Transcript of "strategy.sauder.ubc.ca/hellmann/pdfs/aga inst_all_odds_02.doc"
AGAINST ALL ODDS:
THE LATE BUT RAPID DEVELOPMENT
OF THE GERMAN VENTURE CAPITAL INDUSTRY
Stanford Graduate School of Business
forthcoming in the Journal of Private Equity
For years it was claimed that the German economy is too conservative to develop a significant
venture capital industry. Yet, in a period of few years, German venture capital transformed itself
from a small, stagnant and obscure niche industry into one of the fastest growing and most
visible segments of the economy. What happened? Why did the reasons for Germany’s inability
to develop a venture capital industry suddenly vanish? What made the industry leap forward in a
space of two or three years? And are these changes only part of a bubble, or is the German
venture capital industry here to stay?
Historically, the overall market for private equity investments has been underdeveloped in
Germany. While the first investment funds date back to 1965, the number of private equity
funds remained small; approximately sixty funds were active in Germany in 1995. The gross
investment volume had stagnated at approximately DM 1 billion a year in the earlier nineties. In
1995, the volume of all private equity investments in Germany represented a mere 0.03% of the
gross domestic product, compared to 0.11% in the United States.i The private equity industry in
Germany seemed to be dormant.
Then something remarkable happened. In 1997, the private equity industry suddenly came to
life. The volume of gross private equity investment almost doubled year-on-year from DM 1,4
billion in 1996 to DM 2,6 billion in 1997. The industry association (Bundesverband Deutscher
Kapitalbeteiligungsgesellschaften or BVK) saw its membership jump by 20% per year. By 1999
the investment volume had expanded to DM 6,2 billion, representing more than a fourfold
increase over only four years (see Figure 1).
Figure 1: Private Equity Investments in Germany 1990-99 ii
Gross Private Equity Investments (Billion DM)
941 995 1,229 1,112 1,449 1,141 1,367 2,607 3,837 6,178 DM Million
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Even more intriguing than the growth in overall investment activity was the source of that
growth. In Germany, the term “venture capital” is used loosely and includes a lot of LBOs,
MBO/MBIs, turnarounds and expansion investments, which in the U.S. would have been
classified as (non-venture) private equity. This kind of financing traditionally dominated the
German venture capital industry. The spectacular growth after 1997, however, was clearly
driven by “proper” venture capital investments. Seed and start-up investing experienced an
incredible explosion, growing by almost 1,300% between 1995 and 1999—three times faster
than the overall private equity investment volume (see Figure 2). In 1999, venture capital
investments had reached a level of DM 2,0 billion, almost 50% higher than the entire private
equity investments in 1996.
Figure 2: Growth of Private Equity Investments by Type 1995-1999
Growth of Investment Volume by Type (Indexed)
+ 1,262% Seed/Startup
1100 + 959% Bridge
500 + 441% TOTAL
+ 282% LBO/MBO/MBI
300 + 262% Expansion
1995 1996 1997 1998 1999
Why this extraordinary boom? Most industry pundits have pointed to the March 1997
introduction of the Neuer Markt, the German stock market equivalent of the NASDAQ. They
argue that the Neuer Markt created a new exit channel that provided liquidity for venture
capitalists. The liquid stock market promised higher returns than trade sales or management
buy-outs could offer. With better return, investors became much more willing to make venture
capital investments. According to this “pull” theory, entrepreneurial activity was “pulled” or
triggered by changes in the financial market.
We argue that this “pull” theory is grossly oversimplified. It captures only a small part of the
real driving forces behind the dramatic industry developments. For one, it ignores the advent of
the Internet, which changed the nature of technological opportunities. Interestingly, however,
there appear to have been many other factors that, while they did not always make headline
news, nonetheless seemed to have been equally if not more important. In this paper, therefore,
we explore the more complex confluence of several factors that were necessary for the
spectacular boom. Indeed, we emphasize that there were a number of “push” factors that made
entrepreneurship and venture capital more attractive to Germans.
Why should we care about what happened? The first reason is because this offers many lessons
for other countries developing their own venture capital industries. For the longest time there
was a belief that Germany would never be home to a vivid venture capital industry. Yet, against
all odds, it happened. If venture capital can flourish in Germany, perhaps there is hope for many
other countries as well. Second, a proper understanding of what happened is critical to scripting
a prognosis for the industry’s future. A simplified explanation that overemphasizes a single
factor would imply that as this factor changes, the industry would again recede. In particular,
with the recent bursting of the stock market and Internet bubble, it might seem that the time has
come to write a requiem for the German venture capital industry. Our analysis, however, allows
for a subtler, and interestingly more optimistic, prognosis.
The purpose of this study is to examine the underlying reasons for the sudden rise in German
venture capital. While it is difficult to draw an exact line between private equity and venture
capital activities in Europe – the distinction in Europe is not as clear-cut as it is in the United
States – we will focus primarily on the early stage venture capital market.
