German Crowdfunding Law Has Implications for Angels

By Krista Tuomi, Associate Professor, American University

European crowdfunding laws and experience provide some background on how crowdfunding might work in the US. One of my earlier blogs dealt with some implications of equity crowdfunding for angels, drawing on the experience of Sweden and the UK. It highlighted some concerns about crowdfunding, particularly the low success rates for complex products and those that require follow on financing.  Despite tax and co-funding sweeteners, repeat investment has been low.  Only 17% of Swedes crowdfunded more than once, slightly lower than the 24% reported by a Scottish Crowdcube survey.  Another oft-mentioned concern is that “naïve” investors will get burned, leading to regulatory backlash.  Recent events in Germany may be a test case of this.

Germany has about 80 crowdfunding platforms offering various funding options, the most common being a subordinated profit-participating loan.  By May 2015 portals such as Seedmatch, Companisto, and Innovestment financed more than 174 projects with a volume of almost  €41 million.  A recent study found that few investors have made a return on these investments, however. Of the 86 German projects surveyed only four enjoyed a premature exit through follow-on VC financing. When T-Venture invested in the start-up Smarchive for example, investors could obtain a 25% return by accepting the re-purchase offer.  In 22 other cases, the projects actually went through some form of insolvency procedure.  A particularly prominent failure was that of clean energy developer Prokon, an event which influenced the recent legislation passed by the German government.

The new Small Investor Protection Act attempts to protect investors while still fostering the industry. The pros?  Unlike the rules outline in the American JOBS Act, the German government does not impose any resale restrictions and currently has no limitations on advertising (apart from requiring a warning notice). Also unlike the US, there is no aggregate investor limit.  The aggregate limit is a problematic aspect of the JOBS Act since it will be difficult to enforce and tricky for platforms to administer.  Moreover, it would restrict investors’ ability to manage risk through portfolio diversification. (Of course a diversified investor would not focus on a single investment field like crowdfunding anyway.) 

The Cons? For investments exceeding €1,000 investors will have to confirm they are investing no more than twice their monthly net income OR that assets of at least €100,000 are easily available to them. The maximum amount per investment is €10,000. These rules apply even to angels and venture capital funds, unless they are corporate entities. Although sophisticated investors represent about 15% of the market, they contribute 76% to market volume. If they are unwilling to provide their financial data this could substantially slow the growth of the crowdfunding market.

It is important to watch the impact of this regulation - for the seventeen US states which now allow some form of equity crowdfunding, the ones considering legislation in this area, and of course any national unaccredited crowdfunding rules that are eventually implemented.