The Bankruptcy Risk of Equity Crowdfunded Companies in Germany

The market for equity crowdfunding has grown significantly in Germany. However, several prominent bankruptcies have raised suspicions regarding the quality of companies seeking funding. Inexperienced investors, small funding sizes and a lack of third-party certification can lead to adverse selection processes whereby companies that fail to secure traditional early stage funding turn to equity crowdfunding. A lower quality supply of companies in equity crowdfunding markets would imply higher risk, which in equilibrium should be compensated by higher investment returns. We investigate the adverse selection hypothesis by measuring the bankruptcy risk inherent in German equity crowdfunding transactions and comparing it to concurrent venture capital transactions. While the bankruptcy probability for equity crowdfunded companies is more than six times as high as for venture capital funded companies in the sample, there is no significant difference once we control for further characteristics of the offering. Any regulatory reaction attempting tighter investor protection should consider the cost of shutting out start-ups from seed or early stage capital, which are especially high in Germany as alternative sources of funding are not as well developed as for example in the USA or UK.