VC Fund raising in Germany — A Status Quo

VC Fund raising in Germany — A Status Quo
VC Fund raising in Germany — A Status Quo

Earlier this year I was giving my view on the development of Corporate Venture Capital markets with a focus on Europe. Since then I was receiving feedback in various discussions from fellow investment managers in Fortune500’s, public funds and private VCs. From those discussions I draw my conclusions on what we will see in the European Venture market in the coming years.

Everybody wants to invest in Startups

We are still in a positive investment market because of Quantitative Easing by FED and ECB and will be for the next 5–10 years without doubt. It’s a defensive move by all those parties allocating capital because there is no other way to earn interests on capital. Germany currently is making money out of the old debts so there is no opportunity to gain advantage from allocating capital into rather save investments. But even corporations facing the issue of losing money on patronizing their global profits back into their home countries so they rather make risky investments to avoid additional tax payments. So the markets are flooded with capital rich parties:

  1. VC Funds:

    Smaller (Accelerators, Seed Funds) and bigger funds (deep pockets VCs and stellar VCs) are out and about to raise new capital. They offer their investment capabilities to corporates, public funds and family offices. Their main argument is the experienced investment professionals who have the network to founders and co-investors to create the best deal flow in startup investments.

  2. Corporations:

    Like Alphabet, facebook and Intel Fortune 500 companies want to get into the startup ecosystems. Those activities are driven by interests to connect with the founders and new business models. While investment is part of the game it is not the focus on this activities. While most of those companies are public listed and very few have a fund structure set up those players leak the experience of fund setups and therefore focusing on investments from the balance sheet. Considering their ticket sizes in financing rounds it is smart to invest from corporate pockets and avoid the financial bureaucracy of fund management.

  3. Family Offices:

    Facing a low interest rate markets and high cash from longterm business activities the capital management for those cash loaded organizations need to find new ways. Equity investments in smaller companies is an attractive opportunity while they need to adapt into the higher amount of investments compared to good old days.

  4. Public Funds:

    Governments are feeling pressure from politics to fuel their ecosystems with funding. Public funds — either direct or indirect funding- are pushing public money into the investment markets. While participating in corporate funds is not allowed by Brussels there are still many opportunities to inject public money into the startup companies over time.

Germany is different in fundraising for VCs

Unlike in UK and U.S. there is a challenge for VC funds to raise money from those deep pocket capitalists. The challenge is due to regulatory framework and limited interests from traditional fund resources compared to Anglo-Saxon regions.

In most other regions in the world VC funds raise their investment sources from: Pension funds, corporations and wealth management funds. Recently in London various funds were purely raised from public sources to drive the tech city ecosystem. VCs in Germany face various challenges to get commitments from their targeted limited partners.

Pension funds: contrary to their U.S. and UK based competitors it is uncommon to get contributions from pensions in to the venture capital asset class. Mostly based on risks, those institutions are not common LPs in venture funds. There is no indication that this will change in the near future.

Public funds: There are various sources to gain access to public money for VC funds in Europe. Germany itself with its stateowned bank KFW provides fund in fund investment as well as direct investments in startups in a pari pasu model. High Tech Gründerfonds HTGF is leading Seed investments in young companies on standard VC terms. Additionally most of German counties have public investment arms to support startups with direct investments and loans to support their local ecosystems. Most notably IBB in Berlin, BayCapital in Bavaria and NRW Bank from Düsseldorf. Several of them also provide funds in fund investments which can be received from Luxemburg EIF as well. Still some private (non-public) funds need to be provided by VC funds first to gain access to those sources.

Corporations (DAX30 companies) & Family offices: Known for fund in fund investments are some German brands like SAP (in Earlybird), several publishers like DuMont Schaumberg (in Capnamics) and many more. However with activities of those DAX30 heavy weights entering the investment scene those source could dry up for VC funds faster than anticipated. Recent direct investments by Volkswagen, Porsche, Daimler in automotive show the Uber effect. But also Lufthansa, Metro, RWE, Commerzbank and Merck indicate this trend will increase through the main index of German economy.

