The Future of Digital Financing

Rainer Schenk on Crowdinvesting

e-Book Cover Eric Schreyer, 02.04.2014 – Rainer Schenk on the phenomenon of  Crowdinvesting,  a new online means of financing for startups and small companies ­ developed in the USA and is now increasingly taking hold also in Europe and particularly in Germany.

By exploiting what is known as the ,,collective intelligence” of the crowd of internet users, companies seeking capital are provided with the needed funds. As a return for their monetary contribution, the so called crowd investors are promised interests and a share in the future value of the company. Throughout 2013, only in Germany about EUR 15 million have been invested via crowdinvesting in a total of 66 business projects. This represents a 250% increase compared with the previous year 20121.

With only a few exceptions, the projects financed so far via crowdinvesting have been mostly start-ups, mainly in the fields of E-commerce, Commerce and Creative Economy. Whether this form of financing will keep the momentum going and develop into a sustainable and viable funding source depends on many different factors. Among those, there is also the future attitude of the banking sector and the State towards granting credits, i.e. funds. Moreover, it remains to be seen, whether crowdinvesting can be a suitable source of funding also for already established companies of the SME sector. A survey carried out by the author in 2013 revealed that the majority of companies already established on the market are not familiar at all with this new online form of financing, yet show interest in it and would be willing to raise capital through this alternative funding method. Still, they would rather use it as a complementary financing component within a traditional financing mix.

Crowdinvesting presents both opportunities and risks. Given the gaps in the current German regulation, companies have the possibility to raise considerably high sums via the internet2. The majority of crowdinvesting platforms3 currently operating on the German market are startups themselves and their providers are mostly inex-perienced and do not hold any qualification in the field of Corporate Finance.

Furthermore the platforms’ suboptimal workflows and structures, along with a lack of compliance policies, do not offer crowd investors the necessary basis to make a safe investment decision. Given the platforms’ inadequate organizational structures and their unidirectional focus on startups, there is a substantial risk that the financed projects will fail already during the crowdinvesting commitment, thus implying a total loss of the invested sums for crowd investors.

Although one of the principles behind crowdinvesting is that every crowd investor is allowed to provide only a small amount of capital, thus making the risk for the single investor seem minimal, a project failure would lead to the loss of high capital amounts, which, in turn, could jeopardize the crowdinvesting scene as a whole. In fact, those same social networks that quickly magnify the happiness, excitement and mental as well as financial support among the crowd, can become, with that same speed and force, a disruptive social tool, able to destroy single platforms or worse the whole crowdinvesting movement.

In the digital world, the concepts of friendship and hostility are very often schizophrenically united. The present essay aims at outlining in which ways we can still exploit the phenomenon of crowdinvesting and the wisdom of the crowd, also with the purpose of bringing macroeconomic benefits. Some plausible applications for this new source of financing could be the funding of projects shaping the political energy turnaround in Germany with renewable energy sources, municipalities’ or cities’ investments, projects in the agricultural or in the cooperative banking sector. In addition, online financing could also be used within the long-term financial planning of savers and private individuals who have lost faith in the banking sector and are looking for alternative pension schemes. Lastly, raising capital via crowdinvesting could also make sense when com-bined with a firm’s employee participation plan.

eBook: The Future of Digital Financing by Crowdinvesting

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