Caveat Emptor

In German Version of Crowdfunding, A Battle Over Risks

Who's in the driving seat? The German film Stromberg was crowdfunded. Source: PR
Who's in the driving seat? The German film ''Stromberg'' was crowdfunded.
  • Why it matters

    Why it matters

    Consumer advocates want crowdsourcing to be strictly regulated in Germany but start-ups fear that will kill the industry.

  • Facts

    Facts

    • In the first half of 2014, start-ups in Germany collected €28 million ($36.2 million) through crowdfunding.
    • Eight companies financed by crowdfunding in Germany have gone bankrupt, about 3.5 percent of all crowdfunding invested.
    • A German start-up association is calling for letting firms raise up to €3 million ($3.9 million) through crowdfunding without restrictions.
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    Audio

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The appeal was a great success. Joseph Pulitzer, publisher of the New York World, promised in 1885 to print the names of anyone who donated to his fund-raising campaign to build a pedestal for the Statue of Liberty. Over the next five months, 120,000 readers contributed more than $100,000 and financing for the project was assured.

Today you might call it an early success in crowdfunding – a way to finance projects that was universally applauded in Mr. Pulitzer’s times but is viewed more critically today in Germany.

Only now, of course, the Internet is the vehicle, not newspapers. And millions of dollars, even billions, can be raised by people who sell their ideas to investors on websites like Kickstarter in the United States or Companisto in Europe.

Crowdfunding is used not only for cultural projects, like Stromberg, a German comedy inspired by the hit British series The Office. More and more, businesses are using it to raise venture capital from investors – and bankruptcies are not out of the question.

In the first half of 2014, start-ups in Germany collected €28 million ($36.2 million) through crowdfunding. That’s an increase of €15 million ($19.4 million) from the previous year. With such rapid growth, the German government faces a predicament.

On one hand, venture capital is a limited resource in Germany and needs to be fostered.  “In coming years, crowdfunding can be more important if we allow this form of financing room to grow,” said Brigitte Zypries, a deputy economy minister.

On the other hand, crowdfunding is a part of an unofficial gray capital market, where investors can lose a great deal of money in failed projects.

Germany’s governing coalition has proposed legislation to protect private investors from dangers of the gray market, but with an important exception: Finance Minister Wolfgang Schäuble and Justice Minister Heiko Mass want to take into account the concerns of young start-up companies that are financed through crowdfunding.

Under proposed legislation, companies that use crowdfunding to collect up to €1 million ($1.3 million) – and in which individual investors put up no more than  €10,000 ($13,000) – don’t have to provide investment brochures. The German consumer protection association warns that could be a problem.

“This will create special rules for a type of product that, to some extent, has already proven problematic,” said the consumer group. So far in Germany, eight companies financed by crowdfunding have gone bankrupt – involving about 3.5 percent of the total money invested.

The Association of German Chambers of Commerce and Industry is a vigorous advocate of crowdfunding. It fears that political meddling could put the brakes on dynamic growth.

Lutz Raettig, spokesman for a Frankfurt-based investment initative, also is wary of exempting companies from legislative provisions designed to protect small investors. He acknowledges that on the surface crowdfunding is a fascinating idea.

“But we need an organized market to make this kind of financing possible over the long term,” he said. For now, he believes regulations should be established by stock markets with the help of financial supervisory agencies or political bodies on the level of the European Union. “That will limit crowdfunding in favor of promoting the security of investors,” said Mr. Raettig.

In contrast, the Association of German Chambers of Commerce and Industry is a vigorous advocate of crowdfunding. It fears that political meddling could put the brakes on dynamic growth.

The German Start-Ups Association agrees. “Particularly in the seed phase, the earliest operational phase after their actual establishment, start-ups have no access to international capital and are dependent on domestic sources of financing,” the association said. The start-up group calls for allowing up to €3 million ($3.9 million) to be raised – with no restrictions on the amount of individual investments and online advertising.

In his new book on the subject, Ralf Beck, professor at Dortmund Technical College, argues that national economies depend on transforming innovations into marketable products, and that crowdfunding offers an effective way to close the gaps in financing. He observed that big lenders like banks often only offer money when start-up companies are up and running – and the money is no longer actually needed.

This article was translated by George Frederick Takis. Greg Ring also contributed. Frank M. Drost is a Handelsblatt Berlin correspondet, he writes about banks and politics. To contact the authors: drost@handelsblatt.com landgraf@handelsblatt.com and braecher@handelsblatt.com

      

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