New German Law to bolster Equity Capital Market: Corporate Law Aspects of the Future Financing Act
December 18, 2023, Covington Alert
On December 15, 2023, the German Future Financing Act (Zukunftsfinanzierungsgesetz) (FFA) came into force. One of the main goals of the FFA is easing access to public equity for start-ups and small and mid-sized companies to counter the ongoing trend that many German start-ups and growth companies choose a foreign listing venue, often in the US, for their initial public offering (IPO).
The FFA includes several measures to support equity financing (see below I.) and to promote IPOs (see below II.). It reduces restrictions under German law that previously made equity financing and IPOs in Germany less attractive in comparison to other jurisdictions. In addition, the FFA includes extended tax benefits for employee shares in order to enable fast growing companies to win and retain talent (see below III.). Lastly, the FFA introduces electronic and crypto stocks (see below IV.).
I. New Rules for Equity Financing
1. Simplified Share Issuances
With the FFA it is much easier to implement equity financing rounds, including the exclusion of pre-emption rights of existing shareholders for new shares.
Under the FFA, shareholder challenges to the issuance of new shares relating to their valuation can no longer delay the registration of the capital increase in the commercial register and the related share issuance. In addition, in certain situations the management board has the ability to exclude the existing shareholders' pre-emption rights and to issue new shares with a significant discount, for example in the context of an M&A transaction, in restructuring cases or in connection with public share exchange offers. As a consequence of the new rules, the existing shareholders can now only resort to an appraisal proceeding with the aim to receive cash or compensation shares from the company (on compensation shares see below I.2.).
In addition, the FFA establishes a safe harbor that allows listed companies to issue shares and exclude pre-emption rights if the issuance price is equal to or falls only insignificantly short of the lower of (i) the three months weighted average stock price prior to the decision to issue the new shares or (ii) the current stock price at that time.
2. Settlement of Appraisal Claims
Under the FFA, the award in a successful appraisal proceeding can be settled by the issuing company either by way of a cash payment or – if so stipulated in the capital increase resolution – by issuing compensation shares. Such compensation shares can either be treasury shares or new shares issued to existing shareholders against contribution of their appraisal award. This share settlement option mirrors a new rule introduced in Germany in the summer of 2023 for corporate transformations.
3. Extension of At-The-Market Offerings with Simplified Exclusion of Pre-emption Rights
Previously, listed companies could exclude pre-emption rights of existing shareholders in new issuances of up to 10% of the registered share capital at a discount of up to 3% to 5% to the current stock price (simplified exclusion of pre-emption rights). This has been the most commonly used way of raising equity capital by listed companies in Germany and in practice authorized capital typically has been used for such at-the-market offerings. The FFA increases the threshold from 10% to 20% of the registered capital, thus aligning the stock corporation rules with the EU prospectus rules, which do not require a prospectus for the listing of new shares in the amount of up to 20% of the registered share capital.
Unfortunately, the possible discount range has not been increased in the FFA, which continues to make offerings to international investors less attractive than in other jurisdictions.
4. Increased Limits for Conditional Capital
Conditional capital can be created by the company's shareholders for three specific purposes: (i) issuing convertible bonds, (ii) using shares as consideration in an acquisition, and (iii) issuing stock options to employees and executives. The FFA increases the limits for creating conditional capital as follows:
- The limit for conditional capital increases from 50% to 60% of the registered share capital. However, the limit for conditional capital to be used to issue convertible bonds remains at the current level of 50% of the registered share capital.
- The limit for conditional capital to be used for issuing employee and executive stock options increases from 10% to 20% of the registered share capital (reflecting market practice where employee option pools often amount to 15% to 20% of the capitalization of a company).
II. New Rules Encouraging IPOs in Germany
1. New Multiple Vote Shares
Founders of fast growing companies are able to retain more control after an IPO through multiple vote shares (re)introduced by the FFA. Although multiple vote shares were eliminated in Germany in 1998 with the aim to improve corporate governance (i.e. one share, one vote), in other jurisdictions such as the US, UK and certain EU countries the existence of multiple vote shares apparently has not been a significant obstacle for IPOs. The (re)introduction of multiple vote shares should make it more attractive for founders wishing to retain control of their company to tap the German capital market for growth capital.
The following requirements need to be observed when introducing multiple vote shares:
- Maximum Voting Weight: The maximum voting multiplication is ten votes compared to one ordinary share.
- Unanimous Vote: Multiple vote shares cannot be introduced without the approval of all shareholders, i.e. in practice they can only be created before an IPO takes place.
