Investment Opportunities via the Crowd

Forms of investments and strategies

Equity crowdfunding and crowd lending

10 minute read

Nowadays, private investors increasingly invest via the internet and as part of a larger group of investors – the so-called crowd. Founders, project developers, and creatives raise money via crowd financing on the internet. The market for crowd financing started as a niche market years ago but has grown consistently ever since. According to a study of the portal Für Gründer, around €145 million were raised via the crowd in 2016. This represents a 28% increase in comparison to the previous year.

There are different forms of crowd financing: crowdfunding, crowdlending, and equity-based crowdfunding. Artists and musicians in particular use donation- or return-service-based crowdfunding in order to realize their projects. The crowd receives a symbolic gesture of thanks (e.g. in form of a CD or a book) instead of a financial return for their support.

Founders and project developers, on the other hand, utilize equity crowdfunding and crowdlending in order to raise the capital needed. Here, private investors expect a return on their investment. For them, these investments have the advantage of relying on the collective intelligence of many investors. In addition, entry barriers for private investors are low, so that they can participate in growing markets that were previously closed to those with little capital.

 

Lending used to be the core business of banks. However, as financial institutions have been neglecting this area since the introduction of low-interest rates, the crowd has opened up a niche in this segment through so-called crowdlending. In crowdlending, private individuals grant loans to other individuals or companies via credit platforms.

The term peer-to-peer lending is used for lending to private individuals, while peer-to-business lending is used for lending to companies. While private individuals use the loans mainly for further education and private use, small and medium-sized companies borrow money for the expansion of their production facilities or the development of new products.

For them, crowd financing is an alternative to bank credits, since it is more flexible and quicker. In addition, this form of credit lending incurs less administrative effort than classic bank credits. According to an industry report by Für Gründer, self-employed persons, entrepreneurs and founders received around €76.7 million in 2016 via the crowd - about 15% more than in the previous year.

The most popular credit platforms in Germany are Auxmoney, Lendico and Funding Circle. The platforms review the credit applications of private and corporate borrowers. They allocate the loan applications to a certain risk category on the basis of the applicant's creditworthiness and assign an interest rate to them. They then determine a term and then submit the offer to the crowd. If there are enough donors, the loan is made available.

The minimum investment amount for retail investors is €25–100 depending on the provider. The terms of the loans range from 6 months to 5 years. Small investors benefit from the interest that the borrower has to pay in exchange for the loan. Depending on the platform, borrowers pay a brokerage fee of between 0.25–5.0%. Lenders also pay a 1% service fee on all interest and principal payments.

Interest on the credit varies by the creditworthiness of the borrower. A few platforms have introduced different creditworthiness levels to classify borrowers by. The interest is usually paid monthly, sometimes also quarterly. The financing volume differs depending on the crowdlending platform and ranges from €1,000 to €2.5 million.

Crowdlending offers private investors good return opportunities but is also associated with risks. The core risk is the potential that loans are not repaid on time or can even be canceled completely. If private individuals or companies go bankrupt, investors face the risk of total loss of their investments. On some platforms, collateral can be deposited so that a partial loss is covered.

In order to minimize risk, retail investors should not place their fortune in one single crowdlending project but rather spread it among multiple projects. Additionally, they should scrutinize the offers carefully. What will the credit be used for? Is a timely repayment probable when considering the creditworthiness of the borrower? Generally speaking: The higher the offered interest rate, the higher the probability of loan default.

 

In equity crowdfunding, many investors participate in a project together. These can be real estate or energy projects, or they can be investments in startups and growth companies. In return, they receive a pro-rata share of profits or exit participation, through which they benefit from the sale of the startup.

In 2016, the equity crowdfunding market increased by 58% in comparison to the previous year and generated a turnover of €60 million in total. One distinguishes between crowd financing for startups, energy, and real estate projects.

 

Real estate equity crowdfunding

In real estate equity crowdfunding, private investors gather as a crowd to finance the realization of a construction project. They can participate in the development of the real estate sector with small amounts, which used to be possible only with large capital investments and via real estate funds or shares.

Crowd investors partially finance an existing property or a real estate project via a loan. In return, they receive an annual interest rate of 4.5–7.5%. The minimum investment amounts are between €100 and €1,000 depending on the provider. The terms of the loans range from 18 to 36 months. Well-known representatives of this sector are Exporo, Zinsland, and Zinsbaustein.

