock options and (likely) hurdle shares but not to VSOPs.

German tax law may, subject to the satisfaction of certain conditions, permit a deduction of up to EUR2,000 from the income resulting from the acquisition. In practice, this deduction is ‒ due to its low amount ‒ not important for the structuring of incentives.

More importantly, income tax resulting from the acquisition of discounted shares may be deferred until the occurrence of certain events (Section 19a of the German Income Tax Act (Einkommensteuergesetz, or EStG)). This may result in an avoidance of the dry income problem while enabling the employee to acquire the company shares at an early point in time so as to receive a preferential Capital Gains Tax treatment on the future increase of company value. Recent enhancements and a broadening of company eligibility criteria of Section 19a of the EStG under the Future Financing Act and the Fund Location Act (Fondstandortgesetz), only in effect since 1 January 2024, can be expected to entail a significant increase in incentive programmes under the regime of Section 19a of the EStG. Notably, a change of employer or the reaching of a minimum holding period of 15 years will no longer necessarily result in a termination of the tax deferral. As a result, the tax is only due at the time when the company shares are actually sold by the employee, thereby avoiding the dry income problem.

To sum up, with the Future Financing and the Fund Location Act, the legislator successfully attempted to offset the competitive disadvantage that Germany faced compared with other jurisdictions, such as the USA. However, certain issues persist – for example, the provision (still) excludes later-stage companies, despite its broadened eligibility criteria. Further, it lacks an intra-group clause (Konzernklausel); therefore, employees can only benefit if they acquire shares in their employing company as opposed to any affiliate thereof (notably, the to-be-listed TopCo). Finally, social security contributions incurred at the time of acquisition are not deferred and fall due within the dry income window.

From a process perspective, investment terms are typically outlined in non-binding term sheets, following an assessment of the market and an initial validation of the business model by investment teams. As due diligence progresses and binding documentation is entered into, investors in a round often sign and close their investments concurrently, contingent upon fulfilling conditions precedent. The “option pool” or VSOP ‒ whether newly established or expanded upon (ie, the creation of additional awards within an existing pool or scheme) – would ordinarily take effect at the time of a round’s closing or else may be implemented thereafter, especially if additional structuring work is required.

New investors generally expect growth companies they invest in to increase or “refresh” the size of their employee equity incentive pool at the time they invest. This becomes a key topic of negotiation because it is ultimately a commercial question with direct bearing on the company’s valuation. As part of the key investment terms, existing shareholders and new investors will be required to reach alignment on who bears the dilutive effects of an increase of the incentive pool or the (additional) number of instruments to be awarded. The point has been labelled “option pool shuffle” and concerns the questions of whether the prospective dilution will be borne by existing shareholders only (and run against the pre-money valuation on a fully diluted basis) or by all ‒ ie, existing and new investors alike (in which case, the increase in instruments runs against the fully diluted post-money capitalization).

When it comes to valuation and dilution, investors participating in a round will seek to have visibility regarding the amount of euros they are investing and what their investment amount translates into in terms of their fully diluted pro rata ownership during the foreseeable future. In case the increased incentive pool were to be factored into the post-money valuations and all investors would equally share into the dilutive effect, new investors would immediately be diluted after closing and the relative stake purchased would require adjustment. Therefore, ESOP and similar increases are mostly counted against the pre-money capitalisation and non-dilutive to newly issued shares.

Discussions typically evolve around the substantiation of hiring and retention needs during a predefined timeline that the founding team will be incentivised to demonstrate in order to limit the size and, consequently, the dilutive effect of a pool increase and the new investors’ argument that equity-based incentives are the critical tool of aligning stakeholder interest in a start-up and therefore should be available in adequate quantum.

Share Transfer Restrictions

To safeguard existing shareholders, a GmbH’s publicly available AoAs may incorporate transfer restriction clauses (Vinkulierung) – a violation of which will render a purported transfer null and void. These clauses reflect requirements set out in the shareholders’ agreement and may either restrict the transfer of shares without the company’s authorisation or bestow pre-emptive rights on existing shareholders.

