Review of Crowdfunding Regulation 2014 – Germany

1 Recent developments in the market of Crowdfunding in Germany

During the last 12 months there were the following significant developments in Germany regarding Crowdfunding:

1.1 The Equity Model (individuals make investments in return for a share in the profits or revenue generated by the company/project)

Regarding equity Crowdfunding in Germany there are three main Crowdfunding platforms that operate within the scope of regulation (with different approaches). 

One simply offers securities. Therefore all companies seeking funding (“entrepreneurs”) must transform to a (private) stock corporation first. However, in the past 12 months only one company sought funding on this platform.

Another platform is more complicated and is structured similar to a fund. It does not have a licence, but has prepared an approved prospectus for the platform. They offer silent partnerships.

In the past year a third platform has emerged that focuses on the financing of medium-sized business (Mittelstand) by means of participation rights (Genussrechte). The platform promotes its ability to provide standardised prospectuses for projects exceeding EUR 100,000. However, currently all projects stay below this threshold and therefore no prospectus is required.

1.2 The Lending Model (individuals lend money to a company or project in return for repayment of the loan and interest on their investment)

Due to the lack of a regulation for subordinated profit-participating loans (partiarische Nachrangdarlehen) in Germany, there was a shift towards this kind of investments in the past year. The main reason for this was that subordinated profit-participating loans (partiarische Nachrangdarlehen) can currently be used to collect more than EUR 100.000 without the requirement to publish a prospectus approved by the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – “BaFin”).

This trend led to an increase in platforms and companies/projects that organised Crowdfunding campaigns by means of subordinated profit-participating loans (partiarische Nachrangdarlehen). In these investments the investors participate in the success of the funded project or company as the interests are linked to the profit of the project or company. Still, the investor does not share liability for any losses.

However, the German legislator has noticed this trend and considers it as an approach to circumvent regulation – in particular prospectus requirements under the German Investment Products Act (Vermögensanlagengesetz).

Furthermore, peer to peer lending (“P2P lending”) became popular in Germany. Because of regulatory restrictions in Germany a bank needs to be involved in this process. The bank grants the loan to the borrower and then splits and assigns the loan to the Crowd (lenders). The biggest German P2P lending platform (no. 4 in Europe) alone has – according to the company’s own information – brokered 24.000 loans amounting to EUR 110 million since its launch in 2008.

1.3 The Donations or Rewards Model (individuals provide money to a company or project for benevolent reasons or for a non-monetary reward)

In Germany the Donations or Rewards Models are used predominantly to finance social or creative projects or companies (e. g. NGOs). Here, no financial investment or return is involved. Investors fund projects or companies and get no return at all or a non-monetary reward (e. g. tickets, CDs etc.). In some cases the rewards are of a symbolic value only. Actually the Crowdfunding platform with the largest community (Crowd) in Germany is a platform offering reward based Crowdfunding for creative projects.

Noteworthy is the current trend that well established market players – like cooperative banks (Volksbanken) – started offering their own platforms for donations and/or rewards based Crowdfunding. On these platforms regional projects (sports clubs, schools etc.) look for financial support from the Crowd. Thereby, the regionally organised cooperative banks (Volksbanken) want to bring Crowdfunding also to rural areas and intensify the relationship to their customers.

1.4 Real Estate Crowdfunding

Irrespective of the aforementioned categories, there is an emerging trend in Germany to facilitate Crowdfunding to finance real estate projects.

New Crowdfunding platforms specialised in this kind of projects emerge and existing platforms are extending their business. Just recently a well established German Crowdfunding platform established a European Crowdfunding record by raising over EUR 5 million for a the extension of a wellness resort at the Baltic Sea.

1.5 International approach

Finally, more and more US Crowdfunding platforms and platforms from other European countries enter the German market and plan to establish international Crowdfunding platforms in order to reach (at least) the complete European market with just one platform. However, due to the differences in the national Crowdfunding regulations such projects still require a lot of efforts and legal advice from 28 countries.

2 Recent developments regarding Crowdfunding regulation in Germany

On 16 December 2013 the newly elected federal government mentioned Crowdfunding explicitly in its coalition agreement and stated that “new forms of financing such as Crowdfunding need a reliable regulatory framework”. Later also BaFin addressed the subject and published an expert article on regulatory requirements and investor’s responsibility with regard to Crowdfunding.

