Crowdinvesting has recently become an increasingly popular option for start-ups in Germany to raise capital and has gained attention from investors and the media. With a regulatory framework currently in the legislative procedure, can Crowdinvesting become a real contender for early stage funding of start-ups in Germany? 

Crowdfunding vs. Crowdinvesting: Crowdfunding encompasses different models of funding which can be broken down into several subcategories. All models are based on the premise that a more or less large number of investors (or “backers”) provide funding for social projects or business ventures via dedicated internet platforms. The classification is based upon the type of consideration for the investor. These can be broken down in donation based and reward based Crowdfunding, loan based Crowdfunding (Crowdlending) and Crowdinvesting. 

In a reward based Crowdfunding scenario, investors/backers usually receive a symbolic non-monetary reward, e.g. a mention in the credits of a film they helped to finance. 

Crowdinvesting is geared towards generating returns for the investors. Investors receive an interest in the financed venture’s future profits or equity or debt instruments if the investment involves securities issued by the start-up. Depending on the type of financing instrument selected and the size of total funding, this could trigger regulatory issues with the German Financial Supervisory Authority (BaFin).

Despite the recent media hype, Crowdinvesting is still the smallest category of the Crowdfunding market.

Legal structure of Crowdinvesting campaigns: There are three major types of investment instruments currently used in Crowdinvesting campaigns in Germany:

• The Equity model, where the investor acquires shares in the start-up and thereby becomes a shareholder with fully-fledged shareholder rights such as voting rights;
• The Silent partnership model, which was predominantly used until the end of 2012 in Germany. The Investor is relegated to certain information rights which can be tailored to the specific requirements of the start-up.  However, the public offering of a silent partnership of over EUR 100,000 generally triggers regulatory issues such as the requirement to publish a prospectus under the prospectus legislation, which is costly and time-consuming;
• The Subordinated participating loan model: This instrument has been used since the end of 2012 and is generally not bound by the prospectus legislation. Therefore, regulatory issues should not be triggered. Another advantage of this model is that there are usually no information rights for the investor and due to subordination these loans are qualified as junior debt, facilitating future debt or mezzanine financing.

Current regulatory set-up for start-ups in Crowdinvesting campaigns: As of today, there is no specific regulatory framework specific to Crowdinvesting campaigns in Germany. Depending on the legal structure of the specific Crowdinvesting campaign, the German Securities Prospectus Act or the German Capital Investment Act may be applicable, which may trigger the obligation to publish a securities prospectus and a capital investment information sheet before the respective Crowdinvesting campaign can go live.

The German Federal Government presented a first draft law on the protection of small investors (Kleinanlegerschutzgesetz) in July 2014 imposing various regulatory requirements on Crowdinvesting campaigns, which was heavily criticized by the Crowdinvesting scene and even referred to as the “end of Crowdinvesting” in Germany.  A revised draft was published in November 2014, providing – in a nutshell – less constraining regulatory requirements for Crowdinvesting campaigns if certain conditions are fulfilled. 

As already provided for in the initial draft, Crowdinvesting campaigns structured as subordinated profit-participating loans are exempted from regulatory requirements if the respective Crowdinvesting campaign remains within a threshold of EUR 1 million per year and per issuer. The initial draft of the law on the protection of small investors provided for a maximum investment per investor of EUR 10,000. The revised draft does not distinguish between experienced investors (such as business angels) and non-experienced investors and does not offer a possibility for experienced investors to invest more than EUR 10,000. Rather, it even imposes additional restrictions on investments ranging from EUR 1,000 to EUR 10,000: the investor shall now be obligated to provide a self-reporting (Selbstauskunft) to the respective Crowdinvesting platform. 

Bottom line 
Crowdinvesting can become a promising financing tool for start-ups looking for funding, especially in seed and early stages, and could help to eliminate a bottleneck, i.e. early stage funding for new ventures. 

While an improved regulatory framework could actually benefit the Crowdinvesting business by offering protection to investors, the current draft regulatory framework imposes a considerable number of restrictions for investments in Crowdinvesting campaigns, thus making it difficult for this new funding form to become a real contender for (early stage) funding of start-ups in Germany.

Felix Wolf, Attorney (Munich)