10 things we did (not) realize in respect of the new entity with variable capital introduced in Bulgaria

On 1 August 2023 the most recent amendments to the Bulgarian Commercial Act were promulgated in the State Gazette, which introduced a new type of commercial entity – the company with variable capital (“VCC”). The changes were long-awaited by the business as they provide for an opportunity to apply a large number of structures which are well-known and commonly used in other jurisdictions outside of Bulgaria and which give an opportunity for flexible solutions, aiming to support the long-term growth of start-ups. The following specifics concerning the VCC are worth mentioning explicitly:

• The capital of the VCC is not subject to registration with the Commercial Register
• Simplified procedure for valuation of in-kind contributions compared to all other types of companies
• introduction of the possibility to offer share options to employees and other third parties, as well as to attract capital in the form of convertible loans
• simplified procedure for transfer of shares compares to an LLC
• management by a management board or director(s) which may be, in each case, natural persons or legal entities
• regulation of the possibility to agree on transfer restrictions and special transfer rules.

In any case, in order to understand the potential of the new regulation, it is recommendable to pay special attention to the following:

1. 49 employees or up to 4 million Bulgarian leva

VCC may be incorporated for an entity with less than 50 employees and a turnover or asset value of up to 4 million Bulgarian leva. During the past years we have seen that most of the companies in the technological and IT sector grow at a rapid pace and very often within a period of less than 2 years manage to attract and employ hundreds of employees. Based on this, the restrictions concerning the total number of employees will lead to the VCC being a possible option for entities only short term.

If the general meeting of the VCC establishes during the annual general meeting that the above thresholds have been exceeded, the VCC shall be transformed in one of the currently existing “standard” company forms, such as an LLC or a JSCo by the end of the year, following the year of the relevant general meeting. Eventually this means that the VCC has around 2 years after having exceeded the thresholds to undergo and complete the transformation. A failure to undergo a transformation when the requirements for this are met, may lead to involuntary liquidation of the VCC.

2. A bank account is (not) needed

A VCC will not need a special capital account for its incorporation. This has been promoted as one of the main benefits concerning VCC. However, to the extent there are indeed certain benefits related to this, it shall be noted that any company needs a current account in order to be able to operate (pay salaries and remuneration to suppliers, service providers and other contractors). Thus, the benefits from this simplification will be short term.

3. Capital and shareholders which are recorded in the company books only and ultimate beneficial owners (“UBO”), which shall be registered with the Commercial Register

The capital in a VCC is not subject to registration with the Commercial Register and may be distributed in shares, each of which with a value of no less than BGN 0.1. The shares may be distributed in one or more classes of shares. In this respect there are two main things to be considered:

• the company shall have full clarity of the capital structure and distribution at any given time
• changes to the capital which concern the UBO or the chain of ownership which leads to the UBO will have to be registered with the Commercial Register in compliance with the old 7-day-term under the Act on the Commercial Register and Register of Non – profit legal entities.

Moreover, we can for sure assume that all investors and banks would like, at any time, to be provided with up-to-date information about the ownership of the company, which should usually be supported with official documents.

It is also worth noting that only shareholders who have been entered into the VCC’s shareholders books until the last day of the previous month will be entitled to vote in any given general meeting of shareholders. New shareholders shall be recorded within 7 days after delivering of information about their becoming shareholders to the company. As a starting point, the documents to be provided as evidence have not been regulated explicitly. This should potentially take place in the company’s constitutional documents. Further, a lot of time may pass between the moment of transfer and the moment of notifying the company thereof. To the extent this time is not limited by law, the recording may last for very long. After being notified of a transfer the VCC may further wait for the expiry of the 7- day- term in order to record a new shareholder and by doing this to influence the composition of the general meeting of shareholders. To the extent the law does not regulate any sanctions for delays, it is possible for the person who is responsible for the recording, without being subject to any sanctions, not to register the new shareholders also after the expiry of the 7-day.

Considering the absence of any regulation to the contrary, it seems that until the recording of the new shareholder takes place, the old shareholder would still be entitled to vote in the general meeting, regardless of the fact that it has transferred its shareholding. This requires the transferor and the transferee of the shares to enter into additional arrangements in order to regulate their relations for the time between the signing of the transfer documents and the perfection of the transfer in a way to ensure that their interests are safeguarded. It would also be recommendable to provide for maximum terms for registration of any transfer which shall depend on the signing of the transfer documents (and not the delivery of information about the transfer to the company) and sanctions for the responsible individuals in case they breach the deadlines for reasons which are due to them.

4. Valuation of in-kind contributions without a procedure to be followed before the Commercial Register

The procedure, which concerns the in-kind contributions in respect of the other types of entities requires 3 experts to be appointed by the Registry Agency, which in its hand uses lists of approved valuators. The new regulation an in-kind contribution in a VCC requires a valuation by 3 valuators to be appointed by the company, and not the Registry Agency.