On 22 Mai 2014 the German federal government presented a first package of measures to improve the protection of retail investors (Maßnahmenpaket zur Verbesserung des Schutzes von Kleinanlegern). However, the intended measures would have tremendous negative consequences for Crowdfunding in Germany. Therefore, the federal government already announced to find solutions which meet the requirements of young companies that are financed by Crowdfunding in consideration of the protection of investors.

Hence, on 28 July 2014 the first draft of the German Retail Investor’s Protection Act (Kleinanlegerschutzgesetz) was published, that contains the first specific Crowdfunding regulation in Germany.

A revised draft (hereinafter referred to as the “Draft”) was published on 12 November 2014. The current schedule provides for the coming into effect by mid-2015.

In a nutshell, the Draft provides for the following changes:

• subordinated profit-participating loans (partiarische Nachrangdarlehen) shall qualify as investment products (Vermögensanlagen) under the German Investment Products Act (Vermögensanlagengesetz)
• regulation for all investment products (Vermögensanlagen) – such as silent partnerships (stille Beteiligungen)), participation rights (Genussrechte) and subordinated profit-participating loans (partiarische Nachrangdarlehen) – shall be increased: extended requirements for prospectus, extended obligation to publish addenda to the prospectus, ad hoc disclosures, strict rules for marketing of investment products (Vermögensanlagen)
• exception from most requirements under the German Investment Products Act (Vermögensanlagengesetz) explicitly tailored to fit financing by means of Crowdfunding within a threshold of EUR 1 million

However, please note that the Draft currently is still in the legislative procedure. Therefore, the described planned regulation of Crowdfunding in Germany might well become subject to changes.

3 Current Regulation of Crowdfunding in Germany

3.1 Licence under the German Banking Act (Kreditwesengesetz)

3.1.1 Equity Model / Lending Model

General Rule

Pursuant to the German Banking Act (Kreditwesengesetz), anyone intending to provide financial services in Germany commercially or on a scale which requires a commercially organised business undertaking requires a written licence from BaFin.

The provision of “financial services” includes the brokering of business involving the purchase and sale of financial instruments or their documentation (investment broking), the purchase and sale of financial instruments in the name of and for the account of others (contract broking) and the placement of financial instruments without commitment to take up those instruments (placement of financial instruments).

Current regulation

“Financial instruments” within the meaning of the German Banking Act (Kreditwesengesetz) include securities, investment products (Vermögensanlagen) and shares in collective investment undertakings (Investmentvermögen).

Securities include shares in stock corporations, shares in collective investment undertakings (Investmentvermögen) as well as debt securities including participation certificates. Investment products (Vermögensanlagen) under the German Investment Products Act (Vermögensanlagengesetz) comprise, inter alia, shares in other legal entities (such as limited liability companies, limited partnerships, civil law partnerships or silent partnerships (stille Beteiligungen)), participation rights (Genussrechte) with regard to profits in those legal entities, shares in trust assets and registered bonds.

Planned changes

So far, subordinated profit-participating loans (partiarische Nachrangdarlehen) are not classified as investment products under the German Investment Products Act (Vermögensanlagengesetz). However, according to the Draft subordinated profit-participating loans (partiarische Nachrangdarlehen) shall now be added to the catalogue of investment products (Vermögensanlagen) and therefore shall be covered by the German Investment Products Act (Vermögensanlagengesetz).

Further, according to the Draft also “other investments that grant a repayment claim and a claim for interest” shall – as a rule – qualify as investment products (Vermögensanlagen). According to this wording also P2P lending could be covered by this definition and would – as a consequence – also be subject to the regulation under the German Investment Products Act (Vermögensanlagengesetz). However, the legislator clarified that P2P lending shall be outside the regulation if certain requirements are met. In particular the loans must be granted by a bank in the first place; later the bank splits this loan and assigns it to the crowd lenders.

In summary, where an online Crowdfunding platform facilitates the offering of securities, investment products (Vermögensanlagen) or shares in collective investment undertakings (Investmentvermögen), the operator of the platform provides financial services within the meaning of the German Banking Act (Kreditwesengesetz) and therefore, as a general rule, requires a license by BaFin.

Exemptions from licencing requirement

If securities (such as shares in stock corporations or limited liability companies) are offered, no exemptions are available from the licensing requirement.

However, most German Crowdfunding platforms offer subordinated profit-participating loans (partiarische Nachrangdarlehen) or interests in silent partnerships and can therefore benefit from a statutory exception to the licensing requirement.

