Starting a business in Switzerland comes with a unique set of opportunities, including a robust economy and a strong startup ecosystem. However, every Swiss startup or SME (Small and Medium Enterprise) eventually faces the critical question of financing. Understanding the different options is crucial for making informed decisions that align with your business strategy and growth plans. This article will explore the two main types of financing available—debt and equity—along with their advantages, drawbacks, and tax implications.

1. Debt Financing: Borrowing with Clarity

What is Debt Financing? Debt financing involves borrowing money that must be repaid with interest over a period of time. Common debt options for Swiss SMEs include loans, which can be categorised as standard loans, participating loans and convertible loans.

• Loans: Loans are common in Switzerland and can range from short-term loans for working capital needs to long-term loans for major investments. Some lenders require collateral.
• Participating Loans: Loans can be structured as participating loans (partiarisches Darlehen). The specific feature of this type of loan lies in the agreement of a profit-related remuneration: in addition to or instead of interest, the lender participates proportionately in the profit generated by the borrower.
• Convertible Loans: These are loans that may be converted into equity at a later stage, often upon reaching specific milestones or in subsequent financing rounds. Convertible loans can be advantageous in early stages when valuation is difficult or as bridge financing between financing rounds. If conversion rights are to be created that can be exercised without the participation of the existing shareholders, this is only possible if there is a provision in the articles of association for capital increases from conditional capital. Such a provision must be entered in the commercial register before the granting of conversion rights (see Art. 653b para. 3 Swiss Code of Obligations [CO]).

Regulatory Restrictions: When financing a business with loans certain regulatory restrictions must be observed because loans are repayable debt and therefore meet the definition of public deposits under the Banking Act. The acceptance of deposits from the public on a commercial basis is an activity requiring a banking license. A commercial basis is deemed to be undertaken if more than 20 public deposits (or collectively held crypto-based assets) are accepted on a permanent basis or if a person publicly offers to accept public deposits (even if the number of 20 is not reached; Art. 6 Banking Ordinance). The Banking Ordinance provides a number of safe-harbor rules, in particular for bonds (Anleihensobligationen; see Art. 5 para. 3 let. b Banking Ordinance). In order to rely on this exception the issuer must provide some minimum information and also have its annual accounts audited by a qualified auditor (Art. 727 para. 1 no. 1 CO).

Pros and Cons of Debt Financing:

Pros:

• Retain Ownership: Entrepreneurs keep full control over their company since debt does not involve giving away shares and therefore voting rights.
• Predictability: Loan repayments are predictable, making it easier to plan cash flow.
• Tax Benefits: In Switzerland, the interest paid on loans is generally tax-deductible, which can reduce the overall taxable income of the company.

Cons:

• Repayment Obligations: Debt must be repaid regardless of the company’s profitability, potentially putting pressure on cash flow.
• Collateral Requirements: Many lenders require personal guarantees or collateral, which may not be easily available.
• Effects on the balance sheet: Taking on debt capital can lead to the company being over-indebted on the balance sheet. In practice, it is therefore often advisable to include a so-called subordination clause in the loan agreement. Through such a clause, the lender’s claim is subordinated to all other creditors to the extent of the over-indebtedness and its claims are deferred (amount owed and interest claims). Such a subordination makes it possible to avoid a notification of the judge (Art. 725b para. 4 no. 1 CO).

Tax Consequences of Debt Financing: Interest payments on debt are tax-deductible in Switzerland, which can provide a valuable tax shield for SMEs. The deduction of interest reduces the taxable profit of the business, lowering the corporate income tax burden. However, excessive debt financing might be reclassified as hidden equity (verdecktes Eigenkapital; see circular no. 6 of the Swiss Federal Tax Administration), leading to additional tax burdens.

2. Equity Financing: Sharing to Grow

What is Equity Financing? Equity financing involves raising capital by selling shares or participation certificates (non-voting shares) of the company to investors. This is common in the SME world and can be sourced from venture capital firms, angel investors, friends and families, or strategic corporate investors.

