int finance - crowd investing - term paper

Crowd investing - a new market for entrepreneurs and investors? 1

Contents

1 Introduction 2

2 Crowd investing - definition, tools, types & example 3

2.1 History: The evolution of the "crowd" 3

2.2 Definition, Types and tools 3

2.3 Similar forms of financing 5

2.4 Seedmatch - a short example 5

3 Critical analysis from entrepreneur's & investor's perspective 6

3.1 Entrepreneur's perspective 6

3.1.1 Advantages 6

3.1.2 Disadvantages 7

3.2 Investor's perspective 8

3.2.1 Advantages 8

3.2.2 Disadvantages 9

3.3 Problems & Questions 10

4 A typical project for crowd investing: Trampoline systems 11

5 Conclusion 12

6 Bibliography 13


1 Introduction

A permanent problem that entrepreneurs face at the beginning of their entrepreneurial

starting period is to attract outside capital, due to the lack of collateral cash flows and the

presence of significant information asymmetry with investors.1 Refused by banks and with

the aim of getting people who believe in one, some entrepreneurs have startet to rely on the

internet to directly seek financial help from the general public ("the crowd") instead of

approaching financial investors such as business angels, banks or venture capital funds.

This technique, called "crowd funding" or "crowd investing", has made possible to seek

capital for project-specific investments as well as for starting up new ventures.

This term paper gives an overview on the history and the origin of the "crowd", the

correlation of "crowd sourcing", "crowd funding" and "crowd investing" and examplarily

dwells on the platform Seedmatch. It highlights advantages and disadvantages of investors

and entrepreneurs, further problems and questions and presents a typical and as well one

of the first crowd investing projects: Trampoline systems. Concluding, the term paper will

evaluate briefly both sides of crowd investing and will outline which kind of projects or

firms are most qualified for this new kind of raising money.

2 Crowd investing - definition, types & tools

2.1 History: The evolution of the "crowd"

The meaning of "crowd" can be found earlier in history as one will connect it with: Mozart

and Beethoven already financed his concerts and publications via advance subscriptions

from interested parties.2 The Statue of Liberty (*1886) in New York as well was financed by

small donations of American and French people.3 The student Alex Tew collected 1,037,000

USD between August 2005 and January 2006 by offering pixels 'for sale' to finance his

studies. The trade-off was the placement of advertisement banners on these pixel bought for

et least five years.4

1 Cf: Schwienbacher et al.: "Crowdfunding of small .." (2010), p. 3 2 Cf: Hyperion-records.co.uk (2012-05-09) 3 Cf: Wikipedia: Statue of Liberty 4 Cf: Hemer et al. (2011) / www.milliondollarhomepage.com


The term "crowdsourcing" has been first used officially by Jeff Howe and Mark Robinson in

the June 2006 issue of Wired Magazine and was later used as an generic term for "crowd

funding" and to be more specific as well for "crowd investing": Instead of approaching

banks, business angels or venture capital funds, some first entrepreneurs started to rely on

the "crowd" to directly seek financial help from the public.

The UK-based software company Trampoline Systems raised 1 million GBP through crowd

funding in 2009, which is the largest amount ever raised by a single venture through

crowdfunding.5 In 2010, six crowd funding & investing platforms where founded.6

2.2 Definition, Types and tools

"Remember outsourcing? Sending jobs to India and China is so 2003. The new pool of cheap

labor: everyday people using their spare cycles to create content, solve problems, even do

corporate R&D."7, Jeff Howe said when describing how to use or to source the power of the

crowd of volunteers, predominantly in the internet. Crowd sourcing "takes place when a

profit oriented firm outsources specific tasks essential for the making or sale of its product

to the general public (the crowd) in the form of an open call over the internet"8, Kleemann

tries to set another definition

As mentioned, the term "crowd sourcing" can

be seen as a broader concept, which refers to

using the "crowd" to obtain ideas, feedback,

solutions or even financial help and equity

shareholder. It is divided into four subtypes,

of which is one of them crowd funding.9 Crowd funding itself, "the collective cooperation,

attention and trust by people who network and pool their money together (...) in order to

support efforts initiated by other people or organisations"10, can be divided again in

subtypes.11 One of them is crowd investing, which can be described as equity based

5 Cf: Schwienbacher et al.: "Crowdfunding of small .." (2010), p. 3 6 Cf: Eisfeld-Reschke et al. "Crowdfunding Studie 2011" (2011), online abstract 7 Howe, J.: WIRED Magazine, Issue 16/2006, online 8 Cf: Kleemann et al. (2008), p. 6 9 Cf: Howe: “Crowdsourcing ..” (2008), p. 280-282 & Hammon et al.: “Crowdsourcing ..” (2010), p. 698-704 10 Cf: sprowd.com: „What is Crowdfunding“ 11 Ibid: Howe (2008), Hammon (2010)


crowdfunding with a potential financial return and ownership, mainly used in start-up-

phases.