The following requirements must be met:

• only investment broking and contract broking are conducted,
• only investment products (Vermögensanlagen) within the meaning of the Investment Products Act (Vermögensanlagengesetz) or shares in collective investment undertakings (Investmentvermögen) are offered;
• no acquiring of ownership or possession with regard to funds or shares of customers (unless a specific licence to do so has been obtained).

Where these requirements are met, the operator only needs a licence under the German Trade, Commerce and Industry Regulation Act (Gewerbeordnung) (which is a relatively straightforward matter). This kind of licence would also be sufficient for the operation of a Crowdfunding platform under the Crowdfunding exemption contained in the Draft.

3.1.2 Donations or Rewards Model

Current regulation

Depending on the structure in detail there are good reasons to state that currently these kinds of investments do not qualify as shares in collective investment undertakings (Investmentvermögen) or investment products (Vermögensanlagen). Therefore, it should fall outside of German financial services regulation.

Planned changes

However, the Draft also describes “comparable investments that grant a claim for repayment and interest” as investment products (Vermögensanlagen). As already stated the Draft is currently still subject to discussion – its final interpretation cannot be finally foreseen. However, according to some (unofficial) statements by one of the involved governmental departments it appears to be likely that also certain kinds of rewards based Crowdfunding projects could qualify as investment products (Vermögensanlagen). In this case the aforementioned regulation would be applicable.

3.2 Prospectus requirements

3.2.1 Equity Model / Lending Model

Current regulation

Entrepreneurs issuing securities or investment products (Vermögensanlagen) to investors can be subject to a prospectus requirement, namely a requirement to publish a prospectus approved by BaFin under the German Securities Prospectus Act (Wertpapierprospektgesetz) where securities are offered (e. g. shares in stock corporations) or under the German Investment Products Act (Vermögensanlagengesetz) where investment products (Vermögensanlagen) are offered (e.g. silent partnerships).

Currently, depending on the structure, subordinated loans (Nachrangdarlehen) do not constitute investment products (Vermögensanlagen) under the German Investment Products Act (Vermögensanlagengesetz) and therefore no prospectus is required.

The general prospectus requirement does not apply where the offering of securities or investment products (Vermögensanlagen) does not exceed EUR 100,000 within a time period of 12 months. This applies to the issuing of securities as well as the issuing of investment products (Vermögensanlagen).

Planned changes

According to the Draft subordinated profit-participating loans (partiarische Nachrangdarlehen) shall in the future be covered by the German Investment Products Act (Vermögensanlagengesetz). Consequently, entrepreneurs offering subordinated profit-participating loans (partiarische Nachrangdarlehen) to investors will also be subject to the prospectus requirement under the German Investment Products Act (Vermögensanlagengesetz).

Content of the prospectus

In addition, the Draft provides for extended requirements regarding the prospectus. The prospectus shall only be valid for 12 months after its publication, more information concerning the addressed investors is demanded, BaFin is verifying the operability of the business model and is allowed to demand more information within the authorisation process to guarantee the investors’ protection. Moreover, the Draft introduces extra requirements for additions to the prospectus during an offering and contains on-going obligations to notify the investors about substantial changes.

Crowdfunding-Exception from prospectus requirement

However, the Draft provides for a new exemption from the prospectus requirement for the offering of subordinated profit-participating loans (partiarische Nachrangdarlehen) that is specifically tailored to Crowdfunding.

According to the Draft a lighter regulation shall apply if the following (cumulative) conditions are met:

• Total offering maximum: EUR 1 million;
• Offering of profit-participating loans (partiarische Darlehen) or subordinated loans (Nachrangdarlehen);
• Total amount for each investor per investment product of one issuer (Start-up company, project initiator or similar) is restricted as follows:

1. up to EUR 1.000: no restrictions
2. more than EUR 1.000: cash deposits or financial instruments of the investor must exceed EUR 100.000 or maximum two monthly net incomes
3. EUR 10.000 = absolute maximum investment per investor;

Marketing via online platforms that need to obtain a licence under the German Trade, Commerce and Industry Regulation Act (Gewerbeordnung), under the German Banking Act (Kreditwesengesetz) or the German 

Securities Trading Act (Wertpapierhandelsgesetz, WpHG).

