Crowdfunding investment can take the form of debt investment or equity investment. Both types are alternative forms of business or project financing outside the traditional financial system. In a recent Legal Corner piece on the subject of ‘Subordinated loans as a vehicle of public participation and crowdfunding, we referred to alternative structures to ‘small’ capital market based financing schemes, taking, for instance, the form of equity investments. In this article, we will take a closer look at such equity investments.

Equity capital for a business is put up by its members (or shareholders) making contributions and acquiring shares (or stock). Basic characteristics include, among other things, the investor’s direct participation in the business, the basically equal interest both investors and business founders have in seeing the business develop positively, potential influence on running the business, depending on the amount of the investment (e.g. 26%, 51%, 75%), and no regular payments of interest.

If members of the general public make equity investments, this is called ‘crowdinvesting’ (or ‘equity-based crowdfunding’). The incentive for investors consists in the expectation of above-average returns as compared to the interest obtainable, (in most cases) at fixed rates, on (subordinated) loans. Such returns depend to a large extent on the company’s profitability, which provides the chance of multiplying the capital invested.

What aspects should investors acquiring company shares bear in mind?

Equity investment in a business is a new form of investment for many people. We will therefore only address a few key points an investor should clarify and analyse in advance:

• Number of existing members/shareholders and amount of the shares
• Voting agreement (syndicate agreement) among existing members/shareholders for the purpose of retaining control
• Regulations in respect of the Squeeze-Out Act (Gesellschafterausschlussgesetz)
• Are there any separate agreements between the members/shareholders and the company/partnership?
• Are management salaries and bonus payments at adequate and arm’s length levels?

If a shareholders’ agreement was concluded, it is advisable to check the following points:

• Is there any dilution protection for new investors?
• Obligation to grant additional guarantees for loans or funding?
• Who has the right to nominate members of the advisory board, supervisory board, or shareholders’ committee?
• Are there any profit distribution agreements?
• Is there any liquidation preference?
• Were any additional rights to obtain information and/or any other special rights granted depending on the investment made?
• Are there any agreements regarding future capital increases and business valuation as well as an exit strategy?

This multitude of legal and commercial issues clearly shows that it is absolutely indispensable to analyse and structure any equity investment with great care.