Analysis of the Crowdinvesting Market in Germany. Motives, Chances, and Risks from a Company's Perspective

Table of contents

Index of figures

Index of tables

List of abbreviations

1. Introduction
1.1 Statement of the problem and research question
1.2 Goal and approach of this thesis

2. Theoretical framework
2.1 New institutional economics
2.1.1 Transaction cost economics
2.1.2 Principal-agent theory
2.1.3 Financial intermediation
2.2 Traditional financing
2.2.1 Basics
2.2.1.1 Mezzanine capital
2.2.1.2 Financing phases
2.2.2 Financing methods
2.2.2.1 Private equity and venture capital
2.2.2.2 Business angels
2.2.2.3 Debt capital
2.2.2.4 Bootstrapping and family, friends, and fools
2.2.2.5 Public funds

3. Introducing the crowd into the financing process
3.1 Crowdsourcing - The origin
3.1.1 Types of crowdsourcing
3.1.2 Motivations of contributors
3.2 Crowdfunding
3.2.1 Donation-based crowdfunding
3.2.2 Reward-based crowdfunding
3.2.3 Lending-based crowdfunding
3.2.4 Crowdinvesting
3.2.4.1 Definition and characteristics
3.2.4.2 Actors
3.2.4.2.1 Investors
3.2.4.2.2 Platforms
3.2.4.2.3 Agency problems in crowdinvesting
3.2.4.3 Process
3.2.4.4 Legal situation in Germany

4. Empirical analysis of the crowdinvesting market in Germany
4.1 Overview
4.1.1 Market development 2011-2016
4.1.2 Characteristics of the companies in 2016
4.1.3 Platforms
4.1.4 Financing instruments in practice
4.1.5 Status of crowdinvesting projects 2011-2016
4.2 Critical appraisal
4.2.1 Motives
4.2.2 Chances
4.2.3 Risks

5. Conclusion and discussion
5.1 Conclusion
5.2 Discussion

Appendix

Bibliography

Index of figures

Figure 1: Sources of capital

Figure 2: Financing phases

Figure 3: Overview of crowdsourcing

Figure 4: Agency problems in crowdinvesting

Figure 5: Crowdinvesting 2011-2016

Figure 6: Types of companies

Figure 7: Company locations

Figure 8: Geographic distribution

Figure 9: Status of crowdinvesting projects 2011-2016

Figure 10: Motives for crowdinvesting from a company’s perspective

Index of tables

Table 1: Crowdinvesting 2011-2016, separated into segments

Table 2: Overview of crowdinvesting platforms 2011-2017

Table 3: Characteristics of active crowdinvesting platforms

Table 4: Market shares based on volume in 2016

Table 5: Financing models on companisto.com

List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1. Introduction

According to a study by the German bank KfW, which focuses on the promotion of business start-ups, the number of company foundations in Germany fell to an all-time low of 672,000 in 2016. There are a variety of reasons for this, but according to the study, the main cause is the historically low unemployment rate in Germany. Due to the high demand on the job market, economically active people can choose between an employment relationship or selfemployment. In most cases, people choose the first option as they prefer a stable and secure job than to take the greater risks of being self-employed.

As a further reason, the study states that company founders are struggling to finance their companies, as setting up a business is becoming increasingly more capital-intensive than in the past. In most cases, the financing of companies has to be ensured by financial resources of the founders, private or institutional investors, banks, or family and friends. In this vein, the KfW study states that 16% of founders have been confronted with difficulties in financing their business. Often, their own financial resources are not sufficient for a sustainable business start. In the case that start-ups require debt financing, they have to overcome higher obstacles than already established companies as they often do not fulfill the requirements of lending banks, such as providing collateral (compare Kfw.de, 2017).

Furthermore, according to a 2015 AXA study, missing financial resources are perceived as the greatest barrier to starting a business (compare Axa.de, 2015). This aspect shows that the possible difficulties in financing could lead to some potential founders not starting a business at all. Furthermore, in the literature the financing of start-up businesses counts as one of the most crucial aspects of being successful as a company (compare Mollick, 2014, p. 2). But not only new company foundations need financial resources in the form of financing. Established companies also need enough money to grow or save their businesses. The Berlin-based company Bloomy days, founded in 2012, serves as an example of this. Due to a failed round of financing, the company was forced to file for insolvency in July 2017 (compare Kyriasoglou, 2017). Considering these explanations, it can be noted that financing eventually plays a role for companies, be it during the foundation of the company or in the implementation of a growth strategy.