The times of dump money are over

From my discussions across the German investors scene the trend is foreseeable: Private funds with focus on German based Limited Partners — from small to large- will face hard times in fundraising. The targeted fund sizes are, compared to UK and U.S. funds, small at best. Small funds will have limited potential in financing startups — either many small bets or a few bets- which will lead to small returns on invested capital with higher risks for its fund investors. Looking at the exit history for German based startups will overall lower the attractiveness for potential fund investors.

When talking to German based Fortune 500 companies I learned that many private VC fund partners are pitching their new fund to those DAX30 CEOs to become limited partners. While still there are some committed capital from DAX30 members will be announced soon, the success rate for VCs are very low. While the pitch is hard based on recent exits for German VCs the alternative of strategic corporate investments from their own balance sheets is much more compelling recently. Those boards rather drive their own investments via their M&A units than handing funds to a private VC and hope for some financial return which is not in the focus of a public company anyhow. (20% return in 10 years on a $10m–20m fund contribution will not move the annual results for any of those corporations). Getting access to startups and disruptive business models does not need fund investments. Some corporate innovation hub initiatives gaining and active board members in the founders scene will result in even better achievements than regular access to deal flow of VCs. Founders love to have a chat with Fortune 500 CEO and it will not require equity given to the corporate venture arm of that company.

The investor’s landscape will change dramatically

Following the current trends and developments in board rooms and politicians driving governments strategies this will have a significant impact on the German Venture Capital scene.

a) Expect more Fortune 500, mainly DAX30 and Family Offices, taking active roles in financing rounds in mid-stage and late-stage investments. Seed deals are for angel funds (<$50m) and traditional fonds (fund sizes of $50m-$120m). German corporations will increase their investment activities in their specific industries with an eye on disruptive and innovation. It will be more common for startups to deal with investment professionals from a corporate background driven by M&A metrics. Founders should start to adapt their pitches to their way of understanding business investments. Expect smart money out of deep pockets. It will be a significant change on the other side of the table and there will be a lot of discussions regarding how serious this approaches will be — obviously from the private VC side. But just keep in mind investments such as $1bn by Apple into Didi Taxi or Twitters $70m contribution in Soundcloud. Sillicon Valley is leading a trend again. Those who were always pointing to west coast driven innovation will not be happy to be called on their marketing slides from the past.

b) Public money will drive the mid-stage investments too in the future. Seed investments in Germany were driven mainly by HTGF during the last years. While HTGF is aiming to a larger private share in their new 3rd fund they will be fueled by Germans Ministry of Economics as well as KFW Bank. A good mix of corporate and governments funds will be the source for the next rounds of early stage financing in Germany. IBB in Berlin will continue to support the Berlin ecosystems bound to local investments and Bavaria as well as NRW will follow the Berlin example. Initiatives by local governments are in place to use their regional banks to copycat the Berlin role model in the near future.

c) Private German VC funds will have a challenging time ahead. They will struggle to raise their funds and will announce first closings in the ranges of $50 — $80m while targeting a max $120m for its final closing. The number of VCs will decline in Germany compared to the glory days of 2004’s but the quality of investment professionals has risen. We have seen very profound VCs emerging over the last ten years in Germany with Point Nine Capital and Project A leading the market supported by several Super Angels gaining traction over recent years creating some significant companies to be the poster children for the German startup scene.

d) UK and U.S. based Venture Funds will find their way into Germany again after some rather less successful attempts in the 2010’s years. It will be part of a broader entry for those funds into continental Europe. They were used to the convenient approach to invest in London based companies. After Brexit they need to find new targets and accept the challenge of new legal and regulatory frameworks. Entering a market with a stable economic environment and an undercapitalized funding system will be a very attractive investment territory. While competition will be rather low and stellar funds from the UK and U.S. will always have a competitive advantage over local VC funds they will easily dominate the investment markets for the most attractive deals in Germany.

Overall the investment market for Startups will change significantly over the next 24 months and a lot of new names will become common in the ecosystem. But change is always pushing an industry and the venture capital market will be disrupted as every other industry as well — however maybe not in a way the current incumbents were hoping for.