The company-law route: hive-down under the Transformation Act or formation by contribution in kind

Master carpenter Jonas Feldmann runs his workshop as a registered sole trader. His balance sheet shows equity of 180,000 €, while the business would fetch closer to 600,000 € on the market. A large contract with serious liability risks pushes him towards a GmbH. His plan: transfer 25,000 € to a new account, move the machines and customers across informally, done. That is exactly how you end up with a GmbH that does not own the business.

Two routes, one goal: shares in exchange for the business

Anyone moving a sole proprietorship into a GmbH almost always wants the same thing. The running business, with its machines, stock, receivables, contracts and debts, is to pass to the new company, and the former owner is to receive its shares in return. The business is not sold; it is handed over in exchange for a stake.

German company law offers two techniques for this. The first is the hive-down, the Ausgliederung under the Transformation Act, in which the business passes in a single act as a whole. The second is an ordinary GmbH formation in which the business is contributed in kind and every item is transferred separately.

Both routes lead to a GmbH whose share capital is covered wholly or partly by the business. They differ in their conditions, in the effort needed for contracts and debts, and in the former owner's liability. For tax purposes both can fall under § 20 of the Reorganisation Tax Act, the UmwStG, which the second module covers.

This project must not be confused with a cash formation of a GmbH next to which the sole proprietorship simply keeps running. Someone who pays in cash and later sells the business to the company really does sell: the price is sale proceeds and the hidden reserves are realised. The transformation techniques are designed to avoid exactly that.

The hive-down from a sole trader's assets

The Transformation Act treats the hive-down as a form of division. Under § 123(3) UmwG, an entity transfers part of its assets as a whole to another entity and receives that entity's shares in return. The shares therefore go to the transferring party itself, not to third parties such as its own members.

For the sole trader, § 152 UmwG says where he may hive down to. Partnerships of merchants, corporations and registered cooperatives can absorb the business; a newly formed entity must be a corporation. The typical case in this course is the hive-down to a newly formed GmbH, which comes into existence through the transaction itself.

The great advantage is universal succession. On registration, the assets that are hived down pass as a whole under § 131(1) no. 1 UmwG, liabilities included, as the plan allocates them. No separate transfer acts, assignments or consents from each individual creditor are needed for this.

In a formation there is no counterparty with whom a contract could be concluded. Under § 136 UmwG, a division plan drawn up by the sole trader therefore takes the place of the division and takeover agreement. Through § 125 UmwG, the merger rules apply accordingly, including notarial recording under § 6 UmwG.

Under § 135(2) UmwG, the formation rules of the GmbH Act apply to the new GmbH, and the sole trader is treated as a founder. The share capital must reach the statutory minimum, and a Sachgründungsbericht must be prepared. A division report, by contrast, is not required here under § 135(3) UmwG.

Under § 17(2) UmwG, applicable through § 125 UmwG, the filing must include a closing balance sheet of the transferring entity. The court may only register if it is drawn up to a date no more than eight months before the filing. A balance sheet at 31 December therefore supports a filing up to the end of August.

When the hive-down is ruled out

The first hurdle is in the wording of § 152 sentence 1 UmwG: only a sole trader whose firm name is entered in the commercial register can hive down. Someone who runs a trade without registration can only take this route after registering, where registration is open to them. Otherwise the formation by contribution in kind remains.

The second hurdle is in sentence 2: the hive-down cannot take place if the sole trader's liabilities exceed his assets. The law looks at the trader as a person, not only at the business being hived down. An over-indebted owner is not meant to use the transformation to separate his debts from his assets.

The register court enforces this limit. Under § 160(2) UmwG, registration of the company must be refused if the sole trader's liabilities exceed his assets. Under paragraph 1, the filing is made jointly by the sole trader and the managing directors of the new company.

Before choosing this route, an honest comparison of assets and debts belongs on the table, including private liabilities such as mortgage loans. Anyone close to the line should have this checked before the notary appointment rather than learn it from an interim order of the register court.

• the sole trader's firm name is entered in the commercial register
• the trader's liabilities do not exceed his assets
• a notarially recorded division plan with the articles of the new GmbH
• a Sachgründungsbericht with the annual results and the position of the business
• a closing balance sheet dated no more than eight months before the filing

Formation by contribution in kind with individual transfers

The second route needs no Transformation Act at all. The GmbH is formed in the ordinary way, except that the founder undertakes to make his contribution not in money but through the business. This is open to an unregistered trader just as much as to a merchant, and the GmbH Act has no over-indebtedness bar like § 152 UmwG.