The most common financing methods are theoretically well examined, and empirical data are extensively available. In contrast, crowdinvesting, the subject of this thesis, appeared for the first time in the year 2011 in Germany and can therefore be considered to be a new financing method. As a consequence, the literature and scientific data on the subject are not yet substantial, although some educational institutes conduct research in this regard. Especially for young and innovative companies seeking capital to kick-start their business, crowdinvesting has been labeled as a new trend. Crowdinvesting describes the process where investors are approached about the financing of these young and innovative companies, but sometimes also established companies or selected projects are financed. The basic principle of crowdinvesting is that individual persons on the internet invest money in a company and in turn receive the right to participate in the success of the business. In return, the companies receive the financing amount as equity or debt capital (compare Beck, 2014, p. 10 et seqq.).

1.1 Statement of the problem and research question

As mentioned above, companies face the general problem of how and where to raise capital to achieve their defined goals. This thesis is based on this general problem. Several financing methods exist for companies to raise capital; the companies hence have to determine which of the available financing options are the best for their current situation, and evaluate which option they finally choose. Every financing method has its own advantages and disadvantages. Since the financing option of crowdinvesting is relatively new and still being established as an option, and empirical values are largely missing, companies have to be thorough in determining whether it is a valid option for them. In this vein, this thesis focuses on the following research question: what are the motives, chances, and risks from a company’s perspective regarding the new phenomenon of crowdinvesting?

1.2 Goal and approach of this thesis

Besides answering the above research question, this thesis also aims to contribute to a more detailed understanding of crowdinvesting from a theoretical and empirical perspective. Due to its innovative character, most information about crowdinvesting at the moment is based on working papers, a few specialist books, and database entries. The present thesis uses the existing literature as a core to explain the concept.

To ensure a profound understanding of the topic of crowdinvesting, this thesis begins with a theoretical framework in chapter 2. The chapter describes the theory of the new institutional economics and the basics of financing, including the most common financing methods. Chapter 3 then introduces the crowd as a supporting and financing instrument for companies. In particular, the concepts of crowdsourcing, crowdfunding, and crowdinvesting are expounded and illustrated with examples. Subsequently, following the theoretical aspects, the crowdinvesting market in Germany is empirically analyzed and the financing option of crowdinvesting is critically appraised in chapter 4 to answer the research question. To conclude, the findings of the previous chapters are summarized and an outlook is given within a discussion.

2. Theoretical framework

This chapter provides an overview of the theoretical basics regarding new institutional economics and the various types of traditional financing methods. These theories and concepts serve as the foundation for the following chapters and complement the overall understanding of crowdinvesting, as they influence it in a number of ways.

2.1 New institutional economics

Institutional economics deals with the analysis of institutions, which can generally be defined as follows: institutions are the rules of the game in a society or restrictions of human interaction conceived of by people. Consequently, institutions create incentives in the human exchange, whether in a political, social, or economic way (compare North, 1990, p. 3). However, a consistent definition does not exist in the scientific literature. In particular, institutions can be understood as a contract/contract system or as a rule/control system. As a result, different types of institutions build the framework for individual human action (compare Erlei et al., 2007, p. 22).

Ronald Coase ’ s 1937 article “The Nature of the Firm” is considered to be the birth of new institutional economics. However, the recognized term new institutional economics was created by Oliver E. Williamson almost four decades later, in the year 1975 (compare G ö bel, 2002, p. 49).

