Editor’s Note: The following is a guest post from Karsten Wenzlaff, coordinator of the German Crowdfunding Network and a member of the European Crowdfunding Stakeholder Forum. Wenzlaff discusses the proposed crowdfunding regulations in Germany, and shares his concerns about the outcomes the proposals may have on the crowdfunding industry in the country. You can read his previous post for Crowdsourcing.org about crowdfunding in Germany, here. As always, guest contributors’ opinions are their own and do not necessarily reflect the views of Crowdsourcing.org.
The newest draft of German Crowdfunding Regulation, released by the German Government on November 10, faces increasing criticism from the German Startup Community and the Crowdfunding Industry. While trying to protect small investors, a number of prohibitions will cause huge market distortions, reduce the security of the investors while increasing the bureaucratic burden for platforms.
The Government draft has now been submitted to the Parliament, which scheduled the vote on the law for April 2015. There are increasing signs that the Parliament would be willing to change the law and make it less prohibitive for crowdfunding; however, a crowdfunding-friendly law is unlikely until the next election in 2017.
Equity-based crowdfunding has been legal in Germany for some time. Around thirty different platforms are active in this field and new platforms are entering the market every week. Equity-crowdfunding platforms for startups, SMEs, movies, and real estate have formed in Germany, making Germany one of the biggest and most innovative markets in Europe.
The large platforms have used a type of mezzanine-instrument known as Partiarisches Nachrangdarlehen – or Subordinated Profit Participating Debt. This instrument allows investors to participate in the profits. The Subordinated Debt was so far exempted from publishing a prospectus, a costly document outlining risk scenarios.
The initial draft, published in July 2014, closed this loophole in the law. However, after much lobbying by the crowdfunding industry and support from the crowd-friendly parts of the government, an exemption was created for crowdfunding platforms that mediate investments through an online platform.
The exemption allows crowdfunding projects up to €1 million to be published without an investor prospectus; however, it restricts this exemption to the subordinated debt. Other forms of equity-based crowdfunding, using equity with and without voting rights, are not exempted, even though there are good arguments in favor of using these instruments.
Compared with the initial draft, further restrictions for investors are in place. The access of so-called retail investors to crowdfunding platforms has been decreased dramatically. In the first draft, platforms could only allow investments up to €10,000 without having to publish a prospectus. Now, the limit is reduced to €1000 (no restrictions). If a platform wants to allow investments above €1000, it has to ask the investor for an income statement. If the net wealth is least €100,000, it can allow up to €10,000 as investment. If the net wealth is less than €100,000, it can allow to monthly net incomes.
To anyone outside of Germany, such complex regulation is maybe not understandable. It will most likely make the German crowdfunding market less accessible from the outside and more costly to establish a platform. It will also drive away Angels and VCs from crowdfunding platforms, simply because the platform cannot accept their investments. It is almost ironical that the German government spends millions of Euros in taxpayers money to attract VCs to the German startup industry, but makes it more difficult for large investors to invest into crowdfunding, despite them having considerably more knowledge than maybe the small-scale investor on the internet.
Having the investors declare their income to the platform was adopted with a look towards the US JOBS Act and its regulation on crowdfunding. However, given that the American equity-based crowdfunding market is still not functioning, policy makers should instead look towards the UK or France, which have not implemented such a requirement. Further information on the self-reporting can be found in an analysis here.
Another part of the regulation requires an Investment Products Information Leaflet (Vermögensanlagen-Informationsblatt). This leaflet contains the most relevant information of the crowdfunding project. Originally, the government required the investor to download the leaflet, sign it, and send it back via mail to the platform. Such a strange method for online crowdfunding met with a considerable amount of criticism. According to the new draft, the leaflet now can be signed, scanned, and sent back via email. Electronic signature is not possible, despite the government attempt to create an electronic signature for all ecommerce transactions. Given that the leaflet is not part of the contract, no one can really understand why the restrictions are so severe. The German IT Agenda still seems to be heavily influenced by people who print out their emails and file them away — otherwise such an added bureaucracy without any improvement for the investor wouldn’t be part of the law.
In addition to the added bureaucracy and the limitation on investment, the regulation discusses advertising for crowdfunding projects online. It is possible to advertise them in the printed press in Germany, but not in online media, on Facebook, Twitter, or other social networks. Imagine a digital startup which wants to engage its thousands of fans on Facebook in a crowdfunding campaign: it is not allowed to use its fan page to talk about the crowdfunding effort. Given that crowdfunding uses the internet to create transparency and awareness of risk, this prohibition of online communication seems to be coming straight from the age of stone, paper, and steel.
Other forms of crowdfunding and collaborative finance have been exempted from the new regulation. Donation-based crowdfunding, reward-based crowdfunding, and pre-selling, for instance, are not part of the new crowdfunding regulation.
Regarding peer-to-peer lending, the regulation draft says that loans to private borrowers should not be part of the law, if the bank is an intermediary in the lending process and thus selling the loans from the borrower to the lending. Some lending platforms like Zencap, Lendico, or Auxmoney employ a second intermediary, which buys the loan from the bank and then sells it to the lender. Given that the law claims to be exempting crowdlending from the upcoming regulation, it will be interesting to see if Parliament makes the necessary changes.
The law will be entered into force by July 1, 2015. The parliamentary debate is set for February to April in 2015. Crowdfunding in the current form is still possible until the end of 2015, but we expect large changes in the crowdfunding industry starting in January 2016. The German Crowdfunding Network has said repeatedly that the government should follow the examples set by other countries, such as France, UK, and the Netherlands, which have created a regulatory framework aimed to increase the volume of crowdfunding, something that the current draft is far away from. However, all hope is not lost — laws never enter the German Parliament without being changed, therefore the crowdfunding industry is in deep discussion with the Parliamentarians.
Karsten Wenzlaff is the coordinator of the German Crowdfunding Network and a member of the European Crowdfunding Stakeholder Forum. He has an Mphil from the University of Cambridge with a thesis on Financial Market Regulation and is the CEO of a private research center in Berlin.