Private investors participate in real estate crowdfunding via mezzanine capital in the form of subordinated loans. In the event of a failure of the construction project, the first ones to be paid out are major creditors such as banks. In order to strengthen the rights of crowd investors here, some providers have further developed the format. They make subordinated entries in the land register and appoint trustees to represent the interests of crowd investors.

In order to minimize the risk of a real estate crowdfunding, private investors should never invest their entire assets in one real estate project but should spread their risk as broadly as possible. In addition, they should also look for offers for the latest possible entry in the project if cost and approval risks have already been eliminated. The property developer's voluntary commitment can also be a positive factor. If he has invested in the project himself, this shows that he believes in the success of the project.

The market for real estate crowdfunding grew strongly in 2016, according to a market survey conducted by the information portal crowdfunding.de. The total financing volume amounted to €63.8 million, which represents an increase of 39% compared to the previous year. Equity crowdfunding platforms that specialize in real estate projects generated sales of €40.3 million last year. This corresponds to an increase in sales of 92% compared with the previous year.

 

Energy crowdfunding

Through equity crowdfunding, retail investors can invest in energy projects and thus promote the energy revolution. The crowd can invest in both energy efficiency projects as well as in sustainable energy production. Energy efficiency projects are intended to reduce costs and energy.

Projects for sustainable energy production for electricity and heat primarily focus on regenerating energy sources like wind, sun, and biogas and advertise with their reduction of greenhouse gases like CO2. Among the largest providers of energy investments are bettervest, econeers, and LeihDeinerUmweltGeld.

Retail investors who want to participate in energy projects invest in the construction of photovoltaic systems, biomass heating plants or wind power plants via subordinated loans. They receive an annual return in form of a fixed interest rate between 4–8%. This too is venture capital that is associated with respective risk. A core risk in energy investments is that the investment shows poor performance and does not operate economically.

Another risk is that government subsidies for renewable energies may cease, as has been the painful experience for solar panel investors in Spain and Italy in the past few years. In Germany too, the so-called EEG levy may turn into a problem for investors, for example, if the EEG debtor – i.e. the network operators, energy suppliers or direct intermediaries - who distributes the EEG levy has to declare insolvency.

In order to mitigate this risk, retail investors need to differentiate between the offers. There are projects for the construction of new energy plants as well as projects for the further development of existing plants. The latter’s default risk is lower since the plants have already proven their functionality and economic profitability. As always in venture capital, investors should not invest their entire savings in energy projects and should spread the invested sums among varied projects if possible.

 

Startup equity crowdfunding

Imminently after their founding, young companies often face the problem of not owning enough capital for quick growth. While capital is necessary for startups to implement their business ideas, smaller and mid-sized growth companies need the money in order to launch a new product range, to expand their production facilities, or to finance the expansion abroad.

In order to bridge this venture capital gap, many companies are increasingly turning to the crowd – with great success. According to the information portal crowdinvest.de, more than €70 million have been made available by the crowd. At around 73%, the majority of this capital is still active. In 2016, the financing volume for startups and growth companies was around €18.8 million and played a major role in providing capital to innovative business ideas.

On Companisto, investors find a variety of investment opportunities in order to participate in startups and growth companies. During a campaign, the crowd investors can converse with other investors and the founders. The investment threshold of each campaign – i.e. the minimum financing goal – is at least €100,000. If this financing goal is not met, financing will not occur and all investors will get their money back.

Beyond this, the startup defines its own financing goal and announces how it wants to use the means earned. Investors who invest their money in a startup or growth company can make returns in a variety of ways. Investments in growth companies are loans with a fixed interest of 8% annually. The disbursement occurs semi-annually. The duration of the loans is between three to four years.

Investments in startups on the other hand with a duration of up to eight years are long-term investments. Although these loans also have a yearly fixed interest rate of 1%, investors primarily benefit from a profit and exit participation here. When the startup generates revenue or is sold, the investors participate pro rata.

Equity crowdfunding in young companies is a form of venture capital. Startups develop innovative business ideas that have yet to be established in the market. Accordingly, investors should never invest their entire fortune in startups. Furthermore, they should spread their investments among multiple startups in order to spread risks. This way, they increase the chance that a successful startup compensates for the potential loss of another. You can find out more about this in our academy article “Diversification and Portfolio Theory.”

 

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Status as of 06.03.2017 08:00


 

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