Proof of Funds

What is a proof of funds?

Proof of funds (in German: Mittelbestätigung, also Finanzierungsnachweis or Mittelnachweis) describes the evidence that an investor or prospective buyer has the money for a planned transaction or that it has been bindingly committed to them. Depending on the capital provider and the phase of the process, the form ranges from a simple confirmation of available funds to a legally binding financing commitment. In a similar way, when a house is bought, the seller often asks for the confirmation of financing from the buyer's bank before the notary appointment.

Proofs of funds are requested in funding rounds and in company sales, usually in several stages: first as a rough plausibility check before confidential documents are released, later as reliable evidence with the binding offer. They are requested by the company or the selling shareholders, as a rule through the transaction adviser. They are issued by banks, funds, corporate parents or the investors themselves. In the company purchase agreement, the financing is finally secured by warranties and undertakings of the buyer.

Forms of proof of funds

• Bank confirmation: A bank confirms that funds of a certain amount are available in the prospective party's accounts or securities accounts. It is information as of a reference date, not a payment commitment.
• Financing confirmation from a bank: The bank states that it is willing to provide acquisition financing, that is, a loan for the company purchase, on certain key terms. Non-binding statements of intent must be distinguished from binding loan commitments (commitment letters), which contain only a few clearly defined conditions.
• Equity commitment (equity commitment letter): Financial investors usually buy through a specially formed acquisition vehicle. The fund undertakes towards this vehicle to provide it with equity of a certain amount at closing. Whether the seller can also claim directly under the commitment is regulated by the commitment itself.
• Letter of comfort (Patronatserklärung) or parent company guarantee: If a strategic buyer acquires through a subsidiary, the corporate parent undertakes to provide the subsidiary with the necessary funds. Only the hard letter of comfort, in which the parent commits to providing funds, is legally binding; the soft form is a mere declaration of intent.
• Fund confirmation: for venture capital and growth funds, the statement of fund size, the status of the investment period and available funds, often supplemented by the approval of the investment committee, the body that decides on investments within the fund.

When a proof of funds is requested

In a company sale

In an auction process, indicative, that is, still non-binding, offers describe the planned financing at first only in outline, for example the ratio of equity to debt and the banks involved. With the binding offer, reliable evidence is expected: from financial investors an equity commitment and binding loan commitments, from strategic buyers proof of own funds or existing credit lines. Before the full data room is released, which often happens after an LOI, it should at least be plausibly established that the prospective party can finance the transaction.

In a funding round

In funding rounds, the check is usually less formal. With established funds, publicly known information on the current fund and confirmation that the investment falls within its usual size range and that reserves are provided for follow-on rounds are often enough. With private investors, family offices and unknown parties, by contrast, a bank confirmation is requested. The obligation to pay arises only with the notarial recording of the participation agreement, the core of the investment agreement. The proof of funds is meant to show beforehand that this obligation can be fulfilled.

Securing the financing in the company purchase agreement

Sellers generally expect the financing to be secured already at signing and closing no longer to depend on it. A financing condition, that is, a right of withdrawal for the buyer in case its financing fails, is usually not accepted in auction processes. Instead, sellers require that the loan commitments contain only conditions that the buyer can itself fulfil or that correspond to the closing conditions of the purchase agreement. This principle of secured funds is called certain funds.

In addition, the buyer often warrants in the purchase agreement that sufficient funds will be available to it at closing. For buyers of uncertain creditworthiness, further security is added: a bank guarantee for the purchase price, the deposit of a part amount in an escrow account or a break fee payable by the buyer (reverse break-up fee). The term also matters: sellers make sure that loan and equity commitments remain valid at least until the latest closing date (drop-dead date).

Availability and origin of funds

The question of whether funds are available must be separated from the question of where they come from. Notaries and banks are among the obliged entities under the German Anti-Money Laundering Act (Geldwäschegesetz). They identify the contracting parties and their beneficial owners and, where there are irregularities, examine the origin of the funds. Unclear chains of ownership or changing payment routes can therefore delay or prevent the notarial recording. For foreign acquirers, an investment screening under foreign trade and payments law is added in certain sectors, which also requires information on the acquirer and the financing.