In a historical context, the classical economists, such as Adam Smith, David Hume, and John Stuart Mill, already took institutions into consideration. For them, laws and moral rules were the basis to make the functionality of markets possible. In contrast, the neoclassical economics that emerged in the 19th century most widely neglected the analysis of institutions in their concepts and focused more on formal models, such as the homo economicus model, which represents humans as consistently rational, honest, and self-interested agents (compare G ö bel, 2002, p. 48 et seq.; Wildmann, 2007, p. 28; Richter and Furubotn, 2010, p. 24 et seqq.). With these premises, the economic world was simplified, and it was possible for scientists to describe economic processes mathematically and logically. These assumptions were criticized by the representatives of the “old” or “traditional” institutional economics due to their lack of contact with reality. Roscher, von Schmoller (“historical school of economics in Germany”), B ö hm-Bawerk, von Hayek (“Austrian school”), Eucken (“Freiburg school”), and Veblen (“American institutionalism”), among others, are representatives of the old institutional economics. Subsequently, new institutional economics combines different theoretical components that show a greater affinity to the neoclassical economics than to the old institutional economics (compare G ö bel, 2002, p. 48 et seq.). Transaction costs, uncertain expectations, and bounded rationality are the main assumptions of new institutional economics (compare Richter and Furubotn, 2010, p. 50). To date, no consistent definition exists regarding which specific theoretical components belong to new institutional economics and which not. However, scientists generally agree that the following three elements are core aspects of the theory: transaction cost economics, principal-agent theory, and property rights theory (compare G ö bel, 2002, p. 49). The first two are explained in more detail in the following sections.

2.1.1 Transaction cost economics

As mentioned above, transaction cost economics is a main aspect of new institutional economics. The theory describes the fact that the use of the market is not cost-free and that processes within the firm incur costs (compare Coase, 1937, p. 388 et seqq.). This chapter focuses on the market perspective.

According to Williamson, “a transaction occurs when a good or service is transferred across a technologically separable interface. One stage of activity terminates and another begins” (Williamson, 1985, p. 1). Therefore, transactions can be seen as explicit and implicit negotiations about goods or services between at least two parties. The author also states that transactions are the core unit of theory analysis, and that every problem that occurs as a direct or indirect contracting problem can be usefully investigated with the help of transaction cost economics (compare Williamson, 1985, p. 41).

Transaction costs denote the costs that emerge during the transmission and enforcement of property rights. Different types of costs arise for the initiation, bargaining, agreement, monitoring, and adjustment of reciprocal performance relationships (compare Picot and Dietl, 1990, p. 178). Arrow proposes a more general definition of transaction costs as the “costs of running the economic system” (Arrow, 1969, p. 48). When transaction costs occur before the formation of a contract, they are called ex-ante transaction costs, whereas ex-post describes the transaction costs after the contract has been finalized (compare Williamson, 1985, p. 20). Ex-ante transaction costs include information, bargaining, and contractual costs, and can be summarized as initiation costs, whereas the costs of monitoring, enforcement, and adjustment of contractual conditions count as ex-post transaction costs (compare Picot, 1982, p. 270). For example, ex-ante transaction costs are incurred in the search for a suitable business partner and the associated expenses, such as advertising, fee-based research, customer visits, telephone expenses, and postage; and also include bargaining and agreement costs of contracts, such as the costs of legal advice and business consultants. Examples of ex- post transaction costs are the monitoring of delivery terms and quality control. In addition, transaction costs can be separated into fixed transaction costs, which describe the specific investments as part of the establishment of institutions, and variable transaction costs, which depend on the amount or scope of the particular transaction (compare Richter and Furubotn, 2010, p. 58 et seqq.).

Regarding the characteristics of transaction costs, Williamson defines three dimensions that influence the amount of transaction costs: (1) asset specificity, (2) uncertainty, and (3) frequency. He describes these dimensions as follows (compare Williamson, 1985, p. 52 et seqq.).

(1) Asset specificity is the most important dimension, and distinguishes transaction cost economics from other theories. As a result of transactions, investments are made into specific input factors: for instance, the purchase of a product-specific processing machine or the investment in know-how for the application of firm-specific software. Due to these specialization advantages, relative cost benefits are realized and as a result, production costs decrease. On the other hand, transaction costs can also rise: due to the increasing specialization of the input factors, the dependence on the transaction partner increases. The transaction partner may exploit this circumstance and demand higher prices. A renegotiation may also lead to higher transaction costs.