If these requirements are met, in particular no prospectus is required. Instead only a three-page fact sheet (Vermögensanlageninformationsblatt – VIB) must be provided to the investors to inform them about the company/project. In addition, a lighter regulation under the German Investment Products Act (Vermögensanlagengesetz) is applicable.

Advertisement

However, the Draft significantly limits the possibilities to advertise investment products. At the current stage of the Draft, these changes are applicable to Crowdfunding to the full extend.

The first draft limited the possibilities to advertise investment products (Vermögensanlagen) to certain media, whose main topic is – at least inter alia – the presentation of economic topics. Furthermore, the advertisement had to be related to such presentation of economic topics. The Draft keeps this general principle. However, the press shall be excluded. In effect, this means that advertisement for investment products is permitted in print media as well as their online editions. Advertising campaigns via facebook, twitter or similar social networks still shall remain prohibited in general.

This regulation prevents Crowdfunding platforms from reaching the essential audience for Crowdfunding by approaching the broad public to shoulder funding of uprising enterprises by means of plenty of small investments.

3.2.2 Donations or Rewards Model

Current regulation

Due to the fact, that investments where individuals provide money to a company or project for benevolent reasons or for a non-monetary reward (Donation or Rewards Model) currently do not qualify as investment products (Vermögensanlagen) a prospectus pursuant to the German Investment Products Act (Vermögensanlagengesetz) is generally not required.

Planned changes

However, it cannot be excluded with absolute certainty that certain kinds of rewards based Crowdfunding projects could fall into the category of “comparable investments that grant a claim for repayment and interest” included in the Draft which qualify as investment products (Vermögensanlagen). In this case – as a rule – a prospectus under the German Investment Products Act (Vermögensanlagengesetz) would be required.

3.3 Regulation of Crowdfunding under the AIFMD regime

According to the Capital Investment Act (Kapitalanlagengesetzbuch) the AIFMD regulation of funds and fund managers applies when there is an alternative investment fund (“AIF”) managed by an alternative investment fund manager (“AIFM”). The draft of the German Retail Investor’s Protection Act (Kleinanlegerschutzgesetz) does not affect this regulation.

The Capital Investment Act provides that AIFs include a collective investment undertaking which:

• raises capital from a number of investors,
• with a view to investing it in accordance with a defined investment policy for the benefit of those investors; and
• is not an operating company conducting business outside the financial sector and
• do not require authorisation pursuant to Article 5 of Directive 2009/65/EC (UCITS).

3.3.1 Operating company seeking funding

German AIFMD regulation does not apply to operating companies outside the financial sector which do not invest in accordance with a defined investment policy.

BaFin clarifies in its interpretation guideline on the “Scope of application of KAGB / Interpretation of the term collective investment undertaking” that companies are operating companies if they operate the facility or production themselves within their day-to-day business. However, BaFin states that an operating company can make use of the service of an intra-group company or an external service provider, as long as the day-to-day discretion remains at the company.

Taking this into account, companies seeking funding by means of a Crowdfunding platform could only be operating companies outside the financial sector if:

• their business strategy is simply the commercial success of their business;
• they do not intend to follow any defined investment policy but want to finance their ongoing day-to-day business; and
• they operate the facility, production or project themselves within their day-to-day business or make use of the service of an intra-group company or an external service provider (as long as the day-to-day discretion remains at the company)

In general, these requirements are met by the “typical” start-up or developing company seeking funding for its general commercial business by means of a Crowdfunding platform. Such companies should therefore fall outside the scope of the German AIFMD regulation.

3.3.2 Project Company seeking funding

Equity Model

BaFin illustrates in its Interpretation Guideline that companies that are established to finance a single project (“Project Company”) such as movie, a computer game, a wind farm or a solar park and do not operate the facility or production themselves or by means of an outsourcing company leaving the day-to-day discretion to the “Project Companies” cannot qualify as operating companies.

Accordingly, this kind of “Project Company” might constitute an AIF within the meaning of the German AIFMD regulation if it seeks funding in return for a share in the profits or revenue generated by the project as in the Equity Model.

Lending Model

Investments by means of subordinated loans (Nachrangdarlehen) can generally be structured as non-AIF investments because the investors do not share liability for any losses.

Donations or Rewards Model

Some of the Project Companies do not offer any kind of revenue but instead (often small) non-financial rewards in return (Donations or Rewards Model). In the latter case (e.g. if the promised reward is a ticket or a copy of the movie or game) it can be argued that the funds are not invested for the benefit of those investors and the funding therefore contains no collective investment undertaking and no AIF. BaFin has not yet commented on a possible application of the AIFMD regime to rewards based Crowdfunding.

