GERMANY Trends and Developments Contributed by: Anselm Lenhard and Philipp Büchler, LARK
the seller typically piggybacks on the senior acquisition financing and relies on the protection provided by the covenants agreed between the buyer and the senior lenders, given that interests are largely aligned on the side of all the lenders to the acquisition structure. For the borrower and for the senior lenders, it would also not be prudent to accept a separate extensive covenant regime in the subordinated vendor loan arrangements, which may not only increase the administrative burden on the bor- rower but may also render futile any waiver, consent or amendment requests to which the senior lenders consent if the seller refuses to consent thereto as well. In particular, this would put restructuring efforts at risk by giving a sub- ordinated lender leverage over the buyer and the senior lenders. Separate covenants in a vendor loan agreement are therefore usually limited to covenants ensuring the priority of the vendor loan over shareholder loans in the acquisition structure, preventing dividend and other pay- ments or value transfers by the borrower and the target group to the sponsor and its affiliates, and so-called “anti-layering covenants” , prohib- iting the incurrence of further subordinated debt layered between the senior acquisition financing and the subordinated vendor loan. Pay-in-kind (PIK) interest The subordination of vendor finance has impli- cations for the payment of interest on vendor loans. Usually, the terms of the senior acquisi- tion financing will restrict the borrower’s ability to make debt service payments on vendor loans. Due to these restrictions, and also to provide for risk-adjusted pricing for granted vendor finance, vendor loan agreements frequently provide for PIK arrangements, pursuant to which accrued interest is capitalised and added to the principal of the vendor loan. However, these arrangements
need to be structured in such a way as to comply with the prohibition of compound interest in Sec- tion 248 paragraph 1 of the German Civil Code ( Bürgerliches Gesetzbuch ), which does not allow an automatic capitalisation of accrued interest but requires an agreement after the accrued interest has become due. In practice, this is resolved by a PIK toggle provision in the vendor loan agreement, which can be exercised (and needs to be exercised if payment in cash is not possible) by the borrower at its sole discretion once accrued interest has become due. Unrestricted voluntary prepayments Unlike acquisition finance obtained in the private credit market, call protections that prohibit a pre- payment of a vendor loan or make its prepay- ment subject to a prepayment fee or penalty, in order to ensure a specific minimum return for the seller on the financing provided, are not com- monly encountered features in vendor finance arrangements. The purchaser is typically entitled to prepay a vendor loan, in whole or in part, at any time without any prepayment fee or penalty. In certain cases, the purchaser is even incentiv- ised to achieve an early refinancing of the financ- ing structure (including the vendor loan) through incremental increases of the applicable interest rate over the term of the vendor loan. While vendor finance will continue to be used as an instrument of acquisition finance because of the various objectives it can achieve, it remains to be seen whether a continued narrowing of the gap between the purchase price expectations of sellers and buyers will also result in vendor finance featuring less frequently in acquisition financings for German targets. Conclusion and Outlook From Q2/2025, Germany has a new govern- ing coalition between conservative Christian
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