PROFIT PARTICIPATION LOAN
With a Profit Participation Loan, the lender invests in the company through a credit agreement, usually structured as a loan. However, unlike traditional debt, its return and repayment depend, at least partially, on the borrower's financial performance, granting it its equity-like character. Participation in ongoing losses or liquidation losses is, however, excluded, which sets them apart from profit-sharing participation and leads to their classification as debt – at least in accounting terms.
Just as with traditional debt financing, PPLs should not create a false sense of security, as being inherently compatible with steward-ownership:
- To align with steward-ownership principles and ensure the instrument remains non-extractive, be aware to structure the contract with the type of limitation that fits your company’s needs – whether that’s a specific return limit, or a set duration.
- Make sure that you have a good due diligence process also with these instruments (covenants that could grant ownership rights or far-reaching co-determination rights under certain conditions).
- PPLs are often structured to include a fixed, regular payment, such as a base interest rate combined with profit participation.
- It is both possible and common to provide participatory loans with a (qualified) subordination.
- It’s a nice instrument if a fast and short-term solution is needed that should be more flexible than traditional debt.
PPLs work well for companies beyond the proof-of-concept stage with relatively healthy growth projections and a reasonable line of sight to stable revenues. While PPLs offer more flexibility for capturing upside potential compared to traditional loans (giving them a slightly more equity-like character), they still include fixed interest rates, which can pose challenges for startups without a clear path to profitability. For businesses that are far from achieving positive cash flow, those that need to continuously reinvest profits, servicing fixed interest payments may be a significant burden.
- Profit Participation Rate
- Base Interest Rate (if applicable)
- Repayment Structure
- Term Length (defined maturity date or indefinite duration)
- Profit Calculation Method (specifies how profits are measured (e.g., EBITDA, net income) and when distributions occur)
- Loss Participation (if applicable)
- Seniority & Security