A key role for the development of crowd funding & investing is the interactive web 2.0 and

the usage of the so called social media. User share topics and content and use the power of

the crowd ("collective intelligence") to spread these.

As the topic is young and terms are difficult to define, "crowd funding" and "crowd

investing" is often mixed in literature. Crowd funding has less returns and often deals with

art or social projects, whereas crowd investing deals with the crowd as an optional

financing form which can be seen as an alternative to the bank. Both deal with start-ups or

young companies or projects looking for capital and a crowd willing to invest or spend

money.

Main actors at the crowd investing process are:

1. Entrepreneurs or projects who are looking for capital, mostly start-ups

2. Investors, provider of capital, often fans or people who now the company/the project

3. Intermediates/platforms who act as service provider and receiver & administrator of

capital, often act as well as payment provider

4. Other actors, e.g. stakeholder, who have their own interest on the development of

financed projects (NGOs, industrial relations, subsidy agencies, politics, etc.)

2.3 Similar forms of financing

Beside crowd investing, there are of course other possibilities for start-ups to finance as

well; these shall be condensed in this chapter without going into details:

The simpliest possibility for a start-up is to take a loan at a bank: Capital is borrowed at

interest which has to be paid back without getting shares at the company or project.

Venture capital firms provide adherent equity capital (risk capital) for a temporally limited

duration (usually 3-10 years) and will consult and attent their customer. This form offers

high potentials and chances, but as well high risks.12 In this context, private equity capital

shall not be left unmentioned: It deals with a financing form related to venture capital, but

usually with a shorter duration, more shares and less risks for the investor.13 14

12 Cf: Foerderland.de: „Venture Capital“ 13 Cf: bundesfinanzministerium.de: „Private Equity“ 14 Cf: Wikipedia: „Private Equity“


Worthwhile for start-ups are as well business angels15: wealthy private persons or networks

with founding & management experience provide capital and know-how.

2.4 Seedmatch - a short example16

Exemplarily for a typical plattform to put crowd investing into practice is Seedmatch(.de).

Founded in September 2010 by Jens-Uwe Sauer, this young German company is specialized

in connecting young start-ups and private persons who are willing to invest.

Any company can apply which can exhibit a business plan and which can convince the

expert team of seedmatch of the novelty value and the sustainability of their idea.

The minimum investment amount for investors is 250 Euro, which is unlimited upwards

respectively limited individually by the project. The investor acquires a percentage

proportion of the firm or project in form of silent partner’s interest and he participates on

firm’s profit percentaged.

After the minimum contract duration of 5-7 years the share can be cancelled and the

dividend will be paid to the investor. In case of insolvency of the project, the investor is only

liable until the amount of his capital contribution – there is no additional payment liability.

Currently only private persons can invest, but in the medium term, this will be implemented

for companies as well. Further charges on part of the investor do not incur. According to

Seedmatch17, 149 investors participate on one project – every one of them invests 608 Euro,

on average.

If project is launched, potential investors can submit within 60 days. The project is

‘successful’, when the minimum amount of money for the project is collected: The

investment threshold. In the same way, a maximum amount is defined by the project’s

initiator: The investment limit. Seedmatch’s current investing limit is 100,000 Euro. A

successful fund project pays a commission fee of 5 to 10 per cent of mediated amount of

money. Collected money will be hold in trust by Secupay AG and will be paid of stepwise. In

case of threshold is not reached within 60 days, an additional deadline of 30 days can be

agreed. If the project was still not successful at this end, invested money will be paid back to

the investors.

15 Cf: Foerderland.de: „Business Angels“ 16 Figures & facts in this chapter taken from: Seedmatch.de: FAQ 17 Cf: Seedmatch in Zahlen: Q1 / 2012


Seedmatch offers the possibility of diversification of risk via portfolio strategy: Once logged

in, the investor can combine different investments in his profile to balance any losses with

other investments. This follows the idea of reducing unsystematic risk of shares.18 It offers

as well vivid involvement: Investors get recent updates of the company, they can

communicate via CRM and receive quarterly reports. According to Seedmatch, 271 investors

invest in more than one project.19

3 Critical analysis from entrepreneur's & investor's perspective

3.1 Entrepreneur's perspective

3.1.1 Advantages

Entrepreneurs who can't attract other investors or didn't get bank facilities often see crowd

investing as their new chance and advantage to finance monetary gaps of their start-ups.

