When it comes to highlighting the dangers involved in investing via crowdfunding, Protonet is a case in point. The Hamburg-based server maker had collected more than €3 million ($3.3 million) in funds from online investors through crowdfunding website Seedmatch. But the call for funds ended abruptly early this year, when Managing Director Ali Jelveh was forced to file for insolvency.
"In terms of additional follow-up funding," Protonet "could no longer convince investors," the founder company wrote in February. It was bad news for the investors, who had been inspired to invest by Protonet’s business model and who had now lost their money.
It goes without saying that investments in young companies bear a higher risk than those in established corporations. But, ironically for Protonet, research shows that companies that seek funds through crowdfunding, where firms invite small or large contributions through web platforms such as Seedmatch, are normally more stable.
"There were failures with 13.5 percent, or 43 out of 318, of the cases of funding acquired through crowdinvesting portals," according to a German government study. "Overall, the viability of startups financed through crowdfunding is higher than that of other startups," it found. Germany’s KfW development bank estimates that the default rate is usually just under a third.
Investors would be better off if issuers would use stocks and bonds instead of subordinated loans.
The study was an evaluation of the country’s Small Investor Protection Act. It has been in force since July 2015 and was created after thousands of unprotected small investors lost money over the failure of wind farm operator Prokon. It was enacted alongside special rules for crowdfunding, which come into force if the investment target is less than €2.5 million. Each investor may invest a maximum of €10,000 per crowd project, provided he has a minimum of €100,000 in disposable assets or invests no more than twice his average monthly net income.
But the rules are not enough for the crowd-financing lobby, as emerged in a hearing before the finance committee of the German parliament on Wednesday. The National Crowdfunding Association advocates increasing the issue threshold to €5 million. The association tried to reinforce its argument with the fact that previous projects had paid off.
It names nine crowdfunding platforms, such as Companisto, Fundernation and Zinsland, in its analysis. According to the association, more than €167 million has been invested in 231 projects since 2014. On average, investors earned 5.25 percent interest on €100 of invested capital; about 18 percent of the financing was repaid; and 3.5 percent was lost due to failures. Based on previous experiences, said association chairman Jamal El Mallouki, a total loss among the remaining 78.5 percent is "very unlikely."
Increasing the limit to €5 million would make it possible to fully fund projects through the platforms. At the moment, most firms opt to gather funding from other sources of capital as well as the crowd. However, the government study does not see any reason for an increase. Its evaluation of the projects showed that almost 80 percent of issuers collected less than 80 of funding via the crowd. Less than 2 percent had exceeded the threshold of €2.5 million.
Andreas Oehler, a professor of economics at the University of Bamberg, believes that special rules for crowdfunding are superfluous. In an opinion piece on digital financial investment in Germany, which he prepared for the Federal Ministry of Justice, he argues that only with the help of uniform regulations can the gray capital market be dried out and "the best possible comparability for investors be established."
He describes as “fatal” the fact that most crowd financing is in the form of subordinated loans because it means that investors are taking high risks. If the issuer becomes bankrupt, they must get in line behind other creditors when lodging their claims. According to Mr. Oehler, the chances of these investors getting their money are slim.
Investors would be better off if issuers would use stocks and bonds instead of subordinated loans. However, this was not an option in the past, because of the requirement to prepare a prospectus, a regulated document. Now the federal government is weighing the idea of dispensing with the prospectus requirement for issues of up to €1 million. Mr. Oehler would welcome this. "However, this rule should apply in principle - and not only if the money is used to finance crowd projects," he said.
Another problem is real estate investment. According to the study, €110 million was raised in crowdfunding finance between 2011 and 2015, but only two-thirds of it was used to back startups, with one third going to real estate. The study argues that this goes beyond the legislative intention.
This is a mistake, according to Frank Noé, CEO of real-estate crowdfunding site Zinsbaustein. "Just a few years ago, investing in real estate was primarily reserved for family offices and institutional investors," he said. Crowdinvesting has democratized this form of investment, he added.
Frank Drost is a Handelsblatt Editor in Berlin, covering financial supervision and banks. Katharina Schneider is a correspondent in the finance section of Handelsblatt based in Frankfurt. To contact the authors: [email protected], [email protected]