- Sunset Rules: After a company’s public listing, the shares will lose their multiple votes upon transfer or after a maximum of ten years unless in the last year the shareholders decide to prolong the duration for up to ten additional years (which decision requires a ¾ majority of the share capital for each share class). On the flipside, this means that in non-listed stock corporations multiple vote shares may exist indefinitely.
- One Vote Limitations for Certain Matters: Multiple vote shares carry only one vote for the appointment of the statutory auditor and the appointment of a special auditor.
The practical implications of multiple vote shares are manifold:
- Owners of multiple vote shares resulting in a controlling stake are subject to higher good faith standards vis-à-vis the other shareholders, especially in privately held stock corporations.
- Multiple vote shares alone cannot decide significant matters that require a ¾ share capital majority under the German Stock Corporation Act. Therefore, the current strict system of legal minority protection is not undermined. However, the owner of multiple vote shares may have a veto right.
- When shares lose their multiple voting power a mandatory takeover offer may be triggered if another shareholder consequently crosses the 30% voting rights threshold. In such a case it is possible and will usually be advisable to apply to the German financial regulatory authority BaFin for an exemption from the mandatory bid rule.
2. New Rules for Special Purpose Acquisition Companies (SPACs)
A bit late to the party but nonetheless, Germany introduces specific rules for SPACs in its Stock Exchange Law, largely mirroring international standards. These rules allow the listing of a German stock corporation with funds held in escrow and the goal of completing a target transaction within at most 48 months. Other elements transposed into German law include the redemption right of existing shareholders dissenting to a target transaction and the timely return of funds in case no target transaction is completed in time.
Some important practical features of SPACs are not included in the new FFA rules. For example, German law does not provide for redeemable shares that give the company the right to repurchase them and there is no minimum value requirement for the target transaction.
Thus far, SPAC IPOs in Germany have only taken place by making use of companies incorporated in other EU jurisdictions such as Luxemburg. Whether this will change as a result of the FFA remains to be seen.
3. Facilitating Small IPOs
The FFA reduces the required market capitalization for a listing to EUR 1 million (instead of previously EUR 1.25 million) in order to facilitate smaller IPOs. And stock exchange rules may now provide that a listing in a regulated market segment without additional disclosure obligations (such as the General Standard of the Frankfurt Stock Exchange) does not require a financial institution to co-sign the listing application, which enables stock exchanges to establish segments with lower listing costs for the issuers.
III. New Tax Rules for Employee Shares
1. Increased Tax-Free Benefit
The FFA allows the tax free issuance of company shares to employees up to an amount of EUR 2,000 per year (previously EUR 1,440 per year), with the caveat that the shares are offered to all employees alike.
2. Expanded Rules for Deferred Taxation
The FFA significantly expands a tax rule introduced in 2021 for the deferred taxation of employee share benefits. The 2021 rule was aimed at solving the "dry income" problem of an employee receiving shares as an immediately taxable benefit without simultaneously receiving cash that could be used to settle the tax bill. The solution under the 2021 law was to defer taxation until the employee typically received cash or otherwise lost the merits of the tax benefit, i.e. when she or he transferred the shares or left the company. The FFA extends the maximum period for the tax deferral from 12 to 15 years. Further, in case of a leaver event which results in the return of the employee shares to the company, only the cash benefit actually received by the employee (which often is lower than the market value) will be taxed. In addition, the FFA clarifies that the deferred taxation rules also apply in case the employee shares are offered to employees by a shareholder of the employing company (which in practice is not uncommon).
Unfortunately, the FFA does not address two of the main financing obstacles start-ups face in Germany: (i) the use and carryforward by the company of its net operating losses and (ii) the ability of shareholders to deduct losses on their investments. Also, the new rules do not address possible social security duties triggered by issuing employee shares.
IV. Introduction of Electronic and Crypto Stocks
The FFA introduces the option to issue electronic stocks and for registered shares (Namensaktien) to use blockchain technology to issue the shares as crypto stocks. It is also now possible to create a mix of traditional and electronic stocks.
The introduction of electronic and crypto stocks requires specific provisions in the articles of association. Electronic stocks have to be registered in a central register and crypto stocks have to be registered in a crypto register.
Overall, the FFA is a significant step in the right direction. It remains to be seen if and to what extent start-ups and growth companies will make use of these rules.
If you have any questions concerning the material discussed in this client alert, please contact members of our Corporate practice.
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