3.3.3 Crowdfunding Platform

In general, due to the fact that an operator of a Crowdfunding platform does not raise capital from investors for its own business, he should not qualify as an AIF. Further, there are sound arguments to state that the Crowdfunding platform does not “manage” the underlying investment, but merely arranges investments into projects or companies.

Hence, the operator of a Crowdfunding platform should not be qualified as an AIF or an AIFM.

3.3.4 Pooling vehicle

In case the company seeking funding prefers funding by just one major investor instead of a large number of small retail investors, it is possible that the platform involves a pooling vehicle. A pooling vehicle is a company founded to concentrate a large number of investors. Such pooling vehicle is likely to be an AIF and therefore to be subject to the German AIFMD-regulation.

However, a contractual pooling of the investors could be a viable alternative. In this structure no pooling entity is involved but rather the investors enter into a pooling agreement with the company itself or a third party.

3.4 Licence under the German Payment Service Act (Zahlungsdiensteaufsichtsgesetz)

Any transfer of funds through the operator of a Crowdfunding platform generally constitutes money remittance services (Finanztransfergeschäft) within the meaning of the German Payment Services Act (Zahlungsdiensteaufsichtsgesetz). Such transfer of funds could occur if the investors pay their investment amounts to the operator of the Crowdfunding platform who then passes the funds to the entrepreneur.

In this context BaFin has decided that operators of internet platforms (such as Crowdfunding platforms) in general are not covered by the exemption for commercial agents.

In order to avoid such licencing requirements the operator of a Crowdfunding platform could cooperate with a bank or a licenced payment institution for the handling of payments rather than acting as an intermediary itself. However, the structure of this cooperation must meet detailed requirements by BaFin.

3.5 Possible additional Regulations

Other common regulations to which the operator of a Crowdfunding platform may be subject include:

• German Trade, Commerce and Industry Regulation Act (Gewerbeordnung);
• German Act on Money Laundering (Geldwäschegesetz);
• Consumer Credit Regulation (Vorschriften für Verbraucherdarlehensverträge).

4 Lessons learned from Germany’s regulation for a possible harmonised European Crowdfunding regulation

4.1 Role model (“dos”)

Considering the aim of the Draft to protect investors from dubious and risky investment products, it is certainly a positive signal that the German legislator recognised the importance of Crowdfunding as a new kind of funding and is willing to grant Crowdfunding the possibility to establish in the market.

For a possible harmonised European the following aspects can serve as a role model:

• exception of Crowdfunding from most regulatory requirements (in particular prospectus requirement)
• three-page fact sheet (Vermögensanlageninformationsblatt – VIB) for investors
• only lighter regulation of the Crowdfunding platform

4.2 Aspects that should be avoided (“don’ts”)

However, the predominant part of the planned German Crowdfunding regulation should not build the basis for a possible European Crowdfunding regulation.

In particular, the following aspects should not be inherited:

• limitation of the reduced regulatory requirements to one kind of investment vehicle (profit-participating loans) – rather, all kinds of investments (Lending Model and Equity Model) should be treated equally
• limitation of the reduced regulatory requirements to Crowdfunding projects with a total offering maximum of EUR 1 million – EUR 5 million seem appropriate to enable e.g. property Crowdfunding also to benefit from a lighter regulation
• limitation of maximum investment per investor (EUR 10,000) and restrictions starting at EUR 1,000 – as this excludes so called qualified investors (i.e. angel investors etc.) from Cowdfunding campaigns
• limitation of advertisement for Crowdfunding in particular in online-media and social networks

5 Conclusion

In conclusion, the fact that Crowdfunding was recognised by the German legislator is a very positive signal for the Crowdfunding industry in Germany. The fact that the interests and needs of Crowdfunding are explicitly considered in a law that actually aims to increase the protection of (retail) investors means that Crowdfunding has reached the mainstream.

However, the current draft of a specific Crowdfunding regulation for Germany can only be a first step. Further legislative measures are required in Germany as well as on a European level.

The goal must be to reach a harmonised European Crowdfunding regulation that enables companies seeking for funding and investors to take part in Crowdfunding campaigns across the whole European Union. It will be exciting to see if this will only be achievable by a European regulation or if national regulations can be harmonised in a meaningful way.