(2) The second dimension, uncertainty, can be split into primary and secondary uncertainty, both of which affect transactions. Primary uncertainty describes the fact that due to a random act of nature and unpredictable changes in consumers’ preferences, uncertain circumstances could arise in the future. In contrast, secondary uncertainty is based on the behavior of the transaction partners and concerns the lack of communication between them. In particular, the main issue is possible opportunistic behavior. If both uncertainties are not considered at the beginning of the transaction, then ex-ante or ex-post transaction costs will occur.

(3) Frequency describes the circumstance that by increasing the number of the same type of transactions, scale and synergy effects can potentially be realized, and if these cost efficiencies are utilized, then production and transaction costs eventually decrease per transaction.

All behavioral actions within transaction cost economics are caused by two main assumptions (compare Williamson, 1985, p. 44). The first one is bounded rationality: transaction partners tend to act rationally but in reality, this does not work for them because they only have limited access to information and their capacity to process the available information is also limited. The second assumption is opportunism: it is assumed that transaction partners follow their interests during the transaction process and that, to reach this goal, they are willing to withhold information to delude, mislead, or otherwise confuse their counterpart (compare Kieser and Ebers, 2014 p. 227).

2.1.2 Principal-agent theory

The principal-agent theory analyzes the problems that could occur between at least two economic actors in a principal-agent relationship, and provides different solutions to eliminate or reduce these problems. Several definitions of the principal-agent theory exist in the literature, but so far, no single one has been established due to the relatively young history of the theory. Ross ’ s article from the year 1973 “The Economic Theory of Agency - The Principal's Problem” represents the starting point of the theory (compare Meinh ö vel, 2004, p. 470). He defines the principal-agent relationship in detail as follows: “an agency relationship has arisen between two (or more) parties when one, designed as the agent, acts for, on behalf, or as representative for the other, designed the principal, in a particular domain of decision problems” (Ross, 1973, p. 134). Pratt and Zeckhauser propose a broader and more general definition: “Whenever one individual depends on the action of another, an agency relationship arises. The individual taking the action is called the agent. The affected party is the principal” (Pratt and Zeckhauser, 1985, p. 2).

Typical examples of such principal-agent relationships are the relationship between employer and employee, buyer and seller, and investors and management. In all these cases, for the realization of his interests, the principal transfers certain tasks and decision-making competencies to the agent based on an agreement, such as a contract. The agent receives remuneration for this service. The delegation of the tasks and decision-making competencies is an advantage for the principal, as he can utilize the time, professional skills, experience, and knowledge of the agent. However, the assignment of an agent also leads to problems. For instance, due to the transfer of the decision-making competencies, the agent is put in a position to pursue his interests and goals at the expense of the principal. When the interests of the principal and agent deviate, and the former has no information about the characteristics, actions, and intentions of the latter, the risk for the principal increases that the agent will not act according to the agreed assignment. Therefore the principal has to find institutional regulations that ensure that the agent will fully provide the agreed service (compare Kieser and Ebers, 2014, p. 206 et seq.).

The problems that could occur in a principal-agent relationship and that are analyzed in this theory are called asymmetric information. This asymmetric information can be separated into three types: (1) hidden characteristics, (2) hidden action, and (3) hidden intention (compare Spremann, 1990, p. 561 et seqq.). These are also called agency problems (compare Kieser and Ebers, 2014, p. 211).

(1) Hidden characteristics describe the situation before (ex-ante) the assignment, where the characteristics of the agent himself and the provided services are hidden for the principal. The agent can fake his behavior or pretend knowledge, and this will only be perceptible for the principal after the finalization of the assignment. This circumstance leads to a higher risk of adverse selection, meaning the selection of unwanted contractual partners (compare Dietl, 1993, p. 137; Metzler, 2010, p. 222).

(2) Hidden action appears during and after (ex-post) the assignment. The principal is either incapable of assessing the actions of the agent due to lack of knowledge, or is simply not able to observe these actions for practical reasons. The principal is aware of the outcome of the assignment, but he does not know how much of the work was done by the agent compared to what resulted from external factors. Considering this circumstance, the agent can act opportunistically and is not worried about being unmasked as he exploits the principal’s missing control possibilities. This sort of behavior is called moral hazard (compare Metzler, 2010, p. 222).