The price is individual transfer. Every machine must be conveyed, every receivable assigned, every contract carried over with the consent of the other party. For debts, § 415(1) BGB applies: an assumption of debt agreed between debtor and assuming party only becomes effective once the creditor ratifies it.

If a creditor refuses ratification, the assumption of debt is deemed not to have taken place under § 415(2) BGB. The founder then remains the debtor, and the GmbH is in case of doubt only obliged towards him to satisfy the creditor in time. With many suppliers, lessors and banks, this route quickly becomes laborious.

There is also a timing requirement, explained further in the course on choosing between a GmbH and a UG: § 7(3) GmbHG requires the contribution in kind to be made in full before the filing. For a contributed business, this means every individual transfer must be completed before the notary files the GmbH.

Under § 5(4) sentence 1 GmbHG, the articles must lay down the object of the contribution in kind and the nominal amount of the share to which it relates. A contribution that is not stated there is not a contribution in kind in company-law terms, however much it may be intended as one economically.

The report on the formation by contribution in kind

Under § 5(4) sentence 2 GmbHG, the shareholders must set out in a Sachgründungsbericht the circumstances that matter for whether the contribution in kind is adequate. Where a business passes to the company, the annual results of the last two financial years must also be stated.

For a hive-down, the Transformation Act tightens this content. § 159(1) UmwG refers to § 58(1) UmwG, under which the report must also describe the course of business and the position of the transferring entity. The report thus tells not only figures but also how the business has developed.

Under § 8(1) no. 4 GmbHG, the filing must include the agreements on which the stipulations are based or which were concluded to carry them out, together with the report. Number 5 requires documents showing that the value of the contribution in kind reaches the nominal amount of the share taken up.

In practice a balance sheet or a valuation statement often serves as this evidence. The law does not prescribe a form; what counts is that the court can see from the documents that the business is worth at least as much as the nominal amount the founder receives for it.

Overvaluation: register court and liability for the shortfall

The register court checks that the value is there. Under § 9c(1) GmbHG, it must refuse registration if the company has not been properly established and expressly also if contributions in kind have been overvalued by more than an insignificant amount. A generous valuation thus delays the formation instead of easing it.

If an overvaluation slips through anyway, the shareholder remains liable. If the value of the contribution in kind at the time of filing does not reach the nominal amount, he must pay the shortfall in cash under § 9(1) GmbHG. What matters is the value at the filing, not at the signing of the articles.

Under § 9(2) GmbHG, this claim of the company only becomes time-barred ten years after registration. In a GmbH insolvency it is typically examined by the insolvency administrator, who goes through the formation documents. An overly optimistic valuation can catch up with the founder years later.

The planning lesson is simple: choose a nominal amount that the value of the business covers with certainty, and treat any value above it as a reserve. A low nominal amount costs nothing, whereas a coverage gap has to be made good in cash.

Liability for the old debts

The GmbH's limited liability only works going forward. Under § 156 sentence 1 UmwG, the sole trader remains liable for the liabilities that pass in the hive-down; their transfer to the new company does not release him. Creditors gain a debtor, they do not lose one.

This continuing liability is limited in time. Under § 157(1) UmwG, the sole trader is liable for the transferred liabilities if they fall due within five years of the hive-down and the claim against him is established or an enforcement measure is taken or applied for. For public-law claims an administrative act is enough.

Under § 157(2) UmwG, the period starts on the day the registration of the hive-down in the sole trader's register is published. Paragraph 4 makes clear that the limit also applies where the former owner becomes a managing director of the GmbH, which in practice is the rule.

In a formation by contribution in kind the question arises differently: as long as a creditor has not ratified the assumption of debt, the founder remains his only debtor anyway. The limited liability of the GmbH then only covers the liabilities the company itself incurs after registration.

And the partnership? The change of legal form

Where two or more partners run the business as a civil-law partnership, an OHG or a KG, a third route is available. Under § 214(1) UmwG, such a partnership can acquire the legal form of a corporation by a resolution on a change of legal form. The entity stays the same; it only changes its legal garment.

Under § 197 UmwG, the formation rules of the new legal form apply to the change of form. The capital of a GmbH must therefore be secured here too. Transfers of assets, on the other hand, are not needed because the entity remains identical; contracts and debts stay where they are.

For tax purposes, § 25 UmwStG treats this change of form like a contribution: §§ 20 to 23 of the Reorganisation Tax Act apply accordingly. Everything the second module says about the book-value application, backdating and the lock-up period therefore also affects the partners of a partnership that becomes a GmbH.

A change of legal form is not the same as the option for corporation tax described in the partnership course. There the partnership continues to exist in civil law and is only taxed like a corporation; the option does not bring limited liability.