Pre-emptive Rights/Right of First Refusal

A shareholder seeking to dispose of its shares is under market standard shareholders’ agreements obligated to offer its shares to shareholders (albeit not ‒ as tends to be the case in other jurisdictions ‒ the company) for their acquisition in proportion to their relative stakes in the company at the conditions offered by a third party within a specified acceptance period (Andienungspflicht). These rights tend to be structured as so-called Rights of First Refusal, which permit existing shareholders to take a “last look” and not only to put forth a price they would be willing to pay; this would then set the floor for a third-party transaction (so-called right of first offer).

Rights of First Refusal can be structured in a multi-stage process, as follows.

• Unless all existing shareholders have exercised their Right of First Refusal in a first round, those who did exercise their Right of First Regusal are entitled to acquire the residual (“unexercised”) shares in a second round, set within a specific timeframe.
• Only if the Rights of First Refusal are not fully exercised for all shares subject to the sale in such second round may the selling shareholder proceed in a transaction with a third party, whereby the sale would still be subject to existing co-sale rights.

Tag-Along Rights

Co-shareholders may have the right to demand from the selling shareholder that the sale is only carried out if their shares are, on a pari passu basis, reflective of their pro rata stake in the company, sold alongside the selling shareholders’ shares, and subject to the same conditions. If the co-sale requirements are not complied with, there is no obligation to consent to the sale and the shares remain subject to existing transfer restrictions.

Drag-Along Rights

Co-shareholders may compel the sale of shares under predetermined conditions. Often, drag-along rights are not confined to share deals, but extend to other exit routes ‒ notably, change-of-control transactions that take the form of mergers or the divestiture of substantially all assets (“asset deal”).

Although drag-along rights are usually contingent upon obtaining a qualified majority, there are occasionally drag sales granted as a unilateral option (eg, in scenarios where key milestones have not been met). Notwithstanding the contractual position, enforcement of drag rights in practice may be contingent upon management’s willingness to endorse ‒ or at least permit ‒ an orderly sales process, which may be challenging where there is significant shareholder opposition.

Put/Call Options

Contingent upon a company’s shareholder structure, certain shareholders may succeed in negotiating call option rights over other shareholders’ exiting stakes at a price that is typically reflective of ‒ or based upon ‒ a company’s fair market value (FMV), as existing at the time of the option window. Call options may permit a (group of) particular investor(s) to initiate a change-of-control transaction ‒ for example, in cases of significant strategic value for a corporate VC or in the event shareholders seek to pre-agree on a set “path to liquidity” after a certain time. Call option arrangements are often mirrored by corresponding put options and may entail a premium over, as well as a mechanism to fairly determine, the company’s FMV.

IPO Force Right

It has been argued that a right by one VC investor to request that the company undertakes preparations for an IPO/listing after a predefined period conflicts with the statutory authority of a management board of an AG/SE to act in the company’s best interest, as existing from time to time.

IPO exits are typically driven by easier access to new capital, increased liquidity of the shares, a transparent valuation, improved branding and marketing for the company, and enhanced attractiveness to employees due to employee participation programmes. However, the predominant exit strategy in Germany is getting acquired, primarily by corporate buyers.

When publicly listing shares, issuers can choose from two market segments:

• the regulated market, with higher admission and post-admission requirements leading to higher transparency and typically greater liquidity; and
• the open market, with lower entry and compliance costs, which may be more attractive for SMEs.

The Frankfurt Stock Exchange’s Prime Standard is the sub-segment of the regulated market with the highest ongoing transparency requirements. Meanwhile, its Scale open market sub-segment is currently the only registered German SME Growth Market, which allows SMEs to make use of certain alleviations under applicable EU prospectus and market abuse rules.

In order to be admitted to the regulated market, the issuer must have been in existence for at least three years (subject to exemptions for special purpose acquisition companies (SPACs)), have sufficient free float, publish a prospectus including three years of audited financial statements, and report on a semi-annual (Prime Standard: quarterly) basis going forward.

An inclusion of securities in the open market is not governed by statutory law but, rather, the relevant market operator’s general terms. Accordingly, the admission and post-admissions requirements vary more between markets – for example, with regard to admission document, terms of issuer’s existence, free float, and market capitalisation – and thus provide more flexibility for early-stage companies. Uplistings from the open market to the regulated market are possible but not very common.

