Anyone founding a start-up or entering a growth phase is familiar with the dilemma: capital is urgently needed, yet the founders want to retain control over their company. Swiss corporate law offers an interesting instrument in the form of participation capital. This article explains what participation certificates are, what rights their holders have, and what must be observed in subsequent financing rounds.
1. What Is Participation Capital – and Why Is It Interesting for Start-ups?
Participation certificates (PCs) are equity securities issued against contribution, carrying a par value but conferring no voting rights. Together with the share capital, they form the so-called basic capital of the company and appear on the liabilities side of the balance sheet under equity. Conceptually, they are non-voting shares: the PC holder participates in the economic success of the company without intervening in the decision-making of the general meeting.
For start-ups, this gives rise to several attractive advantages:
- No dilution of voting rights: Investors receive an economic interest without gaining influence over strategic decisions. Founders can thus retain the majority at the general meeting.
- True equity: Unlike debt capital (e.g. convertible loans), no repayment or interest obligations arise. This improves the balance sheet structure.
- Flexible adjustment of the capital structure: Participation capital may be created at the time of incorporation or subsequently — by way of an ordinary capital increase, a conditional capital increase, or within a capital band.
- Possibility of preferential treatment: The articles of association may grant PCs preferential rights over registered shares, which may be attractive for investors.
It should be noted that participation capital in unlisted companies may not exceed twice the share capital. This limit is readily complied with by most early-stage start-ups, but constrains PC financing where the share capital base is very low.
2. Legal Position of PC Holders Compared with Shareholders
The legal position of PC holders must be distinguished from that of shareholders.
No Voting Rights – but Protected Property Rights
The right to vote is mandatorily excluded – including for extraordinary circumstances such as the dissolution of the company. Provisions of the articles of association that nonetheless confer a right to vote at the general meeting are void. It is likewise provided by statute that the following rights do not accrue to PC holders: the right to convene the general meeting, the right to attend, and the right to place items on the agenda and submit proposals. However, the articles of association may grant PC holders these rights in order to secure a minimum of transparency and participation for investors.
By contrast, the property rights of PC holders are afforded strong statutory protection: the articles of association may not place PC holders in a less favorable position than shareholders with regard to the distribution of the balance sheet profit, the proceeds of liquidation, or the subscription of new shares. This prohibition on less favorable treatment means that any deterioration of the position of PC holders is permissible only if the corresponding shareholders accept the same disadvantage.
Statutory Minimum Rights and Rights of Action
Irrespective of the provisions of the articles of association, each PC holder is mandatorily entitled to the following rights: the right to information about general meeting resolutions, the right to challenge resolutions of the general meeting that are contrary to law or the articles of association, the right to bring an action for organizational defects, the right to bring an action for liability against the corporate bodies, and the right to submit to the general meeting a written request for the initiation of a special audit. This legal protection is of considerable practical significance for investors.
"Special Meeting" as a Protective Mechanism
Preferential rights and participation rights granted to PC holders by the articles of association may be restricted or abolished only with the consent of a special meeting of the affected PC holders – and this in addition to approval by the general meeting of shareholders. The special meeting is the only instance in which PC holders are entitled to vote and to exercise related rights. For start-ups, this means: where existing PC preferential rights are to be modified in the context of a restructuring or a new financing round, this dual consent mechanism must be observed.
3. Subscription Rights in Capital Rounds with Outstanding Participation Certificates
Once a company has outstanding PCs and plans a new financing round, Art. 656g CO must be observed. This provision specifies the subscription rights of shareholders and PC holders and is in practice one of the most important – and frequently overlooked – pitfalls.
General Rule: Subscription Right of Shareholders upon Initial Creation of PCs
Where participation capital is created for the first time, existing shareholders have a subscription right over these new PCs — under the same rules as for the issuance of new shares. This subscription right may be withdrawn only for good cause and without unjustified preferential or disadvantageous treatment. For start-ups wishing to use PCs for the first time as an investor vehicle, this means that existing shareholders must either exercise their subscription right, waive it, or have it withdrawn from them for good cause.
Simultaneous Increase of Both Types of Capital
Where share capital and participation capital are increased simultaneously and in the same proportion, the articles of association may exclude the "cross subscription right": shareholders then subscribe only new shares and PC holders only new PCs. This option must be enshrined in the articles of association; in the absence of a corresponding provision, the general meeting may decide on a case-by-case basis whether to provide for a cross subscription right.
Unequal Increase – the Critical Case for Financing Rounds
In practice, it frequently occurs in a financing round that only one type of capital is increased – for example, only new shares are issued to new investors without a proportional increase of the PC capital. In this case, the law provides that subscription rights must be allocated in such a way that shareholders and PC holders can maintain their proportionate interest in the total capital ("preservation of the relative existing holding").
Specifically, this means: where only new shares are issued, PC holders are entitled to a cross subscription right over those new shares. As a result, they actually experience an improvement in their position – they receive shares carrying voting rights. Conversely, existing shareholders suffer a deterioration of their legal position where their subscription right extends to the non-voting PCs. The withdrawal or restriction of this subscription right is possible, but always requires good (objective) cause and must not unjustifiably favor or disadvantage any party.
Practical Recommendations for Start-ups
- Establish the articles-of-association basis at an early stage: Provisions on subscription rights and the withdrawal of subscription rights should be incorporated into the articles of association at the time PCs are introduced.
- Structure financing rounds carefully: Where PC holders are to be excluded from a share capital increase, an objective reason is required and the procedure for withdrawal of subscription rights must be followed.
- Monitor the ratio of share capital to participation capital: Participation capital in unlisted companies may not exceed twice the share capital. A pure share capital increase improves this ratio; a pure participation capital increase carries the risk of the limit being exceeded.
- Conversion of shares into PCs: The conversion of existing shares into PCs requires the consent of all affected shareholder – which in practice creates a high threshold.
4. Conclusion
Participation capital is an interesting but demanding instrument for corporate financing. Used correctly, it enables start-ups to raise true equity without altering the voting rights structure. The statutory protective provisions in favor of PC holders – in particular the prohibition on less favorable treatment and the subscription right rules – must be carefully observed in every capital round.
