After introducting the different ways of crowdfunding existing nowadays in Germany last week, today I’d like to discuss the only investment-model in there a bit further: crowdinvestments are when a very large group in a high quantity but low individual volume invests in an upcoming company to finance its development and growth through a more or less public auction. Or so it should be.

Understanding the system of GmbH

While because of the legal structure in Germany and the high complications (and costs) of changes in shareholders of a GmbH (and UG), the crowd isn’t holding actual shares but a complicated system with shadow-shares and debt-contracts to make that system appear to work. All of that coming with its own set of benefits and problems, most people are unaware of: The GmbH (an UG is the same thing) in Germany is the default legal entity if you want to start a business. It is much lower in initial investments and costs to set up than an AG (which would be similar to the UK and US Ltd.) and as such more than two thirds of companies in Germany and Austria are GmbH. Similar goes for SRL in Italy and Spain and the SARL of France.

And as the intention of the lawmaker was to keep the small- and mid-size business owners safe from the market fluctuation of their own shares, they were created in a way that makes trading those papers really hard - in Germany for example you have to go to a notary every time (a special lawyer who co-signed the papers are correct) and need to be filed to court before taking effect. For big Investments Fonds that isn’t much of a problem. They are not interested in doing intra-day trading with startup and growth companies but invest long-term and big-money of a couple of millions. And the process (with due diligence and stuff) takes weeks till months anyways, a day or two more and another 2k spend on a notary doesn’t really matter. But if you are raising 100k in steps of 250€ per person, it really does.

Introducing the Crowdinvestment-Structure

That is why crowdinvestment today is mostly done through shadow-shares1. And while they have the name “shares”, they are actually not shares of the company, as only those are defined as the shares stated at court are, but a dept-contract based on the company value. And in order to make them look like shares, the creditor gets another bunch of rights for which needs to be asked for before they can be done; the most obvious is that they need to be asked in case the company wants to change their goal and they often get a monthly or quarterly financial report. Which is already super bad, because it suddenly means if you want to pivot you don’t only have to convince your smart business angels and investors but also a group of 400 strangers, who don’t have a clue about (your) business and you are giving that same group highly sensitive company information, making it much easier to get leaked and your competitor to get their hands on. Actually, as the efforts are to high to check everyone, one of your competitors actually be under those investors without your knowledge.

Financial Trouble

But I want to focus on the financial aspect in this article. It is crowd-investment after all. So let’s rethink again, about the credit based on company value is. Let’s take a typical size of 10% the company gives away in shadow-shares for an absolute price of 100k euros. The company is within their first half a year and already got a rather good evaluation of roughly 1Mio€ here. I say roughly, because those shadow shares are a credit-line of the company and as such do not dilute when other investors come on board but are bound to the percentage value of the company (unless specified differently in the contract). Which means, that this credit line is still at 10% after the next, the next and the next financial round, so three years in. Giving the company an evaluation of, let’s say four million and as such the shadow-shares a value of 400k. That is actually a very low evaluation for an internet business, but let’s keep playing.

Now, the way shares usually work, is that an investors holds them and looks for a potential buyer, who’d be interested to take over the shares of the company. While that could theoretically work with shadow-shares as well, they are a high risk credit and you are not having the influence a shareholder has, so no investment fond will be interested in them. And I said before, they are actually the credit-line of the company. Meaning the investor gave a credit to the company and this company is responsible to pay it back - a major difference to investing, where the company is not hold accountable. And then the company realises they did something really stupid, when signing that those credit is due at company value. Sure, often the contracts have a life span of 5 years before they can be called and can only be called by the end of the year, but that makes it even worth.

A company with an evaluation of let’s say 25 million after five years, not that unrealistic, and has a couple of million in revenue. And even if you make the exmaple 100Mio, you still have the same proportional value, as the shadow shares are percentages of your company value. Meaning if the investors call for their money, the company has to pay them 10% of the company value, in this case 2.5Mio. Out of your cash flow. Ouch. Not gonna happen. The company is effectively bankrupt at that point. And as it is proportional, the absolute company value doesn’t really matter, as you are never going to have 10% yearly bonus you could just cut and give to your creditors. While you might be able to call the first one, if all 400 do a call, you can close your business. Though it is actually going rather well and you can pay your employees.

That is why the way crowdinvestment as structured in Germany, actually is a high-risk credit - for both sides of the credit. And not worth it for any company that could in the time span multiply in value. This can work for gastronomy or manufacturing plants, which might increase in value of 10% a year. But not for an internet startup that wants to tripple in value within each year.

Further Implication: funding troubles

But aside from the direct implication for your business in 5 years from now (that you have to close it thought it actually being successful because you are stupid today), there is a very important indirect implication, you are unaware of: with such a contract on your company no big investors will invest in you. Those papers will come up during your due diligence (or you are committing fraud you’ll be hold accountable for at court) and those investors understand its implications. And as of the way those papers are structured, your investors actually come after them. Not. gonna. happen.

As a matter of fact, when I looked into this form of investment in August last year, I talked about it with a lawyer at a dinner party and he told me that as a matter of fact one of the companies, who’d raised a big amount of money that way, was their client and exactly in that struggling position right now. They raised 100k and wanted the marketing exposure, now were talking with investors as the company actually needed like 250k, but because of that contract no one was willing to sign. So that lawyer had to job to figure out a way that could work, but as you need all 400 crowd-investors to sign even if you wanted to buy it back, he didn’t see any option. From what he was telling, I know which company it is and know they eventually failed to get any investors on board because of that, confirming my suspicion.


Be aware of the implications of German crowd-investment models. Aside from this financial aspect, I have a few other aspect in mind, which make this an unattractive investment model for startups and I’d recommend no one to go for it2. Unless you are thinking of it more of a highly incentive-driven marketing model (if you need ambassadors for your company for e.g.) and assume you’ll have it totally sold as whole within the next five years (and paid out your investors that way). But that is not the case for most companies, so I’d recommend you find a way to use the pre-sales system to raise money instead. And if it is only to invite your fans for a coffee…

  1. There is also a system of creating a holding for each one, but that means doubled running costs, so never fall into that trap. 

  2. Interested? I can tell you more over a drink, just drop me a line