As mentioned, crowd investing uses the advantages of web 2.0 resp. social media to reach

huge amount of people. If the entrepreneur's company is already connected with their fans

(e.g. using facebook or similar) it can activate them easily and quickly to invest and using

mouth-to-mouth marketing spread their investment plans, if the project is interesting and it

is appealing them. By using these new media methods, campaigns can often be finished fast

and gets boosted the easier the crowd is addressable: Excited users become multiplicators,

act as an advertisers and establish positive signals and credibility to the project and other

potential investors or even banks.

Furthermore, the crowd owns - which is a common thesis - "collective intelligence" or

"whisdom of crowds"20,21: If the initiator of the project taps these activily, include the crowd

on processes like decision-making, design, market research or et least product tests, he can

achieve a higher surplus than when using limited number of consultants or external experts.

This assumes the existence of CMS (Crowd Management System, Fan Management System

or Community Management System) to manage the crowd/community/fans, which is

expensive but helpful, especially for start-ups.

18 Cf: Wirtschaftslexikon24.de: "Unsystematisches Risiko" 19 Ibid 20 cf: Surowiecki: "The Wisdom of the Crowd" (2004), p. 14 21 cf: Garbe: "Crowd Wisdom - Die Weisheit der Vielen" (2010), 3Sat Reportage


In general, the linked crowd has to be seen as the basis of the prospective market: Investing

people will always stand behind the project or the company and can be convinced easily to

buy their products or services.

3.1.2 Disadvantages

When trying to attract investors for their business idea, entrepreneurs have to make

confidential information accessable to an unclear and unknown public. This has to be seen

as the threat of flowing know-how and spy of ideas and business secrets. Thats why

business ideas that are innovative but easy to copy are not made for using crowd investing.

The development of a web community is cost- and labor-intensive, often time-consuming as

well. An active and working community connected with CRM is the prerequisite for crowd

investing. Otherwise, propestive revenues possibly won't cover required effort and

expenses.

Once developed and established, the crowd needs to be maintenanced regularly and

interacted with, which is extensive and expensive and assumes a well-regulated CRM.

Otherwise the crowd might turn away from this project as they are used to high

interexchange with initiators or at least to each other, which could show bad signals to

other potential crowd investors.

The active and well-informed people of a crowd can also disturb management decisions

made by initiator or founder with publicity effect if they don't agree to essential changes of

project aims or newly established strategies or if they feel treated unjustly. This can take

place for example as a viral protest in the web.

Crowd investing, as a very young process, still has to fight for a positive image. Many actors

could be scared when the power of the crowd is used as this has ambiguous and uncertain

touch. Some conservative financiers from the formal segment, like banks, venture capital

companies, public equity bonds or other corporations, could be deterred and might refuse

further investments in the project or the start-up if it was financed by the crowd in former

times (see initial negative attitude when the concept of business angels appeared in 1998-

200122).

22 cf: Hemer, J. et al.: "Crowdfunding und andere Formen ..." (2011), p. 78


3.2 Investor's perspective

3.2.1 Advantages

Crowd investing brings a certain amount of advantages for private investors. Even persons

with small wallet's wish to invest can be made possible as shares starting from 250 Euro

(Example Seedmatch). Investors get profit-sharings proportional to their shares bought

from the corporation. The system is simple using the platform's CRM. Registration and

utilization of the platform is free of cost for investors (Example Seedmatch)23, neither

percantaged nor fixed costs - the entrepreneurs is charged with a success fee by the

platform which is between five to ten per cent.

Sleeping partner's holdings are the most common form of shares sold via crowd investing

platforms, profits are taxed with a straight flat percentage of 25 per cent. This kind of

shareholding is the easiest and most competative version for all persons involved.

As the share is limited to the invested amount at sleeping partner's holdings, there is no

additional payment liability in case of loss or insolvency of the project or business. So the

only risk for investors is not the get back the invested money.

Crowd investing is often used in early investment stages, especially at start-ups. This means

attractive return opportunities for investors, connected with shareholding of businesses

which might grow to financial valuable companies in the future.

Fans of a business or project is given the possibility to invest and support, to be important

and beeing a part of the business.

Investors get periodical (usually quarterly) financial reports about the business and the

value of their share. After the minimum contract period of five to seven years, the investor is

the given the possibility sell his shares every year.

