According to the World Economic Forum’s latest Global Competitiveness Report published in October 2018, Germany is the world’s most innovative economy. It is the country which can go from idea generation to the successful commercialization of a product the most quickly. Matthias von Oppen, Partner at Ashurst Frankfurt, sheds lights on how to invest in Germany’s digital economy.

Mr von Oppen, you frequently advise Chinese companies on German investments. At the same time, you work on capital raisings for digital companies in Germany. In which sectors do you see significant momentum and interest at present?

von Oppen:  We can see increasing Chinese investments in German engineering companies having state-of-the art technological know-how and expertise, for example in the automotive or robotics industry.  This is driven by the Chinese government’s “Made in China 2025” strategy which aims at making China a global leader in certain high-tech industries, including e-mobility,  cloud computing, telecommunications services based on the “5G” standard, and advanced robotics and artificial intelligence.

As regards digital companies,  we see particular demand from digital transformation and cloud computing businesses for raising the capital related to their expansion strategies. This is satisfied largely through traditional instruments such as public offerings or private placements. On the other hand, blockchain-based fundraising initiatives continue to draw much interest  but their potential for scaling up still needs to be proven.

Which legal challenges typically occur when it comes to a share deal in digital companies in Germany?

von Oppen:  Generally, when investing in a digital company, privacy and data security are key items on the due diligence agenda, and so is protection of intellectual property. In addition, non-EU/EFTA investors interested in acquiring a major shareholding in German companies, need to take into account German restrictions on foreign investments that have recently been tightened up again. Under German law governing investment controls, the government may prohibit an acquisition of direct or indirect shareholdings amounting to at least 10% of voting rights in the so-called critical infrastructure companies and certain defence and IT security companies, or of at least 25% of voting rights in other companies on national security grounds. The government may also request that certain changes are implemented before the investment transaction is completed. As the recent attempted acquisitions by Chinese investors of Leifeld Metal Spinning and a power-grid operator 50Hertz Transmission show, this can be a major deal-breaker, in particular for foreign investors with government backing.

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Besides traditional share deals, German companies increasingly make use of crypto financings. Will Security Token Offerings be the new entry point for foreign investors – inter alia from China?

von Oppen: STOs can indeed become an interesting investing alternative for foreign investors, in particular where a traditional investment in shares could be subject to legal restrictions. Due to the flexibility in creating tokens, token issuers may for example offer security tokens, which provide their holders with certain profit share or exit payment rights without giving them voting rights.

Investment in such non-voting security tokens would, for example, fall outside the German foreign investment control rules, which is an important advantage, in particular in case of Chinese investors. However, other sectoral restrictions may still apply, based on either EU or German law, depending on the legal construction of the STO.

Which regulatory aspects should companies be aware of when considering a capital raising via an STO?

von Oppen:  A public offer of security tokens requires a prospectus, unless an exemption from the prospectus requirement is available. The prospectus must provide comprehensive information necessary for assessing an issuer’s assets and liabilities, financial position and future prospects, and the rights conveyed by the tokens in a clear and understandable way in order to enable investors to take an informed investment decision. Before publication, the prospectus must be examined and approved by BaFin. However, BaFin’s approval does not limit the issuer’s liability for the correctness of the prospectus. Persons responsible for a prospectus (in particular, the issuer), may therefore be liable to pay compensation to any person who acquires security tokens and suffers losses as a result of any material false or misleading statement or any omission of material information in the prospectus.

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Security tokens can also be issued without a prospectus – does this exclude any liability under German law?

von Oppen: No, certainly not. When security tokens are issued without a prospectus, this implies only that the special prospectus liability under the German Securities Prospectus Act does not apply. However, the general principles of civil law liability under contract law and tort law are still applicable. Moreover, it is likely that investors would claim that a white paper prepared for the purposes of the STO constitutes a prospectus within the meaning of the German civil law and assert a claim based on related liability rules. The concept of the prospectus under German civil law is quite broad and includes any written statement which contains or appears to contain material information for the purpose of evaluating the investment offered and to provide investors with comprehensive information on the investment.  As a result, any person involved in the preparation of the white paper would be potentially liable for Incorrect or misleading information contained in the white paper. Finally,  in some cases, security tokens may also be issued based on a securities information note under the German Securities Prospectus Act.

In this situation, the issuer and the offeror are liable towards a buyer if material information in the securities information note was incorrect or misleading or if the securities information note did not include a required warning.

How can all parties involved in a crypto capital raising make sure that the transaction is BaFin-compliant?

von Oppen: Due to the lack of a clear regulatory framework for crypto capital raisings it is particularly important to involve lawyers already at the very early stage of the transaction planning. In addition to thoroughly analysing all elements of the transaction and applicable legal provisions, lawyers would also usually also liaise with the BaFin representatives to hear their view on particular transactional structure. In case of prospectus-based STOs, BaFin will also review and approve the prospectus in accordance with general rules.

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Is data protection sometimes an issue or even a deal-breaker for investments in digital companies?

von Oppen: Data protection compliance is an important due diligence issue when investing in digital companies, in particular those processing sensitive personal data like financial or health information.  The same applies to security breaches. Data protection and cybersecurity weaknesses can result in substantial fines and liability risks, which can significantly diminish the value of the target company. Moreover, having bought a non-compliant company the investor may need to mobilise significant resources to bring the target into compliance. Therefore, a thorough due diligence of data protection issues is necessary, paying particular attention to the sectoral specificity of the target and its geographic reach.

In your view, what is needed in order to strengthen growth investments in Germany’s digital economy from a legal perspective?

von Oppen: Digital economy is a key sector for the future of Germany’s economy and its competitive strengths should be further developed.

This requires creation of tax incentives for investments and reinvestments in start-ups by Business Angels and venture investors, for example in the form of deferred taxation of capital gains.

But regulatory action is also required to facilitate financing of start-ups.  For example in the earlier stages,  it would be recommended to ensure that equity investments are included within the scope of prospectus-free crowd investing instruments, which currently only apply to participatory loans, subordinated loans and other investments which grant the prospect of interest and repayment or a cash settlement of assets in exchange for the temporary provision of money.

In addition, an introduction of a clear legal framework for token offerings as an additional financing tool to venture capital would definitely help to build confidence in this form of financing and facilitate investments. Lastly reducing the regulatory hurdles for equity capital markets investments by institutional investors, in particular venture funds, would be important to increase the IPO activity in Germany as a means for raising new funds by the companies and enabling early stage investors a greater exit opportunity.

About Matthias von Oppen

Matthias von Oppen, LL.M is a Partner at Ashurst (Frankfurt am Main/Germany) specialises in corporate transactions with a particular emphasis on equity capital markets work and listed companies advice. Matthias has an impressive track record in connection with IPOs, rights offerings and a broad range of other securities placements for domestic and international issuers as well as for underwriters.

In addition, his expertise covers M&A, venture capital and digital economy transactions (including ICOs) as well as company law. Matthias also co-ordinates the China desk of Ashurst’s German offices.