20.7 Mezzanine 581Real equity kickers such as share option rights, conversion rights, or transfer-
able warrants can give the mezzanine lenders a share in an equity upside. Where
the equity kicker does entitle its holder to subscribe for shares, the firm must com-
ply with particular company law rules – rules on the issuing of share option rights
or similar rights; rules on the increase of the number of shares; rules on the pre-
emptive rights of existing shareholders; and, in most cases, rules on the increase of
the legal capital of the company (section 5.4).^119
For example, when a German AG issues warrants, it must create “conditional capital”
(bedingtes Kapital) in anticipation of the exercise of those rights.^120 The creation of condi-
tional capital must be authorised by a qualified majority of three-fourths at the general
meeting.^121 In contrast, a German GmbH cannot create conditional capital. Instead, a
GmbH could in principle decide on an increase in capital and the waiving of pre-emptive
rights.^122
When a mezzanine investor exercises his share option rights, conversion rights, or
warrants, the ownership structure of the company will change. In order to avoid it,
the firm and its owners often ensure that the equity kicker may be exercised im-
mediately before an IPO or a trade sale and may not be exercised earlier.^123
Alternatively, the controlling shareholders of the firm and the mezzanine inves-
tors can choose a synthetic equity kicker such as a “tag-along right” (see below) or
a “back-ended fee” (see below). Synthetic equity kickers neither entitle their hold-
ers to subscribe for shares nor dilute the existing ownership of the firm.
A tag-along right is triggered in the event of the sale of the controlling block in
the firm. A tag-along right can consist of an obligation of the controlling share-
holders to ensure that mezzanine investors will have an option to sell their mezza-
nine instruments to the buyer of the controlling block at the same price per instru-
ment as the price paid for each share.^124
A back-ended fee is an additional payment on top of the purchase price. It will
be made after the expiry of a certain period of time on the basis of the perform-
ance of the firm.^125
The amount of share option rights or conversion rights is set to provide the
lenders with a target rate of return on their investment based on the loan yield plus
the value of the equity kicker.^126
Equity mezzanine. In acquisition finance, mezzanine loans (that is, subordinated
debt instruments with an equity component) are more common than mezzanine
(^119) For Swiss law, see Barthold BM, op cit, pp 228–230.
(^120) § 192(1) AktG. For the contents of the decision to create conditional capital, see § 193
AktG.
(^121) § 193 AktG. This fulfils the requirements of the Second Company Law Directive. See
Articles 25 and 29 of Directive 77/91/EEC (Second Company Law Directive).
(^122) §§ 53(2) and 54(1) GmbHG.
(^123) Diem A, op cit, § 38 number 16.
(^124) Ibid, § 38 number 17.
(^125) See, for example, Barthold BM, op cit, pp 226–227.
(^126) Diem A, op cit, § 38 number 15; Gayle C, op cit, p 301.