3.2.2 Disadvantages

Needless to say that crowd investing also holds disadvantes for the investors, which shall be

examined now. First of all a sleeping partner's holding brings the impossibility of having a

say in the corporation. Due to the high amount of investors, this could be very difficult to

handle if the possibility would be enabled.

23 cf: Seedmatch FAQ


The minimum contract duration of usually five years24 brings the disadvantage of being

impossible to sell shares if the company is going insolvent.

When it comes to insolvency, micro credits like sleeping partner's holdings will be handled

subordinately in all likelihood.25 This means to the crowd investors that they might never

see again any of their money due to the prior-ranking liability compared to banks or major

investors.

In addition, investors are often not qualified sufficiently to judge validity and chances of

success of a project in financial ways. Furthermore, not all entrepreneurs provide all

information required to evaluate this. It can happen that entrepreneurs provide erroneos

data which lead investors to misinterpretations. If a project fails, some investors might be

disappointed and could avoid in case of recurrence specific platforms or crowd investing as

a whole in the future. Parts of that could be seen as a disadvantage for entrepreneurs as

well.

3.3 Problems & Questions

Some side aspects and problems still seem not to be regulated as crowd investing is a very

young topic. Micro equity contracts must have been able to stand up in court and comply

formal demands, for example certified by a anotary. Sometimes it is not clear wether

specific contracts satisfy in the digital way they are and might be obligatory only in a

physical way.26

Some crowd investors run the risk of being seen as commercial investors when their action

has mainly profit character27; private lender could be seen as quasi banks.

It is to verify if a asset has the character of a value paper (Cf. Brunner, 1882). This results in

the question whether the Securities Prospectus Act (Prospektgesetz, WpHG) is in charge

and if a sales brochure has to be created, which would be expensive and must be approved

by BaFin28,29.

24 cf: Seedmatch FAQ 25 cf: Hemer, J. et al.: "Crowdfunding und andere Formen ...", (2011) p. 79 26 KWG: Gesetz über das Kreditwesen, 1998 27 Cf: KWG, §1 Abs 1.2 28 BaFin: Bundesanstalt für Finanzdienstleistungaufsicht, www.bafin.de 29 Cf WpPG: Wertpapierprospektgesetz, version of 2005-06-22


4 A typical project for crowd investing: Trampoline systems30

Trampoline systems is an award-winning31 enterprise software vendor based in London,

founded in 2003. The company's SONAR CRM product helps customers increase the win

rate in B2B sales. It automatically maps the flow of communications between sales

executives and a customer and presents an overview of the relationship. In 2009

Trampoline became the world’s first technology business to raise finance through crowd

investing. While the global venture capital industry was in the "most severe crisis of its

history", they instead decided to pull lots of 10,000 GBP or more from the crowd, aiming for

one million GBP.

The company announced a program to raise a total of one million GBP spread over four

rounds. The first round of 260,000 GBP was completed in October 2009 and a second round

of 350,000 GBP opened in August 2010.

30 Figures in this chapter are take from crowdfunding.trampolinesystems.com (assessed 2012-05-15) 31 Cf trampolinesystems.com (assessed 2012-05-15)


5 Conclusion

In this paper, I have presented the ways in which modern strategies are crucial for a

corporation’s economic success. I have first worked out a short definition of the term

strategy in its general sense. ny Europe.

Crowd investing turned out as a giant marketing tool to attract other investors as this

pioneer demonstrates.

Seiten 95-99: "Eignung von VF als Lückenbüßer" ...

BLA BLA

und Seiten 111-115

BLO BLO


6 Bibliography

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Cosh A., Cumming D. and Hughes A.: "Outside Entrepreneurical Capital",

(2009) Economic Journal 119, 1494-1533

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neuartige Finanzierungsformen für Kreativprojekte”,

(2010) Landeshauptstadt Stuttgart, Wirtschaftsförderung

Garbe, A.: "Die Weisheit der Vielen / 3Sat",

(18.06.2010), 3Sat Reportage - Sendung 10.04.2011, Topic: "Online Crowd"

Hammon, L.; Hampel, S.; Hippner, H.: “Crowdsourcing” in: WISU, Nr. 5, 2010, S. 698-704

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(2012-05-09)

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q12012 (2012-04-04)

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risiko.htm (2012-05-15)

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n/a: "Gesetz über das Kreditwesen"

http://www.bundesbank.de/download/bankenaufsicht/pdf/kwg.pdf, (1998)

int finance - crowd investing - term paper

Documents

minimum contract duration

additional payment liability

directly seek financial

venture capital funds

crowd funding

private equity

trampoline systems

venture capital