Equity Crowdfunding – The Most Important Terms

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The language of equity crowdfunding

7 minute read

In the past, access to investments in startups and real estate was limited to wealthy investors. Technological progress means that anyone can now invest in startups and real estate. Before investing for the first time, however, it is important to become familiar with the vocabulary of equity crowdfunding. What is do terms like crowd, startup, and pitch deck mean?

 

The triumphant advance of the Internet also brought about a new way of raising money for projects and startups from investors - crowdfunding or equity-based crowdfunding. Instead of finding a small group of supporters who provided the necessary capital as before, one can turn to a large crowd of people via the Internet - the so-called crowd.

This was also the origin of the idea of crowdfunding where many people contribute a small amount to realize a project. In crowdfunding, they don't do this for financial reasons but donate their money to a project (donation-based crowdfunding) or expect a copy of the product in return (performance-based crowdfunding).

Equity crowdfunding in companies has additional financial motivation. As such, it is more an investment than a donation. Crowd investors give young companies the capital they need in their early stages and in return expect a financial return on their investment. They receive this either in the form of an exit participation or a fixed interest rate. The investment is facilitated via a so-called equity crowdfunding platform.

Platform operators such as Companisto present the crowd with various options for investing in startups or real estate. The platform operators are usually only intermediaries between the startup or the project developer and the crowd investors. They also support the startups or project developers in the successful execution of their campaigns.

 

On equity crowdfunding platforms like Companisto, everything revolves around investing in startups. A startup company is a young company that is characterized by two main characteristics: It has an innovative business idea and is a fast-growing company.

The innovative business idea should solve an existing problem in a previously unknown or more efficient way. The startup presents the exact nature of the problem and what the solution should look like in a pitch deck.

The term pitch originally comes from the advertising industry. There, it is common for advertising agencies to compete for an order within the framework of a pitch in front of a potential customer. The pitch presents the most important ideas in a short and concise way.

There are various pitches in the startup world. The shortest pitch is the so-called elevator pitch, i.e. the presentation of one's own business idea in the time that a founder spends next to an investor in an elevator. The challenge for founders is to present their business idea to the potential investor in the shortest possible time (between 30 seconds and one minute).

On equity crowdfunding platforms, the startups present themselves to the investors with a pitch deck or pitch video. A pitch deck is usually a collection of presentation slides on which the problem, the solution, and the underlying business idea are presented.

A pitch video serves the same purpose as a pitch deck but can give investors a more personal impression of the founders. In addition to the pitch, there are other points about equity crowdfunding that investors should pay attention to.

 

Equity crowdfunding is a venture capital investment and therefore belongs to the high-risk investments which also have a very high return potential. Since investments in equity crowdfunding are made through loans with qualified subordination, investors can lose their invested capital completely in the worst case scenario. In the best case scenario, venture capital investments have the potential to generate three-digit returns on the sale of a startup.

In the past, venture capital investments were made exclusively by professional venture capital investors (VCs). They bundled the money of several wealthy investors into a venture capital fund and then invested in startups and growth companies. Before venture capitalists invest in a startup, they carry out an extensive risk assessment. In return for their investment, they then grant the founders access to their network of experts and access to large corporations for potential takeovers.

Venture capital investors adopt risk diversification strategies by investing in a wide range of startups. They take the calculated risk that the majority of these companies fail and rely on the few startups that make the big exit to more than compensate for the losses of the others. When diversifying, investors try to spread their investments across as many economic sectors and startup phases as possible - and thus significantly reduce the risk of a total loss.

Business angels are wealthy private individuals who provide initial capital to young companies at an early stage. Their investments usually range from high five-digit amounts to mid-six-digit amounts. They also make their network available to the founders. In return for their early involvement, they receive shares in the company and profit in the event of the startup being sold.

 

In Germany, investments in real estate or startups always take the form of a profit participating loan. A profit participating loan (or participatory loan) is a loan that is used to finance a project or a company. In return, the lender receives a profit-related (= participatory) share in the success. For this purpose, participatory subordinated loans are linked to interest, whereby the repayment of the loan has a final maturity.

Participatory loans are subordinated (so-called subordinated loans). A subordinated loan is only serviced when other preferential claims have been fully serviced. The subordinated loans are thus associated with a qualified subordination to other creditors. As a result of the subordination, the creditor temporarily waives the fulfillment of his claim in order to strengthen the position of other (potential) creditors or to prevent an over-indebtedness of a company in terms of the Insolvency Code.

Participatory subordinated loans include certain information rights (also known as reporting or updates), depending on their structure. For equity participations, these information rights are partly derived from the law; for participatory subordinated loans, they are laid down in the loan agreement itself. You can read more about the other differences between equity and participatory loans in a separate article.

There are two different participation models on Companisto: Profit sharing and fixed interest. Investments in startups are investments that generate their returns through exit and profit sharing. If the startup generates profits or is sold, the investor receives a share of the proceeds in proportion to the amount of his investment. In addition, there is an interest rate of 1 percent, whereby the repayment of the loan has a final maturity.

Although investments in growth companies - i.e. companies that already generate sales - do not have exit or profit sharing, they are linked to a fixed interest rate. Here, too, the participation takes the form of a subordinated loan with a final repayment date. There is also a semi-annual interest payment, whereby the interest rate varies between 4 and 8 percent depending on the offer.

 

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André Jasch

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