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Law on the Protection of Small Investors Passed, Threatens Equity-Based Crowdfunding Industry

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Dear Companists,

Yesterday, the German federal government agreed on the draft of a law on the protection of small investors, which still has to be passed by the German Bundestag and Bundesrat. This law is intended to better protect small investors from risky investments in the future, and it is actually tailored to multi-billion financial instruments. Despite the significantly lower amounts of capital raised through equity-based crowdfunding and the unquestionable opportunities this way of funding provides to the German economy, the government intends to regulate the equity-based crowdfunding industry in the same fashion as multi-billion financial instruments. Even though the draft of the law includes some exceptions for equity-based crowdfunding, its provisions are unintentionally threatening a young German growth industry.

 

Read at the end of this update what you can do about the law.

 

The German equity-based crowdfunding scene is still in its infancy because it is only three years old. Within this short period, however, it has already made a major contribution to the solution of a problem German entrepreneurs have been facing for decades: the lack of capital necessary to implement innovative ideas. Indeed, company founders in Germany hardly have any access to financing.

The protection of investors is key to the equity-based crowdfunding industry, for the confidence of investors is essential to the long-term success of equity-based crowdfunding. Ultimately, however, the law on the protection of small investors contains provisions that neither reflect the reality of modern crowd-based financing rounds nor improve the protection of investors. In particular, the following three elements of the law are threatening the German equity-based crowdfunding industry:


1. Maximum Amount of 1 Million Euros Is Too Low

In other European countries, the financial markets have recently been regulated according to the latest recommendation by the European Commission. The laws proposed in London and Paris differ significantly from those proposed by the German government. For instance, equity-based crowdfunding campaigns in Germany are to be limited to an amount of only 1 million euros, otherwise an expensive prospectus will have to be prepared. This limit was set to 5 million euros in the UK and to 4 million euros in France, which leads to a significant competitive disadvantage for the German equity-based crowdfunding industry that will in turn make it more difficult for young German companies to access funding.

Also, the law will not provide any additional protection to investors, but increase their risk. Indeed, if a technology company needs 3 million euros to develop a technological innovation, one million will not help the company. The preparation of a prospectus (which would be required to raise more than 1 million euros) would lead to high costs of approx. 50,000 euros – an amount not available to young companies. Such companies are searching for capital and are thus unable to bear these costs. The provisions of the law on the protection of small investors will cause young companies to receive much less capital through equity-based crowdfunding than they actually need. This, in turn, reduces the chance that the companies will reach their goals and increases the chance that the companies will fail. In the end, a limitation of the maximum amount that may be raised through equity-based crowdfunding will thus increase the risk for the investors involved.

Furthermore, a limitation of the maximum amount to 1 million euros makes no sense because individual investors will already be protected by the intended limitation of their individual investments. Consequently, this provision will solely prevent additional people from investing in order to provide the required total amount of, for instance, 3 million euros together.


2. Investment Limits for Individual Investments Are Arbitrary

The provision limiting individual investments to 10,000 euros – even for investors with total assets exceeding 100,000 euros – is also questionable. For equity-based crowdfunding projects to be successful, it is essential that a few high individual investments be made. In the majority of cases, such high investments are made only after a careful evaluation of the offer. For small investors in particular, such investments provide useful guidance, which is even improved by the opportunity for investors to discuss investment projects.

A strict investment limit is also generally unsuitable to improve investor protection. Consequently, a strict investment limit regardless of a person's wealth is little more than paternalism. It is impossible to understand why a person with considerable personal assets or a very high income should not be allowed to invest more than 10,000 euros. The maximum individual investment should thus be based on the individual wealth and on the income of investors rather than be limited to 10,000 for everybody. In fact, such individual limits have already proven to be feasible in other European countries.


3. Investment Information Form Increases Bureaucracy

Moreover, the current draft of the law requires each investor to sign an investment information form for every single investment, otherwise the investment will not be considered effective. According to the law, each investor is to print out this form, sign it, and mail it to the equity-based crowdfunding platform. Alternatively, investors may print out the form, sign it, scan it, and electronically transfer it to the platform; those investors who do not own a printer or scanner will still have to mail the form. Therefore, the investment process will become unnecessarily bureaucratic and will not provide any additional protection to investors, for displaying a digital version of the form for a set duration would have the same effect, but would be less bureaucratic. This unnecessary change of media should thus be prevented in any case, and investors should be enabled to electronically confirm that they have read the form.

 

The law still has to be passed by the German Bundestag and Bundesrat. We are currently discussing with the German Crowdfunding Network (GCN) what each of you can do to influence the passing of the law. We will shortly inform you about this in another update.

 

Best regards,

The Companisto team



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