• Venture Capital (VC): VCs provide funding in exchange for equity, often coupled with strategic guidance and mentorship. This option is suitable for high-growth startups seeking large investments.
• Angel Investors: These are wealthy and usually business-experienced individuals who invest in exchange for a stake in the business. They often bring valuable industry knowledge and networks.
• Strategic Corporate Investors: Are investors that invest in startups or smaller firms with the goal of aligning with their strategic objectives rather than focusing solely on financial returns.

Joint-Stock Company: If equity capital is to be raised outside of the founding team, this usually requires that the company be set up as a joint-stock company. Furthermore, you should carefully consider who you include in the group of shareholders. This is because shareholders, unlike providers of debt capital, have certain rights of inspection and control in addition to voting rights at the general meeting.

Shareholders' Agreement: It is advisable to conclude a shareholders' agreement at the latest when equity is issued to third parties. A shareholders' agreement with customary clauses is usually a condition of professional investors considering an investment. If you already have an extended group of shareholders, it may be difficult to conclude a uniform SHA because the approval of each shareholder is required, regardless of how small their stake is. This can lead to certain shareholders holding out for example in an exit situation.

Participation Certificates (Partizipationsscheine): For some investors, the issue of participation certificates may be an interesting alternative, as participation rights do not carry voting rights.

Pros and Cons of Equity Financing:

Pros:

• No Repayment Obligation: Equity financing does not require repayment, which can alleviate cash flow pressure in the early stages.
• Access to Expertise: Investors often bring valuable experience, industry knowledge, and networks that can aid the company’s growth.
• Alignment of Interests: Investors share in the company’s success, aligning their interests with those of the founders.

Cons:

• Dilution of Ownership: Founders give up a portion of their ownership and control over the company, which can be a disadvantage if they want to maintain control.
• Complex Valuation Process: Determining a startup’s valuation can be challenging, particularly for early-stage companies.
• Potential for Disagreements: Conflicts between founders and investors can arise, especially if strategic decisions diverge.

Tax Consequences of Equity Financing: Equity financing in Switzerland is subject to special tax rules. Funds raised through equity are not taxable as income for the company. However, a stamp duty of 1.0% is levied on the issue of shares and other participation rights, with an exemption of CHF 1 million. In connection with the increase in equity capital, certain reporting obligations to the Federal Tax Administration may apply. Dividend payments to investors are subject to a withholding tax of 35%, which can be reclaimed under certain conditions (in international relations, the relevant double taxation agreements must be observed). The tax consequences at the investor level are generally determined by the tax law of the investor's country of residence.

3. Prospectus Requirements

If debt or equity is issued in the form of transferable securities and offered to the public, the issuer must prepare a prospectus and have it approved by one of the Swiss prospectus review offices. The requirements are set out in Article 35 seq. of the Financial Services Act (FinSA). A number of exceptions apply, including if the securities are offed only to professional clients, to fewer than 500 investors, if the minimum ticket is at least CHF 100’000, or if the public offer does not exceed a total value of CHF 8 million over a 12-month period (Article 36 FinSA). Swiss prospectus law is largely in line with the EU Prospectus Regulation. Prospectuses approved by a competent EU authority can be recognized in Switzerland.

4. Comparing Debt and Equity: What’s Best for Swiss Startups?

Choosing between debt and equity financing depends on the company’s current stage, growth potential, and the founders' long-term goals. Startups with a clear path to profitability and stable cash flows may prefer debt financing to retain full control. On the other hand, high-growth startups that require substantial capital and expertise might lean towards equity financing.

A hybrid approach can also be viable, combining debt with equity to balance the advantages of both. For example, using convertible loans allows a startup to initially benefit from debt financing and later convert it into equity, aligning with the company’s growth trajectory.

Conclusion: Tailoring Financing to Your Needs

Navigating the financing landscape is crucial for Swiss startups and SMEs aiming for sustainable growth. Debt and equity each have their own set of benefits, risks, and tax consequences, making it essential to choose the right approach. Seeking advice from legal and financial advisors who are familiar with Swiss regulations can help ensure that your financing strategy aligns with your business goals while minimizing tax burdens. With the right mix of financing, startups can focus on what matters most: Building and scaling their ventures.

Please do not hesitate to contact our experts Sebastian Wälti or Hans Kuhn if you have any questions or comments about financing options.

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