The preparation and execution of an IPO can be divided into three phases, as follows.

• Conception phase (between five and seven months) – creation of the issuance concept (including investment case, placement volume and source (company vs shareholders), holding obligations (lock-up), use of proceeds, choice of market segment, and placement strategy/target investors).
• Implementation phase (between three and four months) – preparation of investor presentations as well as the securities prospectus and application for BaFin approval. The prospectus is based on a comprehensive due diligence of the issuer by the global co-ordinators of the bank consortium.
• Placement phase (one month) – underwriting agreement with the lead consortium bank(s), book building, and pricing. Trading usually commences one day and closes two days after pricing.

General economic conditions and capital market sentiments influence the timing. The issuer’s IPO readiness is also critical, including factors such as financial performance, growth trajectory, corporate governance structure and regulatory compliance.

As most start-ups in Germany are organised as a GmbH, the IPO necessitates a structural conversion into a legal form suitable for public listings (AG, SE, or partnership limited by shares (Kommanditgesellschaft auf Aktien, or KGaA)).

Alternative exit strategies to a traditional IPO involve:

• a direct listing, whereby the issuer’s existing securities are admitted to trading without a concurrent public offering – sometimes a private placement with institutional investors is organised immediately prior to the listing; or
• a de-SPAC transaction, in which a private entity goes public by merging with a publicly listed SPAC.

With the newly passed Future Financing Act, the German government aims to enhance capital market access for businesses, particularly start-ups, high-growth companies and SMEs ‒ for example, through expansion of the VAT exemption for VC funds, simplification of the listing and post-listing requirements, and reduction of the minimum capital required to EUR1 million.

There is a tangible market need for pre-IPO secondary market trading, particularly to facilitate liquidity for certain investors and employees who hold equity-based compensation in privately held companies. However, so far no relevant market structures have evolved in Germany or Europe.

In 2022, Forge Global Holdings Inc (a leading private securities marketplace) announced its international expansion together with Deutsche Börse. Forge Europe will establish a digital marketplace for European companies and investors that provides access to Forge’s US liquidity network. While Nasdaq used to operate a private exchange under the name of Nasdaq Private Market, the venture was spun out in 2021.

Pre-IPO secondary market trading faces certain legal challenges. Generally, a published securities prospectus is required for a public offer of shares (as further outlined in 7.1 Securities Offerings). Given that more start-ups are being organised in the form of a GmbH, a prospectus according to the Prospectus Regulation (“ProspektVO”) is not required, as a GmbH share is not a security within the ProspektVO. Pursuant to Section 6 of the German Asset Investment Act (Vermögensanlagengesetz, or VermAnlG), the public offer of investments (which encompasses GmbH shares) requires the publication of a prospectus. Exceptions are made in Section 2(1) no 3 of the VermAnlG owing to the low distribution of the investment (no 3a ‒ maximum of 20 shares) or because the costs of publishing the prospectus are not in proportion to the issue size (no 3b ‒ maximum of EUR100,000 over 12 months or at least EUR200,000 per investor) or because the high purchase price of the investment only addresses purchasers who are capable of providing their own qualified information (no 3c ‒ maximum of EUR100,000 over a maximum of 12 months).

Determining the FMV of privately held company shares for secondary market transactions can be challenging, owing to the absence of publicly available pricing data and market benchmarks. As there is a shortage of investors facing a higher number of potential investment targets, an information asymmetry persists ‒ particularly on the buyers’ side.

Shareholders’ agreements contain various share transfer rights and restrictions such as ROFRs, co-sale rights and tag-along rights. These apply in respect of secondary transactions and can complicate, or even block, a sale.

It remains to be seen how well transfer restrictions in German market practice adapt to the evolution of secondary trading and whether shareholders’ agreements will pre-permit certain transactions going forward.