(3) Hidden intention refers to the agency problem where the principal ex-ante does not know how the agent will behave during the assignment. The agent’s actions are observable for the principal, but hidden intention becomes a problem in those cases where the principal is dependent on the agent due to irreversible investments. Ex-post, the principal is no longer in a position to induce the agent to engage in behavior that meets his interests. The agent can exploit this situation opportunistically. This circumstance is called a hold-up (compare Dietl, 1993, p. 141).

The principal-agent theory also provides solutions to eliminate or reduce agency problems.

To avoid adverse selection, the principal can screen the agent ex-ante to obtain information about his characteristics. Examples of this are quality assessments and performance tests. In contrast to screening, the agent can also take the initiative and signal to the principal that he is willing to disclose his characteristics before the assignment (compare Scholtis, 1998, p. 48 et seqq.). To avoid moral hazard, the principal can implement incentive systems. One possible method is to let the agent participate in the profit of the assignment. This way, the agent is more motivated to consider the interests of the principal (compare Spremann, 1990, p. 581 et seqq.). A further method, which is also valid for hold-up, is the installation of control systems. The principal can design a contract that explicitly describes how the agent must act during the assignment. Then, if the agent does not comply with the agreed terms, he will be sanctioned (compare Antle, 1982, p. 505 et seqq.; Spremann, 1990, p. 577 et seq.).

These solutions can be summarized as monitoring, governance, and bonding costs, and they all incur expenses for the principal and agent. Furthermore, two additional costs occur, agency costs as a whole. Firstly, the agreement on assignments leads to expenses for the principal and agent. Secondly, residual costs arise for the principal due to his welfare loss, which represents his missed potential utility maximation as a result of the divergence with the agent and related negative effects. The greatest possible efficiency of principal-agent relationships is realized with minimum agency costs (compare Jensen and Meckling, 1976, p. 308 et seq.; Kieser and Ebers, 2014, p. 210 et seq.).

2.1.3 Financial intermediation

Applied to the capital market, a perfect market would mean that capital would be frictionlessly transferable. As described in the previous two sub-sections, however, the economic market is not perfect due to the existence of transaction costs and information asymmetry. That is why specialized institutions, so-called financial intermediaries, aim to even out the imperfections of the capital market within the financial systems (compare Pilbeam, 2010, p. 33).

In general, the term intermediary describes an actor who becomes engaged in the process of exchange with the goal of intermediating (compare W ö he and D ö ring, 2008, p. 415). Greenbaum et al. concretize intermediaries’ area of activity on the financial market, describing them as “entities that intermediate between providers and users of financial capital” (Greenbaum et al., 2016, p. 24). The relevant literature does not clearly define precisely which institutions count as financial intermediaries. Diamond uses the term as a synonym for banks (compare Diamond, 1984, p. 393), whereas Bitz uses it to refer to stock exchanges, rating agencies, and insurance companies (compare Bitz, 1993, p. 12 et seqq.). Breuer provides a more detailed separation, identifying four different types of financial intermediaries: finance surveyors (e.g. rating agencies), finance auctioneers (brokers), finance market-makers (securities traders), and finance producers (commercial banks) (compare Breuer, 1993, p. 15 et seqq.).

The function of financial intermediaries can be considered as assisting in the transfer of funds from providers to users of financial capital. During this process, financial intermediaries conduct five economic subfunctions: (1) the provision of a payments mechanism, (2) maturity transformation, (3) risk transformation, (4) liquidity provision, and (5) reduction of transaction, information, and search costs. These subfunctions are described in the following (compare Merton and Bodie, 1995, p. 5 et seqq.; Pilbeam, 2010, p. 32 et seq.).

(1) The transfer of funds is linked to risks (e.g. the payments could be lost) and costs (the transfer itself). Especially commercial banks as financial intermediaries facilitate the transfer of funds, as nowadays the direct exchange of cash between agents is no longer needed due to non-cash means, such as credit cards and electronic transfers. A functioning payment mechanism contributes to ensuring that transfers of funds are safe and cost-effective.

