While we figure out how to increase German capital investment into venture, which policy changes would help to improve access of German startups to American venture capital regarding early-growth capital access, especially in ‘Made-in-Germany’ deep tech topics?
Between 2015 and 2018 US investment into German venture capital-backed companies totaled USD 3.7 billion. During the same time frame German investment into German venture capital-backed companies was USD 3 billion. Given that the US venture capital market is much more developed than its German little sibling, this may come to no surprise. However, VC firms traditionally invest a large share of their capital into their respective home markets. But looking at capital flow in the other direction, from German venture investors into US-based VC-backed startups, an astonishing USD 4.9 billion have been committed during the 2015-2018 time period (Pitchbook, 2019). This includes not only pure VCs, but also government institutions and corporate VCs. Do German investors trust home-grown startups less to successfully generate competitive return on investment than they do their American counterparts?
If Germany-based VC investment would want to match US levels in relation to GDP, it would have to increase 15-fold from about USD 2 billion to about USDÂ 30 billion compared to the +130 billion USD invested in VC in the US annually. These numbers are not to be confused with the total investment into German startups, which has been ever rising and will likely hit USD 6 billion in 2019. I want to point out the percentage of that capital actually stemming from Germany, as only if German money is at work, will Germany benefit long-term financially from these developments.
These facts notwithstanding, the German venture scene has been thriving compared to where its coming from, with capital invested increasing every year since the last recession. Especially the availability of seed funding has improved manifold. Similarly, late-stage investments have increased, and unicorns have emerged out of Germany at an increasing rate, even if it is still lacking globally dominant tech companies headquartered and built domestically, besides industry leader SAP.
The statistics above reveal a problematic dynamic in the mid-size funding range: Germany is lacking venture funds that are capable to push a high number of startups from high-growth small venture to high-growth large venture, meaning the funding round between USD 30-50 million remain very difficult to achieve for German startups with a national lead investor. While there are a number of European funds that are capable to lead such rounds, namely Target Global, Index, DN, EQT Ventures, Atomico or Lakestar among others, additional funding often needs to come from sources outside of Europe. Especially in lighthouse ‘deep tech’ startups like Volocopter and Lilium for example, both competing to dominate the race to develop the first flying taxis, lead investors are often neither German nor American, but stem from Asia. While the knowhow and the jobs are created in Germany, the potential long-term capital gains will flow elsewhere and the Intellectual Property may be at risk.
Acton Capital, at 11 years in operation one of the established German Venture Capital funds, today announced it has locked down its fifth fund, totaling 215 million USD, aiming to invest between 5 to 20 million per startup in Europe and North America. Other funds like Earlybird, Point Nine and Project A Ventures are approaching similar ranges. At this target size, it is promising to see them approaching the critical range for startups aiming to push beyond Europe, yet the size of established US firms’ funds regularly exceeds the USD 1 billion mark. The largest German fund Target Global has access to USD 770 million AuM, a considerable size, enabling it to lead deals that American VCs join in on as they prefer to have a strong local lead. While US investors have taken the lead, this remains extremely rare, as they typically prefer to have a local partner for due diligence, pricing and negotiations, reiterating the need for more local capital. Size certainly isn’t everything, far from it. But for the current German startup landscape, it is key to become relevant on a global level.
Changing the German fund landscape and size will not be achieved overnight. It is rooted in much larger issues connected to its retirement system, the people’s culture towards investment and regulation on what asset classes large insurance and private pension fund companies are allowed to invest into. The long-term goal to significantly grow German venture capital must remain in focus nonetheless and it will require extensive legislative changes, making it a major undertaking in a country heavy with bureaucracy and ‘Angst’ of change as well as a surprisingly low level of financial literary even among academically educated citizens when it comes to compound interest.
In the meantime, it should be paramount to increase investment from venture firms based in the largest, most experienced and most developed VC market: the US. As part of my fellowship, I evaluate what the main barriers to invest into Germany are for US-American venture capital firms with the goal to single out the most pressing topic that is also attainable to tackle through increased attention and active political debate.
While it can be considered positive that European seed rounds financed with participation from US investors have increased from 10 % in 2012 to 17 % in 2018, this needs to be looked at on a more granular level, as many US-involved fundings still concentrate on the UK.
Having started off with the New York Venture Capital scene, it became quickly evident that NYC has a major advantage for the topic – it brings together Wall Street, institutional investors, highly experienced VC investors and regular delegations of visiting German politicians. Raising the topic at several events within the American Council on Germany’s regular schedule, I quickly learned that I’m not alone being worried about the future of the country’s ‘Lebensstandard’, if attitude and culture towards entrepreneurship and risk-taking don’t change over the next decade. The general credo seems to be that large-scale pension fund investment into VC in Germany is near-impossible to achieve, as it would go against so many of German’s traits of prudence and conservative money management, also known as cash hoarding at negative interest rates. Clearly, idealism and stubbornness will be required.
Venturing out to Boston and then to the Bay Area brought up another element: Young Germans with the right skillset and the motivation to create new, innovating companies often are inclined to not only study here in the US, but to stay on, founding their company right here. Incorporation is much easier, access to capital is more abundant and regulation around running a firm is overall lower and easier to master. Speaking at the Transatlantic Sync Conference in Palo Alto, Axel Springer Hy CEO Christoph Keese reminded present German political appointees of the need to increase private citizens’ understanding and interest of investment significantly to retain levels of prosperity in the long-term. He told me that he has been lobbying the topic for more than a decade, yet little movement was to be noticed within our political apparatus.
German member of parliament and transatlantic coordinator for the German Bundestag Peter Beyer signaled understanding for the frustrations of aspiring German entrepreneurs that it still makes little sense to build a deep tech company in Germany when you can do it in the US and contemplated a visionary thought: The goal to double German-originating venture capital every year, in order to ease towards a massive push for more German companies, ideas and entrepreneurs, both female and male.
Because this was another sentiment reiterated by American VCs – Germany does not necessary lack the capital – but it lacks the sheer number of startups and founders that are willing to go the extra mile and take leaps of faith for game-changing ideas. While traditionally strong in engineering and with a record number of patents claimed, Germany is unable to replicate this technical prowess in its startup landscape – and then fund it.
Thus, the work on reducing red tape and making it easier for startup companies to be founded, for them to be maintained from a bureaucratic perspective, to receive tax incentives and to make employee share participation easier are all potential areas of interest for policy change which will be further explored and drilled down on in this fellowship. One difficult topic mentioned is the need of startups to hire slow and fire fast – because hiring mistakes are inevitable and can grind a young company to halt, especially for early key roles. Whether it’s possible to touch this topic though, remains to be seen, as exceptions for startups vs ‘Mittelstand’ or corporations are a tough sell.
In a conversation with politician-turned-investor Karl-Theodor zu Guttenberg, he underscored the importance of inclusion of all political parties when pushing the topic entrepreneurship in the Bundestag, making sure to remind elected officials of their common goals to prepare Germany for the second quarter of the 21st century. Being brief but concise and being informed about the political needs as well will be paramount for German entrepreneurs lobbying for a modernization of legislation around ‘Unternehmertum’. Campaigns like www.notoptional.eu take the lead, now we need to take it further.
Nikolas Michael Leon Noetzel is a 2019 DZ BANK Fellow on Transatlantic Business and Finance. His research took place between September and December of 2019.Â