crowdfunding

Crowdfunding, literally translated as swarm financing, is a form of funding that usually occurs via unique internet platforms.

There, companies or projects are presented and advertised. The aim is for a large number of investors (the “crowd”) to jointly finance these projects.

The operators of the crowdfunding platforms select the projects and companies to be presented on the forum, decide on the type and structure of the financing and often carry out an independent evaluation (“rating”) of the project.

Finally, they bring together the capital-seeking companies or project owners (the borrowers) and the investors (the financiers).

The crowdfunding instrument is used in particular by those companies that cannot or do not want to raise the necessary funds for the realization of their projects in a conventional way.

In addition to bank loans, venture capital, business angels, or subsidies, crowdfunding opens up another source of financing, especially for creative, cultural, and social projects, but also for raising capital for start-up companies in the early start phase (“seed phase”).

As a rule, in the run-up to a project, a minimum sum required for the realization is defined, which must be reached within a certain period. Otherwise, the crowd, i.e., the investors, should be reimbursed for any amounts already paid.

A prominent example of crowdfunding is the feature film based on the TV series Stromberg. In December 2011, the production company called for the film to be financed online.

The company wanted to collect one million euros by March 2012. This goal was achieved within a week.

What types of crowdfunding are there?

Crowdfunding platforms and the participation opportunities offered are very diverse. In practice, there are essentially four models today:

Crowd investing

In crowd investing, the investor receives either a share of future profits from the funded project or if the investment involves securities investments, shares, or debt instruments.

Crowdinvesting is usually implemented via profit-participating loans. Characteristic of this is the subordination of interest and repayment claims in the event of insolvency.

Crowdlending (credit-based crowdfunding)

With crowdlending, an internet platform usually mediates the conclusion of a non-subordinate loan agreement between a bank (lender) and the project owner (borrower) seeking a loan.

The bank, in turn, sells the repayment claim from the loan agreement – directly or via an intermediary – to individual investors (the crowd) using the Internet platform.

The investors (lenders) receive a promise that the amount will be repaid to them with or without interest.

Donation-based crowdfunding

The public donates money to a specific project within a certain period without receiving anything in return.

Compensation-based crowdfunding

The donors receive a symbolic, non-monetary consideration, such as their name being mentioned in the credits of a co-financed film or personal belongings of the artist whose work was co-financed.

Since you do not receive any financial consideration for your donation-based or consideration-based crowdfunding investment, these two forms do not qualify as financial investments.

In terms of supervisory law, BaFin, therefore, focuses on the two forms of crowdlending and crowd investing. The following statements and information also refer to these two crowdfunding models.

What opportunities and risks are associated with crowdlending and crowd investing?

Crowdfunding can offer benefits to both funders and funders. It is an additional opportunity for companies to close financing gaps and test their projects on the market.

Donors can specifically support exciting ideas and projects, including those in which private investors have not been able to invest.

However, there are also risks associated with this form of financing. Therefore you should note the following:

• You do not invest in the platform but the project of a third party that the platform has included in its offer. Advertising, professional representation, and confidence-building measures by the platform operator as an intermediary should not obscure the fact that you have to trust the project initiator. This applies in particular if the platform assigns independent evaluations for projects in which it regularly has a commission-related interest.
• A total loss of the invested funds is possible. With the subordinated loans often offered in crowd supporting, your capital can also be used to prevent the complete loss of other creditors. The company can refuse repayment and interest payments if this would trigger an insolvency reason.
• In other words, a company can use up all of the subordinated capital before it even has to file for bankruptcy.
• If the supported company or project falters or fails, in the worst case, you will lose all your deposited funds. Especially with start-up companies, the risk of bankruptcy is more significant than with companies already established themselves on the market.
• As an investor, you usually have no say in the matter. This means you make your money available to the company similar to a shareholder without receiving comparable information or control rights by law.
• In contrast to a shareholder, you also have no voting, co-determination, or instruction rights. Therefore, pay attention to the exact structure of the contracts and find out about the respective form of financing.
• The terms depend on the specific project. Especially with maturities of several years, you as an investor should check whether you can do without your money for that long.
• Remember that you often cannot get out at all or only with losses, especially if the borrower should get into a crisis. Find out from the provider under what conditions you can sell your participation.
• Make sure what happens to the money you have invested if the required sum for a project does not come about, for example, because there are not enough investors.
• Platforms may retain some amount to cover their costs. As with all investments, you should get an overview of the cost and fee structure of the respective offer.
• Be aware that most crowdfunding platforms do not require BaFin approval but mainly act as financial investment brokers within the meaning of the trade regulations. These offers can thus be assigned to the gray capital market.
• Investments in the gray capital market are not inherently associated with a greater risk. They are by no means dubious per se, but unfortunately, it is also easier for hesitant providers to sell their products or embezzle deposited funds.
• In addition, providers of the gray capital market are not subject to statutory security schemes.

Before making an investment decision, you should carefully weigh up the associated opportunities and risks. If you do not receive clear and specific information from neutral and trustworthy sources, you should be particularly attentive and careful, despite asking questions and doing your research.

You are responsible for choosing a product that corresponds to your risk tolerance and investment goals. You should pay attention to both the form of financing and the investment property.

In particular, you should compare not only different crowdfunding projects when making your decision but also consider other forms of investment.

What costs and fees can I incur with crowdlending and crowd investing?

Typically, investors can invest an amount of their choosing. However, a certain minimum investment amount is often required, often in the low three-digit range.

In addition, private investors may incur the following costs, for example:

• There may be costs for registering and using the platform.
• The platform may charge a surcharge for investing (agio).
• It is also conceivable for the platform to share in the generated proceeds, for example, from the sale of a co-financed start-up company.
• Other parties may also receive commissions or fees, for example, for sales or the system’s design.

Be wary if you are not offered information about costs and fees or if they are unclear.

What do I have to consider with crowdlending and crowd investing?

Investors willing to take risks should invest in crowdfunding projects since a total loss of the funds deposited is possible if a project fails.

Even if you can often participate with relatively small amounts, you should make sure you can cope with losing your invested capital.

You should definitely understand the business model if you want to invest in a project or company. You should, therefore, critically examine the underlying business plan.

You should also find information about the platform, provider, and product on the websites. Risk information and contract terms should be easily accessible. If not, caution is advised.

If, despite asking questions and doing your research, you do not receive clear and specific information, you should be particularly attentive and cautious.

Once a contract has been signed, it becomes difficult to withdraw from the investment without incurring losses.