Capital Increase

What is a capital increase?

Capital increase (German: Kapitalerhöhung) refers to the increase of the share capital (Stammkapital) of a GmbH (German limited liability company) or of the share capital (Grundkapital) of a stock corporation (Aktiengesellschaft, AG) by amending the articles of association (the company agreement). The Stammkapital is the amount entered in the commercial register that the shareholders must contribute as the company's basic funding. In a GmbH, the increase generally creates new shares. Whoever takes them over makes a contribution for them in cash or in kind. The contribution goes to the company, not to the existing shareholders.

The capital increase is the legal core of every equity financing. In a funding round, the participation agreement governs the economic terms, the shareholders' meeting resolves on the increase, the investors take over the new shares, and the increase takes effect on registration in the commercial register. The legal basis is Sections 55 et seq. of the German Limited Liability Companies Act (GmbHG), for the capital increase from company funds Sections 57c et seq. GmbHG, and for the stock corporation Sections 182 et seq. of the German Stock Corporation Act (AktG).

By the source of the funds, there are two basic forms. In the effective or ordinary capital increase against contributions, new capital flows to the company. The nominal capital increase from company funds, by contrast, merely converts existing reserves into share capital.

Course of a capital increase in a GmbH and an AG

In a GmbH, a capital increase against contributions proceeds in five steps:

1. Increase resolution: As an amendment to the articles of association, it requires a majority of three quarters of the votes cast and notarisation (Section 53 GmbHG). The articles may provide for stricter requirements. The resolution sets the amount of the increase, the nominal values of the new shares and the persons admitted to take them over.
2. Declaration of subscription: Each subscriber declares which new shares it takes over. The declaration requires notarisation or notarial certification (Section 55(1) GmbHG).
3. Payment: Before registration, at least one quarter of the nominal value must have been paid in on each new share. Investors usually pay the nominal value in full.
4. Filing: All managing directors file the increase for registration in the commercial register in publicly certified form. They declare that the contributions have been made and are finally at their free disposal (Section 57 GmbHG). A list of the subscribers must be attached, among other things.
5. Registration: With registration, the capital increase takes effect; only then do the new shares exist. The notary then submits the updated list of shareholders.

In practice, the participation agreement, shareholders' agreement, increase resolution and subscription declarations are often notarised at a single notary appointment. Payment follows as soon as the agreed conditions to completion have been met.

In a stock corporation, the general meeting resolves, generally by a majority of three quarters of the share capital represented (Section 182 AktG). The new shares are taken over by a subscription form, and every shareholder has a statutory subscription right (Section 186 AktG). The increase takes effect on registration of its implementation.

Nominal value, premium and capital reserve

New shares must be denominated in whole euros; a nominal value of EUR 1 per share is usual. The price an investor pays in a funding round is far above that. Only the nominal value becomes subscribed capital, as the Stammkapital is called in the balance sheet. The excess amount flows into the capital reserve. This happens either as a premium (Aufgeld) fixed in the increase resolution (Section 272(2) no. 1 of the German Commercial Code, HGB), or as a contractual additional payment agreed only in the participation agreement (Section 272(2) no. 4 HGB).

Venture capital investors often make the premium payment as a contractual additional payment, because it can be structured flexibly, for example in tranches or depending on milestones. For the company, both are equity. The share capital is subject to the capital maintenance rule and therefore may not flow back to the shareholders; the capital reserve can be released again under the statutory conditions.

Cash capital increase and capital increase in kind

In a cash capital increase (capital increase against cash contribution or cash payment), the contribution is made in money. It must be received, after the resolution, for the final free disposal of the management. Use for the business before registration is, according to case law, in principle harmless. If the amount flows back to the contributor, for example as a loan, the payment discharges the obligation only under the narrow conditions of Section 19(5) GmbHG. Payments before the increase resolution also fulfil the contribution obligation only exceptionally.

In a capital increase in kind, an asset is contributed instead of money, for example a business, rights in software or a receivable. The object and nominal value must be set in the resolution (Section 56 GmbHG). The registry court checks whether the value reaches the nominal value and may demand evidence. If the value falls short, the subscriber must make up the difference in cash. If a shareholder converts a loan into equity, the receivable must be recognised at its actual value, which in a crisis may be below its nominal value. In the case of convertible loans, therefore, often only the nominal value is paid in in cash and the loan receivable is contributed as an additional payment into the capital reserve.

Nominal capital increase, authorised capital and conditional capital

Capital increase from company funds

No new capital flows in here. The company converts capital reserves or revenue reserves into share capital, and the new shares go to the shareholders in proportion to their existing holdings. The basis is an audited balance sheet whose balance sheet date is at most eight months before the filing. This route is used, for example, to increase the share capital before a round or to standardise nominal values.

Authorised capital

Under Section 55a GmbHG, the articles of association can authorise the managing directors for at most five years to increase the share capital by issuing new shares against contributions. The nominal amount of the authorised capital may not exceed half of the share capital existing at the time of the authorisation. A new shareholders' resolution is not needed to use it, but subscription declaration, filing and registration are. Authorised capital serves, for example, a second closing, tranches or compensation shares under anti-dilution protection.