(2) Providers and users of financial capital could have different expectations about the investment period and maturity of funds. Providers of financial capital seek to have their investments returned to them on short notice. In contrast, users of financial capital have the intention of keeping the received funds, such as credit, for as long as possible. Maturity transformation describes the process whereby financial intermediaries, e.g. commercial banks, convert short-term liabilities towards investors into long-term assets such as loans.

Financial intermediaries deal with a large number of providers and users of financial capital, which is why they are able to perform maturity transformation.

(3) With the transfer of capital, the risk arises that repayments will not occur on schedule, or not completely. Within risk transformation, different mechanisms, such as hedging and diversification, are available for financial intermediaries to shape the risk according to the wishes of the financial capital providers and users.

(4) Providers of financial capital usually require a high degree of liquidity. Some financial intermediaries, known as market-makers, can provide the technical possibilities for liquidity. Market-makers bring together numerous potential buyers and sellers of a financial asset in a marketplace, such as the stock exchange. Providers of financial capital can rapidly sell their securities there.

(5) Many potential providers of financial capital lack the time, skill, and resources to analyze prospective users of financial capital. Financial intermediaries benefit from economies of scale, as they analyze many prospective investment opportunities. Therefore, they employ highly qualified staff to assist in the process of finding suitable investments.

In contrast, financial disintermediation describes the process whereby financial intermediaries are entirely or partially left out of the relationship between providers and users of financial capital. When applied to the banking system, the process of disintermediation can be separated into two stages: the first describes the detachment of commercial banks by investments banks, and the second exploits the elimination of investment banks by the direct relationship between providers and users of financial capital (compare Paul, 1994, p. 52 et seqq.).

2.2 Traditional financing

This section provides a general overview of the basics of traditional financing. It also expounds the most common financing methods for start-ups and small and medium-sized enterprises (SME).

2.2.1 Basics

Financing and investing activities are essential economic requirements for companies to create and sell products or services. These two activities are conditional on each other. For production, investments are needed, and for investments, financing is required. In other words, investing can be described as converting capital into assets, and financing as the provision of this capital (compare Metzler, 2010, p. 34). In more detail, the term financing can generally be defined as the provision of different types of financial resources for the realization of the operational output of products and services. Furthermore, financing refers to exceptional financial processes, such as company foundation, capital increase, merger, restructuring, and liquidation (compare W ö he et al., 2009, p. 2 et seq.).

Financing affects the equity or debt capital of a company. It can be differentiated according to several criteria, such as the legal position of the investors, maturity, reasons for financing, and the source of capital from a company’s perspective (compare Perridon et al., 2017, p. 419 et seqq.). This section focuses on the latter. Figure 1 below shows the various sources of capital.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: Sources of capital

Source: Own presentation based on Olfert and Reichel, 2008, p. 33

Briefly summarized, the sources of capital can be separated into external and internal financing. As part of external financing, a supply of capital can be provided by the company

owners in the form of cash, or by the participation of shareholders. Both options are

considered to be equity financing. Debt financing is also external and describes the granting of credit by creditors, such as banks. On the other hand, internal financing can be conducted by self financing through the retention of profits, depreciation, or accruals. Furthermore, other financing is internal and explains rationalization measures or the sale of capital assets (compare Perridon et al., 2017, p. 422).

2.2.1.1 Mezzanine capital

So-called mezzanine capital holds a special position. Economically, the term refers to financing instruments that show characteristics of equity and debt capital and therefore have a hybrid status, although from a tax perspective the instruments have to be assigned to a single category (compare Beck, 2014, p. 138). In general, the two categories can be defined as follows. Equity mezzanine shows typical equity characteristics as it includes profit participation for the investors whereas voting rights, for instance, are excluded. Debt mezzanine includes typical debt capital characteristics: for instance, a creditor receives interest payments but is disadvantaged in the case of the company’s insolvency. In addition, mixed forms also exist, and mezzanine capital can be applied in several variants. Depending on the usage in the capital market or the source of capital, mezzanine capital can be differentiated into capital market viability (convertible and warrant bonds, preferred stocks, exchange-traded participation papers) and non-capital market viability. As the latter is relevant for crowdinvesting, the following describes its three different instruments: (1) subordinated and shareholder loans, (2) silent partnership, and (3) participation rights. In contrast, capital market viability instruments are not be the object of this chapter (compare Olfert and Reichel, 2008, p. 268 et seqq.).

