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Equity Crowdfunding versus ICOs

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Battle of the participation forms

7 minute read

Initial coin offers (ICOs) have triggered a huge hype in the financial sector. Startups collect millions of dollars from many investors within a short period of time. However, most investors do not even know which rights they are granted in an ICO - and which they are not.

In equity crowdfunding, investments in companies are offered in the form of participatory loans; in ICOs they take the form of digital tokens. In our first battle between the different participation forms, participatory loans competed against equity. This time, we will observe the direct competition between company participations through equity crowdfunding and ICO tokens.


Equity crowdfunding is a form of financing for startups and growth companies in all economic sectors.  Company participations are always offered in the form of participatory loans. These stipulate profit participation, through which the investor participates in the success of the company. The exact conditions are laid out in the participation agreement between the investor and the startup.

Initial Coin Offering (ICO) is a form of financing that has recently been used by startups whose business models are based on blockchain or deal with cryptocurrencies. Linguistically, the word is based on the English term Initial Public Offering (IPO).

However, an ICO does not offer company shares; instead, it sells virtual coins of a digital currency - so-called tokens. Therefore, ICOs are also known as token sales, as these tokens are sold in a public bidding process. In a token sale, investors exchange either classic currencies (dollars, euros, yen, etc.) or cryptocurrencies (Bitcoin, Litecoin, Ether, etc.) for the startup's tokens.

Depending on the legal structure, these are considered to be either utility or equity tokens. In theory, an equity token is a kind of digital equity participation, i.e. the token holder becomes a shareholder. In practice, however, we are not aware of a single case in German-speaking countries in which an ICO was carried out with an equity token. Most ICOs run on utility tokens. These tokens are not company participations; they are digital value coupons that give investors discounted access to the startup's products or services.



Investor Rights

The utility tokens of most ICOs provide very limited rights. These usually comprise preferential conditions for the (yet to be developed) products or services of the financed startup. ICOs are, in principle, a form of crowdfunding.

Formally, they are only donations, as no equity or mezzanine capital is issued. It was not without reason that a board member of the renowned venture capital firm Andreessen Horowitz described them as "Kickstarter on steroids." In most cases, investors receive neither co-determination rights nor profit participation, which they could legally claim in the event of a dispute.

Investors do not receive co-determination rights in equity crowdfunding either; however, they do receive information rights. An investor is entitled to a quarterly report and to annual financial statements by the startup. Investments via equity crowdfunding are linked to profit participation or fixed interest rate. If the startup is sold, the investor receives a share of the exit proceeds. The investor also participates when the company generates profits.



Equity crowdfunding is venture capital. Startups and growth companies are financed at a very early stage. As a consequence, the default risk is high. In contrast to crowdfunding, however, where the crowd supports an idea with donations to develop a product prototype, equity crowdfunding startups usually have a marketable product, initial sales, and customers.

In contrast, many ICO-financed startups are at a very experimental stage at the time of financing. All it takes to start an ICO is a white paper outlining the business idea. In many cases, these startups have neither a product, nor an operative business, nor a valid legal form. Few of them can show existing customers and sales. ICOs are thus much more similar to classical crowdfunding.

Default rates reflect the fact that ICOs are significantly riskier than equity crowdfunding. The default rate for equity crowdfunding is around 25 percent about five years after the sector's launch, which is roughly in line with the expectations of traditional venture capital funds. By contrast, according to the information portal Tokendata, more than half of all ICOs have already failed after less than a year, including some of the largest ICOs with investments in the hundreds of millions. It is suspected that many of these ICOs have been fraudulent from the outset.

In addition to the usual risks of a venture capital investment, ICOs are also exposed to an exchange rate risk. Since many ICOs are not settled in classical currencies but in other cryptocurrencies, investors first have to exchange their euros on a crypto exchange, for example for ethers. An output price is set in advance for the ICO, for example 100 of the startup’s tokens for 1 ether.

However, the market for cryptocurrencies is subject to extreme fluctuations, double-digit percentage price changes are not uncommon. It is possible that the investment offered may shift to the disadvantage of the investor in the course of financing, for example, if the price of ether collapses. In equity crowdfunding, on the other hand, investments are only made in classic currencies. These are subject to such small fluctuations that the offered participation is not significantly affected.



Equity crowdfunding is a relatively young financial industry, however, regulation and investor protection already play an important role. Equity crowdfunding is regulated by the Retail Investor Protection Act (Kleinanlegerschutzgesetz) and each platform is subject to supervision by the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin). The amount of a financing round is limited to EUR 2.5 million and each individual investor may not invest more than EUR 10,000 in a startup.

In addition to a statutory right of revocation, investors are also entitled to detailed advance information. Before investing, they can inform themselves about all the opportunities and risks of the offer with the help of the Investment Information Sheet (Vermögensanlagen-Informationsblatt - VIB). The VIB must comply with legal standards and is checked by the BaFin for accuracy and completeness before each equity crowdfunding campaign.

In addition, the equity crowdfunding industry has agreed on uniform standards to increase investor protection. The investors also have contractually regulated information rights. The startups must submit a report on their current status once a quarter and publish their annual financial statements once a year. This means that there are both reporting obligations prescribed by the asset investment law and additional reporting guidelines for some platforms.

ICOs operated in an unregulated grey area for a long time. However, the industry’s Wild West days are over, as the BaFin recently made clear. In future, each ICO will be examined on a case-by-case basis to determine whether it is a financial instrument subject to authorization. Depending on the legal structure of the token sale, the BaFin distinguishes either between securities in accordance with the German Securities Prospectus Act (Wertpapierprospektgesetz - WpPG) or investments in accordance with the German Investments Act (Vermögensanlagengesetz - VermAnlG).

For example, if a token embodies "shareholder rights" or "transferable and tradable on the financial market" it is a security. This would also affect the tradability of the tokens, which would be treated as securities. As a result, ICOs as a form of financing for startups would be regulated just as strongly as equity issuances. In other cases, a token may also be subject to the Investment Act and would thus be regulated in the same way as participations with participation certificates or participatory loans.


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Status as of 04.04.2018 15:36


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