Conditional capital increase in a stock corporation

Only stock corporation law recognises the conditional capital increase (Sections 192 et seq. AktG). It serves mainly convertible bonds and stock options for employees and the management board. The share capital increases only to the extent that the beneficiaries exercise their rights and the new shares are issued. GmbH law has no such form.

Subscription right and dilution

The GmbHG does not regulate an express subscription right. According to the prevailing view, however, shareholders have a right to take part in a capital increase in proportion to their holding; an exclusion must be objectively justified. In funding rounds, existing shareholders therefore regularly waive expressly in the notarial deed. The shareholders' agreement often also secures a contractual subscription right for future rounds (pre-emptive rights).

Anyone who does not take part is diluted: their percentage falls, but the value of their shares is preserved where the increase is made at an appropriate price (dilution). Besides the percentage, dilution can touch thresholds to which rights or tax consequences are tied. Examples are the blocking minority of more than one quarter, with which amendments to the articles can be prevented, and the majority of votes on which a business split depends.

The company's loss carry-forward is also important for tax purposes. If a person or a group of acquirers acquires more than 50% of the shares within five years, previously unused losses can be forfeited under Section 8c of the German Corporation Tax Act (KStG) (income tax). Capital increases count to the extent that they shift the shareholdings. Whether an exception applies is checked by the tax adviser before the round.

Worked example: capital increase in a Series A

A GmbH has share capital of EUR 30,000, divided into 30,000 shares of EUR 1 each. A founder holds 18,000 shares. In a Series A, a fund invests EUR 6 million at a pre-money valuation of EUR 24 million. An employee pool is not to be taken into account.

• Price per share: 24,000,000 / 30,000 = EUR 800
• New shares: 6,000,000 / 800 = 7,500 shares of EUR 1 each
• Share capital after the increase: 30,000 plus 7,500 = EUR 37,500
• Fund's percentage: 7,500 / 37,500 = 20%; cross-check via the valuation: 6 / (24 plus 6) = 20%
• Contribution to the nominal value: EUR 7,500; statutory minimum before filing: 7,500 / 4 = EUR 1,875
• Additional payment into the capital reserve: 6,000,000 minus 7,500 = EUR 5,992,500, that is, EUR 799 per share
• Founder's percentage: before 18,000 / 30,000 = 60%, after 18,000 / 37,500 = 48%
• Maximum amount of authorised capital created afterwards: 37,500 / 2 = EUR 18,750 nominal amount

The company books EUR 7,500 as subscribed capital and EUR 5,992,500 as capital reserve, together the EUR 6 million inflow in the bank account. With the round, the founder loses her majority of votes but keeps the blocking minority.

Distinction: capital increase, secondary sale and convertible loan

• Secondary sale: sale of existing shares by a shareholder. The purchase price flows to the seller, and the share capital remains unchanged.
• Convertible loan: The capital first flows as a loan, and the shares arise only on conversion, which in turn is implemented through a capital increase.
• Additional payment without a capital increase: Shareholders contribute equity into the capital reserve without receiving new shares, for example as a later tranche of a round.
• Capital reduction: the counterpart under Section 58 GmbHG. In restructurings, it is combined with a capital increase (capital cut, Kapitalschnitt).

Common mistakes

• Formal defect in the subscription. A merely written declaration of subscription is not enough; without notarisation or certification, the registry court does not register.
• Payment before the resolution. Amounts transferred in advance count as a contribution only exceptionally and in the worst case have to be paid again.
• Repayment of the contribution. If the contribution is passed back to the investor as a loan shortly after payment, the contribution obligation may continue to exist.
• Missing waivers. If a waiver of the subscription right by an existing shareholder is missing and the exclusion is not objectively justified, the shareholder can challenge the resolution.
• Registration time not planned for. Until registration, the new shares do not exist; follow-on steps such as tranches or share transfers are postponed accordingly.
• Percentages not calculated fully diluted. Employee pool and convertible loans change the percentages agreed in the term sheet.

Frequently asked questions

When is a capital increase effective?

On registration in the commercial register. Resolution and subscription establish the obligation to contribute beforehand; the new shares arise only on registration.

Can a capital increase in a GmbH be done without a notary?

No. The resolution must be notarised, the declaration of subscription notarised or certified, and the filing with the commercial register is made in publicly certified form.

May the company use the money before registration?

In principle yes, if it was paid in after the resolution for the free disposal of the management and is used for the business. A flow back to the contributor is harmful.

Must every shareholder consent?

No, three quarters of the votes cast are enough, unless the articles provide otherwise. Nobody can be forced to take over new shares, however, and the shareholders' agreement often provides for consent rights of the investors.

How long does registration take?

That depends on the registry court. Between filing and registration, there are often a few days to several weeks.

The Roemer Capital view

Before a round goes to the notary, we reconcile the figures of the term sheet with the fully diluted cap table: price per share, number of new shares, nominal value and additional payment. If the percentage in the term sheet and the percentage after the capital increase differ, we clarify this with all parties before the notarisation appointment.

We coordinate the timetable of notarisation, payment, filing and registration with the company's law firm and carry it into the liquidity planning. Implementing the capital increase is a matter for the law firm; our contribution is to make sure the economic figures are right and the inflow arrives on time.