(1) Subordinated loans are unsecured and usually bullet loans provided by creditors. Characteristics are that the loans are agreed, subordinated, and the right of termination is restricted. These loans are debt capital from a balance sheet perspective, but they also show characteristics of equity capital, as creditors forgo the collateral security and are subordinated in the event of insolvency. The latter means that a subordinated loan is serviced only after traditional loans and before equity capital. Similar to subordinated loans are shareholder loans. Besides a low rate of interest, an additional feature of these loans is the profit or turnover participation for the creditor, which is called equity-kicker. However, the creditor has no influence on the business of a company in the form of voting rights.

(2) Depending on the characteristics, a silent partnership can be considered as equity (atypical silent partnership) or debt (typical silent partnership) mezzanine. The typical silent partnership resembles the shareholder loan due to interest payments and profit or turnover participation for the creditor. Conversely, the difference is that the creditor can restrictively monitor the business of the company, such as through access to the annual accounts. Besides the profit or turnover participation, a loss participation also exists, but this is excluded in most cases. A further characteristic is that a typical silent partner does not participate in the increase in the value of a company, and the creditor only receives his initial deposit back after the contract has ended. On the other hand, in an atypical silent partnership, the creditor also participates in the increase in the company value. In addition, the scope of influence is stronger in this partnership: for instance, the right of approval is granted to the creditor.

(3) Participation rights are similar to shareholder loans, and as their name suggests, they represent the possibility to participate in the profit of a company. Any influence on the business of a company is excluded. The minimum terms of participation rights are usually five years, and during this time they cannot be terminated. This is why they are considered to be equity mezzanine. Unlike shareholder loans, participation rights also share the loss of the company. Exchanged-traded participation rights are called participation certificates.

2.2.1.2 Financing phases

Financing can occur in different stages in the lifecycle of a company. Figure 2 provides an overview of these financing phases and, for each of them, describes the situation of the company, cash flow status, and the usual financing methods. The respective financing phases are described in the following.

Figure 2: Financing phases

Abbildung in dieser Leseprobe nicht enthalten

Source: Own presentation based on Schefczyk, 2006, p. 26 and von Daniels, 2004, p. 23

The phases “seed” and “start-up” are summarized as “early stage”. Seed stands for preparing the foundation of a company by financing the finalization and implementation of an idea. Research investment and product development are the main activities during this phase. Next, start-up describes a company’s administrative foundation process. In this phase, product development is nearly complete, and the main focus is on the first marketing campaigns. Moreover, the production start is prepared. The company has not yet introduced the products to the market. In the “expansion stage”, the production is financed, or the growth activities of an established company are started. Here the primary focus is on improving the equity ratio by increasing production, sales, and product differentiation, or launching new markets. Finally, the “bridge” and “MBO/MBI” phases are part of the “late stage”. During the bridge financing, a company is provided with capital to prepare an initial public offering (IPO) or to overcome growth thresholds before the sale of the company to an investor. The last phase is the financing of the acquisition by the present management, which is called management buy-out (MBO), or by external management, called management buy-in (MBI) (compare Schefczyk, 2006, p. 24 et seq.).

2.2.2 Financing methods

The following sub-sections describe the most common traditional financing methods in detail.

2.2.2.1 Private equity and venture capital

The terms private equity and venture capital are often used synonymously, although most literature counts private equity as an umbrella term which includes venture capital, buy-outs, and mezzanine capital (compare Schefczyk, 2006, p. 8; Olfert and Reichel, 2008, p. 264). In general, both terms refer to the investment in the equity of non-market-listed companies by specialized holding companies, private equity funds, or private persons. As the source of capital, the two can be denoted as equity financing. Their characteristics are the close relationship between the investor and the management of the capital-seeking company and the fact that the investor has voting and monitoring rights (compare Metzler, 2010, p. 564). However, there are slight differences between the two terms regarding the type of companies in which they invest.