It shall be noted that the law does not set out any requirements applicable to such valuators. Nevertheless, it seems fair to assume that the same criteria should be applied which are currently applied for the appointment of experts – they shall be valuators with the required professional qualification that further meet certain independence requirements.

Apart from the above the simplification of the procedure is likely to contribute for speeding up the capital increase procedure and shall, therefore, be welcome.

5. Preferences and other special rights

The new, more detailed regulation of the potential preferences which may be agreed for shareholders reflects practices which have been applied in other countries for quite a while. Transfer restrictions, rights of first refusal, tag along and other drag along rights have been mentioned. A similar regulation would be most welcome also in respect of the remaining corporations and not only for a VCC, since it merely reflects what has become a rather common market practice which requires regulation in the law.

In this respect, it shall be noted, that the initial documentation concerning such special rights will require special attention and careful consideration since it will be decisive for the whole existence and development of the company.

Further, it shall be noted that all such arrangements shall be considered when (in fact before) the VCC undergoes transformation of the legal form in order for the shareholders to assess to what extent and how would such arrangements be transferred to the company after the reorganization. Considering the current wording of the law, it seems that the growth of the company and the related mandatory change of the legal form would affect or even lead to the termination of the validity of some arrangements (e.g., convertible loans, employee option plans or the possibility for the VCC to acquire its own shares). It is highly recommendable to consider the reorganization and its potential implication in the very beginning when putting in place the first constitutional documents.

6. Transfer of shares by agreements in simple written form

The stricter requirements concerning the form of the agreements and the related resolutions of the general meeting are generally provided for in order to mitigate the risk of fraud. The regulation of the VCC provides that the shares in the VCC may be transferred by an agreement with notary certified signatures. The certification of the content which is required in case of transfer of shares in an LLC does not apply. This would indeed solve a number of practical challenges, in particular, in case of certifications abroad. Further, the law provides for an option to waive the special form requirements and to transfer the shares by agreements signed in simple written form. This will without any doubts speed up the process and reduce the transaction costs, whereby, at the same time, it will increase the level of risk due to the absence of a notary to confirm at least the identity of the signatories.

7. Inheritance of shares and acquisition of own shares

The inheritance of shares and the admission of the heirs as shareholders in the VCC will take place by law, based on a notification and does not depend on a resolution of the general meeting (as is the case in an LLC), except where the heir refuses to become a shareholder.

This decision will definitely resolve a number of practical challenges and partial unfair positions. On the other hand, the new regulation does not include any rules as to how should the value of the shares be determined (as is the case with the LLC, where the law explicitly states that the value of the shares shall be determined as of the end of the month of termination of the participation and based on the balance sheet of the company – something which is by far not always fair but at least it sets out clear rules concerning the valuation rules and methodology).

It shall be noted that according to the new regulation the relevant moment to determine the share value is the time of termination of the participation and not, as in an LLC – as of the end of the month of the termination. It is also unclear, when a shareholder is diseased and its heirs do not wish to enter the VCC, which will be the relevant moment in time for the valuation – the time of death or the time of the refusal.

The possibility for a VCC to acquire its own shares has been regulated explicitly. This will also contribute for additional flexibility and as such should also be considered for an LLC.

8. Options and convertible loans

The share options and the convertible loans have been regulated explicitly. In this respect it shall be noted that the convertible loan is not something totally new under Bulgarian law – any loan may be contributed in-kind in the company’s capital also under the current regulation. The new regulation is not very detailed – it includes one paragraph which may open room for flexibility or to some controversial and arguable practices. It seems that the purpose is to contribute for the possibility, based on preliminary arrangements between the parties, for a loan to be converted into equity without complying with a large number of formalities.

A separate provision regulates the share options to employees. It seems that this regulation shall be considered as a special one which may only be applied vis-à-vis employees only and not third parties. It shall also be noted that the law does not use the term employee but rather refers to hired person, which may also relate to third parties.

9. General Meeting – by electronic means of communication, invitations by e-mail and no later than 30 June

The possibility of communicating with the shareholders regarding the general meetings by electronic means is also provided for – something that should be considered an extremely positive change which had to take place long before  2023. This legal framework is also among those that should also be adopted in other types of corporations in order to reflect the communication development over the past decades.

It is worth noting that the general meeting is to be held by the 30th of June, considering that after the annual financial statements’ publication deadline was extended to the 30th of September after Covid-19, most companies started holding their regular annual general meetings in September.

10. Management flexibility

The new regulation introduces the possibility of electing a board of directors, through which larger investors can, should they choose so, be granted a more significant involvement and control of the management activities, or the company can operate by single managers – as is the case of LLCs. The board of directors may include, similarly to a JSC, both natural and legal persons. Based on the references in the law, it also appears that a manager can be a legal person and not only a natural person.

These new options should also be considered a positive change as they provide an opportunity for more flexible structures.