The crowd – quick money for mid-sized companies?

In early May it took Bundesliga club Hertha BSC Berlin a mere 9 minutes and 11 seconds to raise EUR 1.5 million through crowdfunding. Voelkel, a producer of organic fruit juices based in northern Germany, also started to use the services offered by crowdfunding platforms. The approach taken by the football club and the family-run firm exemplifies a major trend - while crowdfunding was initially used primarily by private individuals and start-up companies, it is now increasingly being considered as a source of funding by mid-sized companies.

Cologne, 18 July 2017 February 2017 saw the launch of the FinCompare comparison website which specialises in alternative funding options for small and mid-sized businesses. Within a few weeks after the launch, the company had some 400 clients seeking a funding volume of more than EUR 200 million on its books.

A total of over 200 platforms are currently active in Germany, operating in different fields ranging from donation-based and reward-based crowdfunding to crowd investing and crowd lending. While their total combined share in the overall funding market is still negligible, there has been a significant rise in both the number of funding projects and the total volume of funding in recent years. Extensive media coverage of crowdfunding and fintech topics may have been one of the factors which have boosted interest in this area. Other factors certainly include a change in social values and growing interest in sustainable and pioneering investments. From a mid-sized company perspective, crowd lending and crowd investing are the most appealing options.

Crowdlending means that money is collected from investors and made available to a company for a defined period – typically between three and five years – at a fixed interest rate. In most cases, borrowers are not required to post collateral, which is seen as advantageous compared to traditional bank loans by many companies. In 2014 Zencap was the first platform to lend money to a company in this way. In the meantime Auxmoney has emerged as the leading crowdlending platform in Germany where a total volume of EUR 76.7 million was provided through crowdlending in the year 2016.

Crowdinvesting is different in that it offers companies access to more equity-like funding. In this case the crowd makes profit-sharing investments in the form of (partially) subordinated loans which earn a fixed interest rate plus a share in the success of the funded business. Maturities are typically between five and seven years. Investors’ share in the success mostly comes in the form of an interest bonus paid if and when the company meets a defined sales target, a specific key ratio or a company value multiple. The year 2016 saw a total of EUR 58.8 million invested in Germany this way.

A funding route with added benefits

Apart from providing companies with capital, crowdfunding campaigns offer a variety of added benefits which would typically entail additional costs in traditional equity raising exercises. For starters, a public crowdfunding campaign has a marketing effect in that it raises the company’s profile and creates welcome exposure for its products and services. Crowd investors who believe in the business model to be funded may become multipliers and brand ambassadors who spread the company’s message in their social environments. This may prove advantageous both in terms of promoting the crowdfunding project and in respect of marketing the products and services. In addition, the partially direct contact with pro-active crowd investors offers opportunities to feed ideas and suggestions from the crowd community back into the development of products and services. The success of a crowdfunding campaign may also serve as a real-world indicator of the potential market for the project for which the funding is sought. If the crowdfunding campaign remains unsuccessful, the feasibility of the project as such should be scrutinised.

The costs charged for the use of the platform range between 0.25% and 5% of the funding volume, depending on the operator. This fee will typically become due only if and when the funding materialises. Some providers charge an additional annual management fee.

Interest rates between 4% and 10%

Interest rates are typically a reflection of a borrower’s creditworthiness. In crowd lending they range between 4% and 10% per year. The Kapilendo crowdfunding platform recently used by Hertha BSC Berlin has defined a number of criteria to limit the investment risk and enable potential investors to assess the risk. According to these criteria, the company must demonstrate a minimum track record of three years in its market, annual sales revenues of at least EUR 1 million, a positive equity ratio and a net profit. In a next step, the platform operator will analyse the annual accounts, the company’s business and operations, any existing debts as well as industry default ratios and ratings researched and assigned by credit reporting agencies. Based on this analysis, the platform will propose a term sheet showing the investment class, the interest coupon, the fee structure and the repayment schedule.
Aside from this analysis, the lending risk is also mitigated by the crowd intelligence created by the multitude of potential crowd investors. Even so, more and more platforms additionally rely on assessment grids provided by rating agencies.

Professional planning is key to success

Some mid-sized companies may see a disadvantage in having to publicise their plans and projects in order to gain access to crowdfunding. In addition, where a crowdfunding project fails to go through, the company’s image may suffer rather than benefit from the positive marketing stimulus discussed above. This is why a thorough preparation as well as sufficient resources for implementation and marketing are key to the success of a crowdfunding campaign.
The rising number of different platforms means that potential investors are now faced with a “crowded” marketplace and increased complexity. This puts a premium on professional planning and effective communication in order to steer the campaign to a successful conclusion and make the most of the ensuing marketing opportunities.

Insights from the master’s thesis “Crowd investing – an alternative for German mid-sized companies“

While the rising regulatory requirements imposed on banks have so far not resulted in less lending to mid-sized companies, this might change in the future.

Crowdfunding projects offer companies added value, most notably at the marketing level. This is true particularly for companies selling products and services directly to consumers (B2C). There is also some evidence that giving investors a share in the company’s profits can amplify the general marketing effect of a campaign.

As crowdfunding becomes a more established funding route, this alternative source of capital will increasingly be considered also by mid-sized companies wishing to reduce their dependence on incumbent banks. A major challenge to be overcome by many mid-sized companies is the need to go public and explain their investment plans, which is a prerequisite for any successful crowdfunding campaign. As more experience is gained in this field, this alternative source of funding is set to gain in popularity also among established companies.

This paper summarises some of the insights from the master’s thesis “Crowd investing – an empirical study of this alternative source of company funding for mid-sized companies in Germany” currently being written by Andreas Wessel with the support of IR.on AG. The author is working towards his master’s degree in business administration at the Cologne University of Applied Sciences.