Worked example: proof of funds and funding requirement at closing

A financial investor bids a purchase price for the shares of EUR 26 million for a company. At closing, bank loans of the target company of EUR 4 million must also be repaid, and the buyer's transaction costs are EUR 1 million. With the binding offer, the investor submits a loan commitment and an equity commitment.

• Funding requirement at closing: 26 + 4 + 1 = EUR 31 million
• Loan commitment for the acquisition financing: EUR 13 million
• Equity commitment of the fund: EUR 16 million
• Funds evidenced: 13 + 16 = EUR 29 million
• Shortfall: 31 minus 29 = EUR 2 million

The evidence covers the purchase price for the shares, but not the entire funding requirement at closing. The seller side therefore demands that the equity commitment be raised to EUR 18 million, so that 13 + 18 = EUR 31 million is evidenced. It is also noticed that the loan commitment expires three months after signing, while the latest closing date in the draft contract is four months after signing. Both points are clarified before exclusivity, because afterwards they can be enforced only with less room for negotiation.

Distinctions: proof of funds, financing commitment and credit check

• Financing commitment: the binding obligation of a capital provider to provide funds, and thus the strongest form of proof of funds. A simple confirmation such as a bank confirmation, by contrast, shows only that funds exist, not that they will be used for this transaction.
• Capital commitment in the participation agreement: the investor's contractual obligation to make the contribution. The proof of funds precedes it and is meant to show that it can be fulfilled.
• Credit check: the assessment of the creditworthiness of a company or person as a whole. The proof of funds relates to a specific amount for a specific transaction.
• Confidentiality agreement (NDA): regulates the handling of the information that a prospective party receives. It says nothing about its ability to pay; both conditions are checked separately.

Common mistakes

• Requested too late. If the evidence is requested only after the full data room is released, confidential information is already with a prospective party whose financing capacity is unclear.
• Vague wording accepted. A confirmation of "sufficient funds" without an amount, reference date and issuer proves nothing.
• Evidence via intermediaries. Only a confirmation that comes directly from the capital provider or its bank is reliable.
• Only the purchase price reconciled. Liabilities to be repaid, transaction costs and purchase price adjustments also form part of the funding requirement at closing.
• Conditions of the loan commitment not reviewed. Conditions that go beyond the closing conditions of the purchase agreement act like a hidden financing condition.
• Terms not aligned. If a commitment ends before the latest closing date, the financing is unsecured precisely in the phase in which the transaction is to be closed.

Frequently asked questions

What must a proof of funds contain?

At a minimum, the issuer, the name of the prospective party, a specific amount and the date to which it relates. It becomes reliable when it names the specific transaction, states a period of validity and comes directly from the capital provider or its bank. For commitments, the conditions under which the funds will flow are included.

What happens if a prospective party does not provide evidence?

It generally receives no access to in-depth documents. An area with less sensitive information can remain open until the evidence is available or the prospective party drops out of the process.

How current must a proof of funds be?

Current enough to reflect the position at the time of the decision. Bank confirmations are information as of a reference date; a confirmation several months old says little about the present. New evidence is therefore often requested before signing.

Does a proof of funds replace security in the purchase agreement?

No. A proof of funds is information before the contract is concluded, from which generally no claims against the issuer arise. Legal security for payment is provided only by the provisions in the purchase agreement, such as a financing warranty from the buyer, an equity commitment with its own claim for the seller or a bank guarantee.

Does a proof of funds also apply to existing investors?

In a weakened form. For existing investors who want to take part in a follow-on round, the main question is whether their fund still provides reserves for follow-on investments. If not, the round is planned without their share.

The Roemer Capital view

Before a prospective party receives full access to the data room, we clarify how it intends to finance the transaction. In a sale process, this step falls in the period between the confidentiality agreement and the LOI, and in funding rounds in the period before the term sheet. We reconcile the evidence submitted with the entire funding requirement at closing: purchase price, loans to be repaid and transaction costs.

If it turns out that commitments are time-limited or contain conditions that go beyond the purchase agreement, we raise this in the negotiation while several prospective parties are still in the process. The client's law firm carries out the legal review of warranties and commitments; our contribution is the economic assessment and the reconciliation of the figures.