For an AG, in the event of a sizeable transaction such as a capital increase with pre-emptive rights exclusion, a prospectus is not required in the case of a public offer if the offer is exclusively directed to qualified investors (who can be assumed to have sufficient sources of information to obtain the necessary basis of knowledge) (Article 1, paragraph 4(a) of the ProspektVO). If a public offer targets non-qualified investors, a prospectus is not required if it is addressed to fewer than 150 natural or legal persons (Article 1, paragraph 4(b) of the ProspektVO). Similarly, for a GmbH, a prospectus for a public offer is not required if the offer is addressed to a limited number of natural or legal persons (Section 2, paragraph 1 no 6 of the VermAnlG).

If there are numerous employees/ entitlement holders within an AG, the transferability of shares is usually largely restricted. Consequently, in such cases, these shares do not qualify as securities under the ProspektVO. Even in instances where transferability is not restricted, a prospectus is not mandatory if a document is provided containing information about the quantity and characteristics of the securities, as well as the reasons and particulars of the offer (Article 1, paragraph 4(i) of the ProspektVO). In the case of a GmbH, a prospectus is not mandated under the exception outlined in Section 2, paragraph 1 no 6 alt 2 of the VermAnlG.

Foreign Direct Investment (FDI) Screening

The German foreign investment screening framework is governed by the Foreign Trade and Payments Act (Außenwirtschaftsgesetz) and the Foreign Trade and Payments Regulation (Außenwirtschaftsverordnung). The competent authority, the BMWK, has the authority to examine whether the investment in a domestic company through the direct or indirect acquisition of voting rights is expected to negatively affect the public security or order of Germany or another EU member state or with regard to projects of EU interest.

As part of the cross-sector regime (sektorübergreifendes Verfahren), the law currently lists 27 categories (including critical infrastructure in a number of sectors and other business activities in many different areas, such as software, healthcare, AI, and semiconductors) where the acquisition by a non-EU investor requires a mandatory filing and prior clearance by the BMWK. Voting rights thresholds of 10% or 20%, respectively, apply – depending on the applicable category. If the German company is active in certain areas of the military, defence, or government IT security, acquisitions by non-German investors of 10% or more of the voting rights trigger a mandatory filing and pre-closing clearance requirement as part of the sector-specific regime (sektorspezifisches Verfahren). In all other cases, the BMWK is entitled to review any acquisition by non-EU investors of at least 25% of the voting rights, even if no mandatory FDI filing is required.

For an investor who already owns a participation above the entry thresholds, the crossing of certain further thresholds may require prior clearance (20%, 25%, 40%, 50% and 75%). Pursuant to guidance from the BMWK, the acquisition of additional voting rights as part of capital increases or financing rounds are only covered by the German FDI regime if the percentage share of voting rights crosses a relevant threshold as a result of the transaction (ie, not if an investor acquires shares only to the extent required to prevent a dilutive effect).

Foreign investment approvals have become increasingly significant in the realm of VC and start-up investing, as the German regime was amended several times during the past few years to cover a broader range of activities without regard to the size of the business. At the same time, almost half of the VC funds invested in Germany derive from third countries, according to reports of the German Startups Association. In 2023, the BMWK indicated the possibility of a further expansion of the regime. The German government is currently working on a comprehensive revision of the legal framework, with the intent to instigate a dedicated investment screening law.

Investments in Regulated Banks, Financial or Payment Services Providers and Insurance Companies

In the fintech/insurtech space, investors that intend to acquire a direct or indirect participation in a German regulated bank or other financial institution (eg, financial services provider, payment services provider, e-money institution and investment firms) in excess of 10% of capital or voting rights is required to submit a notification to BaFin and obtain pre-closing approval in the context of an owner control procedure (Inhaberkontrollverfahren). During this procedure, BaFin reviews ‒ among other things ‒ the strategic plans, financial standing and reliability of the investor. The legal basis depends on the company’s regulatory status. Crossing of 20%, 30% and 50% thresholds requires additional clearances. In the case of German banks that fall under European banking supervision, the approval process involves the European Central Bank.

An owner control approval is also required for direct and indirect investments in insurance and reinsurance undertakings as well as in certain regulated asset (fund) management companies – in each case, also starting at 10% of the capital or voting rights.

Stamp Duties and Currency Control

The German government imposes no stamp duties nor any control on the purchase or sale of foreign currencies.