The Silent Partnership under German Law
German law provides for a large number of different financing instruments which have in common that they allow for straight forward financing for both start ups and established businesses. In what follows we highlight one of these instruments, the silent partnership:
Under German law, two parties may enter into a so called silent partnership. The partnership is “silent” because it will not engage in third-party transactions. Further, the silent partner's identity will not be disclosed in the commercial register.
The parties have ample contractual liberty and can basically agree everything they deem fit, in particular with regard to profit distribution.
A silent partnership is often used when one partner’s contribution consists in contribution of funds and the other party shall have a large degree of liberty to carry out the operative work of a business. The silent partner may be an individual or partnership or a company.
The silent partner participates in the profits and losses of the active partner's business. It is possible to participate only in a specific division of the active partner’s business (tracking stock).
Unlike the participation in the profits, which is compulsory, participation in the losses can be waived or be confined to the amount of the silent partner’s contribution. After dissolution of the silent partnership, the silent partner has a claim to repayment of his contribution.
Typically, the silent partner makes a cash contribution. However, he may also make a contribution in kind. In exchange he is entitled to supervision and information rights and participates in profits. However, he usually does not have a say or even a veto right in management decisions. Typically, the silent partner will be granted a veto right with regard to actions which clearly exceed the ordinary course of business (e.g. setting up subsidiaries; mergers etc).
The participation in profits can be structured in various ways. The silent partner could, for instance, be granted a fraction of the businesses profits and/or a one-off payment during an exit scenario (Equity Kicker).
The cash contribution can be structured in a way that it will be deemed equity (Eigenkapital) and therefore contribute to a positive rating of the business. Among other conditions, a subordination agreement will be entered into so that the silent partner’s claim for repayment is subordinated to other creditor’s claims.
If the investor requests more control concerning operations he may be granted extensive veto-rights also regarding day-to-day management. Such a so called atypical silent partnership leads to significantly different taxation of the silent partner's income. Therefore, it is vital to retain tax advice prior to setting up a silent partnership with a German business.
Should the silent partner be a foreign tax resident, the applicable double taxation treaty (Doppelbesteuerungsabkommen) should be consulted at a very early stage in order to find a tax optimal structure. Depending on the applicable treaty wording, a foreign silent partner could be qualified either as a lender or as a shareholder triggering different applicable tax scenarios.
ABOUT THE AUTHOR: Dr. Philipp Schön
Dr Philipp Schön is a corporate lawyer at Rose & Partners, LLP. Admitted to the bar in 2009, from his Berlin office he advises both domestic and foreign clients in corporate and real estate law and has represented repeatedly both domestic and foreign clients in small and mid-cap transactions. Beside his native German he advises in English and Spanish.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.