The Future of Digital Financing by Crowdinvesting

Abstract

The phenomenon of „Crowdinvesting“ – a new online means of financing for start-ups 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 2012^[1]. 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 internet^[2]. The majority of crowdinvesting platforms^[3] currently operating on the German market are start-ups themselves and their providers are mostly inexperienced 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 start-ups, there is a substantial risk that the financed projects will fail already during the crowdinvesting commitment^[4], 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 co-operative 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 combined with a firm’s employee participation plan.

Keywords:

Crowdinvesting, crowdfunding, online financing, collective intelligence, renewable energy technology, alternative financing, employee participation, agriculture co-operative society.

1 Introduction

I will begin the present essay by discussing the current development stage of crowdinvesting in Germany. By doing this, I will also refer to the currently applicable legal framework, which has remained unchanged since the introduction of crowdinvesting. At present, a significant action by the government to address the issue of crowdinvesting is not to be expected. Theoretically, crowdinvesting has great potential: It is a modern internet-based financing tool that exploits the sociological principle of collective intelligence -„The whole is greater than the sum of its parts“^[5] - using modern information and communication technology. Crowdinvesting is the answer of the collectivity of internet users to a crumbling financial sector, where traditional structures are not efficient (anymore) and banks, following the last financial and economic crisis, have lost the trust of the public. Thanks to crowdinvesting the crowd comes together and makes it possible, again, to fund interesting projects. Meanwhile, the banking sector has become aware of its compromised status and many banks are trying, sometimes with a fawning attitude, to win the favor of the population back and restore confidence. In reality, the banking sector is like a wolf in sheep’s clothing and especially the biggest institutes will not learn from experience. On the other hand, smaller banks, and particularly the co-operative system of agricultural credit banks (Raiffeisenbanken), have the chance, thanks to the close relationship they have with their members (associates), to change and move in a new, modern direction and act as a link between savers and small and medium enterprises looking for capital. In fact, crowdinvesting and co-operative societies clearly share a lot of similarities. Introducing crowdinvesting in the already existing structures of the co-operative banking system would represent a major breakthrough for online financing. Provided that the crowdinvesting scene became more professionally organized, in the future this new means of financing could be used to fund not only companies, but also environmental projects, projects for the employment of renewable resources, as well as municipalities’ investments (kindergartens, schools). In the present essay I shall discuss all these alternative applications of online financing. Before concluding it is important to point out that no extensive academic literature is available on the subjects of Crowd Intelligence and Crowdinvesting^[6], which demonstrates how both with this essay and with my dissertation about the Opportunities and Threats of Crowdinvesting I am investigating a new field of research.

2 Crowdinvesting State of the Art

Since 2011, this new financing tool for start-ups called crowdfunding, or more precisely crowdinvesting, has been gaining momentum in the USA as well as in some Western European countries. Originally, the core idea behind this phenomenon was to provide financial support to artistic and cultural projects in the field of creative economy without excepting anything noteworthy in return. Now it is progressively developing into an actual form of corporate financing for companies operating in many different branches. The father of online funding is Jeff Howe^[7], who in 2006 published an article in Wired magazine putting down in black and white that a new movement he called „crowdsourcing “ was emerging. This represented the starting point of a phenomenon whose rapid evolution has continued to date. In the financial sector, this has brought two new terms: crowdfunding and crowdinvesting. Crowdsourcing is the practice of providing services by soliciting interactions and contributions from the crowd. By means of information and communication systems based on Web 2.0 technology, a multitude of intrinsic as well as extrinsic agents is integrated in a collaborative and competitive structure where each member contributes with his or her personal and unique knowledge^[8]. Unlike crowdsourcing, crowdinvesting does not exploit the wisdom, creativity or productivity of the crowd of internet users, but rather its willingness to provide, along with an enormous number of other so-called crowd investors, financial support to companies in order to help them raise enough capital to realize their investment plans. This is done via specific online crowdinvesting platforms that through interactive processes bring together two separated groups: on the one side companies seeking capital and on the other crowd investors with capital available. It has come to such an interaction because both groups lack/need something. The companies in question are mainly small enterprises or start-ups, which as such have always had a hard time realizing their ideas due to a shortage of own funds. Against a backdrop of reluctance on the side of the banking system to grant them much needed credits, this need for capital represents an increasingly urgent issue. With the introduction of Basel III in 2014, this trend will certainly not be reversed.

[...]

^[1] See http://netzwertig.com/2014/02/06/crowdinvesting-2013-wachstum-deutschen-marktes/, retrieved 7/02/2014.

^[2] See Schenk, Rainer, Legal Aspects of Crowdinvesting in Germany, 2012.

^[3] At the moment, the market is shared between 4 crowdinvesting platforms (Seedmatch, Bergfürst, Innovestment, Companisto).

^[4] The average commitment period for a crowdinvesting participation is currently 5 to 7 years.

^[5] See Aristoteles

^[6] This also explains the limited amount of reference sources used to write the present essay.

^[7] See Jeff Howe: The Rise of Crowdsourcing in www.wired.com. June 14, 2006. Retrieved 1/08/2012.

^[8] Nicole Martin, Stefan Lessmann and Stefan Voß, Crowdsourcing: Systematisierung praktischer Ausprägungen und verwandter Konzepte. [Crowdsourcing: A systematization of its forms and other related concepts]. Institut für Wirtschaftsinformatik, Hamburg University, 2008.