Participatory loan: definition, advantages, disadvantages

For companies, one form of fundraising is the inclusion of silent partners. They have no voting rights, but they share in the company’s profits and losses. A participatory loan is also a participation financing, however in the sense of paragraph 488 of the German Civil Code (BGB), “Obligations typical of a contract in a loan agreement”.

The difference to a silent participation depends on the following factors:

  • It is a standard secured loan.
  • No regular interest has been agreed. Rather, this is based on the annual profit.
  • The lender has no say in business decisions.
  • There is no entrepreneurial risk for the lender.
  • There is no participation in any losses.
  • There is no common purpose for lenders and borrowers.

Partial loans can be concluded with a contract term or for an unlimited duration. In order to justify a distinction from the silent company, the lender is often entitled to a contractually guaranteed right of termination at any time.

A fixed interest rate can be agreed, but this has to be clearly subordinate to the development of profit and sales. Even if the profit sharing is calculated as a percentage of the profit, the parties often agree to maximize it. If the loan is based on an agreed return of ten percent and is maximized to $ 10,000, the lender will only receive $ 10,000 even if the profit is $ 200,000. The annual profit sharing is reduced if the participatory loan has an annual repayment.

If the participatory loan serves to finance a start-up and is unlimited in time, the loan contract often also provides for an “exit clause”. This means that the lender will be involved in the start-up’s sales proceeds if it is sold or listed on the stock exchange.

 

Legal status of the participatory loan

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In theory, a participatory loan could meet the requirements for a deposit business in accordance with Section 1, Paragraph 1 of the Banking Act (KWG). This would make banking a regulated business. In order to avoid this situation formally, partial loans are either secured or they are contractually explicitly defined as subordinated loans. If the participatory loan is considered a subordinated loan, there is no longer an unconditional obligation to repay, unlike a deposit.

The subordinated loan describes a form of loan in which all claims of senior creditors are serviced before the subordinated creditors are serviced.

Even if these equity loans are offered as an investment, there is no regulation by the Capital Investment Code. The background is that, unlike traditional investment investments, loans do not provide for loss sharing. The agreed subordinate does not mean loss sharing, but according to BaFin only a temporary refusal to perform.

 

The tax treatment of income from a participatory loan

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With regard to the distribution, the legislator draws a clear line between silent participation and participatory loan. The distributions from a silent participation are considered trade income and must be taxed accordingly with the personal tax rate and under certain circumstances also with the trade tax.

The distribution from a participatory loan, on the other hand, is subject to the flat-rate tax of 25 percent. For the company, the payments to the donors are to be treated as operating expenses for tax purposes and have a profit-reducing effect.

 

The advantages of participatory loans

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First of all, participatory loans offer a certain independence from the banking sector. Borrowing from private investors is also becoming increasingly important in Germany. In the area of ​​real estate financing, the interest rate of banks is known to also depend on the amount of own funds. This also applies to property developer measures if the real estate has not already been sold on a rice board and the buyers’ first funds have flowed. Partial loans can close a crucial gap between equity and the portion to be financed in favor of lower bank interest rates.

For small and medium-sized enterprises (SMEs), participatory loans with a weaker credit rating are also a cheaper financing method than a bank loan. In addition, these loans do not have to be published in the commercial register.

While banks demand a fixed interest rate, participatory loans allow companies to take a breather in weaker financial years due to the profit-based distribution. On the other hand, the borrower can quickly separate from the lender if the business develops positively. The notice period is three months in accordance with paragraph 488 BGB.

Since the participatory loan is included in equity, the company’s equity ratio increases, and with it the credit rating.

 

The disadvantages of the participatory loan

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The disadvantage of the equity loan for the company is that the lender usually takes a certain risk premium into account in the amount of the distribution, which can make an equity loan more expensive than bank financing.

For the investor, the risk of total loss remains due to subordination. Even if BaFin sees a lack of profit distributions as a “temporary refusal to perform”, this can be permanent. In the event of insolvency, all primary creditors from the bankruptcy estate will be served first. If there is nothing left for the subordinated lenders, the complete loan default occurs.

 

Who is a participatory loan for?

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In principle, all companies benefit from a participatory loan who want to keep their liabilities to banks as low as possible. Start-ups are often launched through partial financing. In the real estate as well as in the industrial sector, participatory loans are often not the full financing, but close possible gaps to bank loans.

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