Venture capital mostly focuses on young and innovative companies with high growth potential. The investment takes place in the early stage of a company's lifecycle, and the running time of the supplied capital is three to seven years. In most cases, a predefined exit scenario is targeted, with the aim of a high rate of return for the investors. The provision of securities by the capital-seeking company is not needed. Besides the financial aspects, venture capital also includes support and consulting for the capital-seeking companies (compare W ö he et al., 2009, p. 143 et seqq.).

In contrast, private equity, in the narrower sense, focuses on investing in already established companies. The capital-seeking companies may be not making the profits they should be due to inefficiency. Private equity focuses on buying these companies and streamlining operations to increase revenues and sell the company at a later time via different exit channels, such as an IPO (compare Zantow et al., 2016, p. 119 et seqq.).

2.2.2.2 Business angels

Closely related to private equity and venture capital, business angels are private persons who provide start-up companies with capital and, more importantly, engage themselves in the day-to-day business processes (compare Zantow et al., 2016, p. 125). This engagement is the main reason why start-up companies decide to choose business angels instead of other financing types. Business angels become active in the early stage of a company’s lifecycle and support the management of the start-up company with their know-how, experience, and network of contacts. This support is a sustainable and value-adding factor for start-up companies.

The motives for business angels to participate in a risky start-up company with high growth potential are financially and non-financially based. Besides an expectation of high rates of return, business angels want to bring in their professional experience in an entrepreneurial environment, contribute to a successful company foundation, accelerate new and innovative product ideas, and have an effect on the young company’s development. Furthermore, business angels see their activity within a start-up company as a personal challenge.

Business angels can participate using the forms of silent participation, subordinated loans, participation rights, and equity financing. Business angels and start-up companies mostly come into contact through already existing business or private contacts, business angels’ networks, or business plan competitions. Only in a few cases do tax consultants, lawyers, or banks connect business angels and start-up companies (compare Schneck, 2006, p. 405 et seqq.).

2.2.2.3 Debt capital

Debt capital in the form of traditional loans is an individual agreement between creditors, usually banks, and capital-seeking companies to borrow an amount of money over a predefined period of time. Especially for medium-sized companies, bank loans are an important instrument for debt financing as a source of capital (compare Zantow et al., 2016, p. 141). The loan between both parties is an obligation. This means that the creditor will receive interest for providing the money and that he does not assume any liability for the business activities of the capital-seeking company. In general, a loan is only granted if the latter provides loan collateral. Different types of loans exist, and they are often differentiated by maturity. The classification depends on the term of the loan. Short-term loans last under one year, medium-term loans one to five years, long-term loans over five years (compare Schneck, 2006, p. 117).

Venture debt is a special form of debt financing as it concentrates specifically on companies in the early stage of their lifecycle. In most cases, companies are not credit-worthy for conventional loans, and collateral for the loan cannot be provided during this stage as the cash flow is usually low and no assets are available yet. Venture debt offers loans with the duration of one to four years without requiring collateral. In compensation for the increased risk, the creditor receives a higher rate of interest (compare T ö nies and Fischer, 2013, p. 192).

2.2.2.4 Bootstrapping and family, friends, and fools

Bootstrapping describes a financial method based on the money and effort of the company’s founder (compare Gianforte and Gibson, 2005, p. XV). With this method, the founder tries to find creative and parsimonious strategies to gain control of resources. This strategy can be separated into two forms (compare Harrison et al., 2004, p. 308): the first describes the creative ways to acquire capital without bank loans or raising equity from external sources (compare Freear et al., 1995, p. 394 et seqq.), whereas the second form involves minimizing or eliminating the need for capital by securing resources at little or no cost (compare Winborg and Landstr ö m, 1997, p. 471 et seqq.).

A clear disadvantage of bootstrapping is the limited amount of cash flow at the beginning of the company. Founders often ask people they know for money. These people are usually family, friends, and “fools”, also called the “3 Fs”. They are willing to invest or lend money at this early point of the company with such a high amount of risk (compare Kollmann and Kuckertz, 2003, p. 19).

2.2.2.5 Public funds

All methods discussed above are financed by the private sector, but public institutions are also involved in the financing process.

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