Our methodology involved an extensive study of available literature, such as business
magazines, newspapers and industry statistics. The core of the research was an extensive series
of interviews with a wide variety of key industry participants.iii The different perspectives
expressed allowed us to thoroughly develop our main argument. After offering a brief history of
German venture capital, we explore the central factors that explain the explosion of the industry
in the late nineties. We also evaluate the current state of the industry and conclude with
questions about the future.
II.HISTORICAL DEVELOPMENT OF VENTURE CAPITAL IN GERMANY
Slow growth over the first thirty years
1965 probably marks the birth year of the German venture capital industry: the founding of the
first four organized venture capital funds. In the following years, more funds were started, but
most produced disappointing results and perished quickly. By 1975, the total investment volume
had reached DM 372 million.iv
In 1975, the industry witnessed its first significant event with the creation of the Deutsche
Wagnisfinanzierungsgesellschaft mbH (WFG). This was the first ambitious effort to create a
proper venture capital vehicle. It was founded by a consortium of all the leading German
financial institutions and supported by the federal government. The motivation was a belief that
Germany was in danger of falling behind the United States especially in terms of the
commercialization of new technologies and their importance for economic growth and
employment. However, the experiment of the WFG proved a complete failure. The majority of
investments made by the WFG resulted in a net loss, and the WFG soon abandoned its early
stage technology investment strategy (see Becker and Hellmann, 2000).
In the eighties, a number of venture capital firms followed the U.S. model and emerged with
moderate success. By 1985, the overall market portfolio had grown to DM1 billion. Despite
new federal initiatives to foster start-ups in high technology, such as the “Beteiligungskapital für
junge Technologieunternehmen” (BJTU), venture capital investments in the early nineties
remained stagnant at approximately DM1 billion a year. By 1996 the entire venture capital
portfolio reached DM7 billion and consisted mainly of mature private equity investments.
Overall, the growth of the venture capital industry before 1997 had been frustrating and slow.v
Entrepreneurship à la Germany: “Mittelstand”
A popular myth is that Germany has no entrepreneurial culture. There is a longstanding tradition
of entrepreneurship in Germany, but it follows a somewhat different pattern than the Anglo-
Saxon model of entrepreneurship. Entrepreneurship in Germany dates back to the second half of
the nineteenth century, the so-called “founding years” (Gründerjahre). At the end of the
nineteenth century and the beginning of the twentieth, we find the creation of some of the well-
known industrial empires, such as Siemens and Daimler-Benz. And while some of these
entrepreneurial start-ups grew into large conglomerates, most entrepreneurial activity centered
on the so-called “Mittelstand.” The term “Mittelstand” refers to medium-sized enterprises (up to
approximately 1,000 employees) that are usually regional, family-owned businesses. Typically
they specialize in specific industrial niche markets, especially manufacturing machinery and
automotive parts. After World War II, the “Mittelstand” fashioned an important engine for
Germany’s economic reconstruction. With more than 800,000 companies, the “Mittelstand”
remains an important force in the German economy today.vi
If an entrepreneurial spirit always existed in Germany, why did venture capital take so long to
develop? The answer lies in the types of entrepreneurial activities and the entrepreneurs behind
the ventures. A typical “Mittelstand” company generally was started and managed by a family.
Initially bootstrapped from family resources, with time it would secure loans from commercial
banks, with founders pledging both personal and company assets as collateral. Given the more
traditional, slow-moving industries in which these businesses competed (especially in machine
tool manufacturing, or “Maschinenbau”), there was no need for rapid growth. Instead, they grew
gradually, relying mostly on retained earnings rather than external equity. Many founders
wanted to make a good living with their enterprises, but few had the intention – or skills, for that
matter – to build large-scale businesses. The concept of sharing equity with outsiders was
foreign to these entrepreneurs. They viewed their family businesses with pride and put great
emphasis on retaining control. The business model pursued by a typical “Mittelstand” company,
while clearly entrepreneurial, was distinct from the business models that would attract venture
capital. Consequently, venture capitalists encountered considerable difficulty working with
traditional German entrepreneurs. The chairman of the venture capital industry association, Dr.
Holger Frommann, commented: “[German venture capitalists] had difficulty to build a positive
image and had to fight against the deep-rooted and widespread mentality of the German
‘Mittelstand’, the ‘King of the Castle’ mentality.”vii
Social norms as disincentives
Social norms embedded in German society prevented the widespread acceptance of venture
capital. Traditionally, the ideal job for a middle manager was a stable career position with good
compensation and status within an established company. Those with the skills to run a
successful start-up had little incentive to do so. Professional failure invited social stigma which a
failed founder would carry for a lifetime. Concurrently, financial success was not necessarily
viewed with admiration either, but with envy. In the rather egalitarian German society, a
successful entrepreneur could easily be admonished as a “capitalist pig.” From a social
perspective, it was relatively safe to start a family-oriented “Mittelstand” company; but there
were no social incentives to start a high-risk, large-scale business that would require venture
capital. Interestingly, these social norms created adverse selection among entrepreneurs.
Successful managers were less likely to give up the security of their current employment, and the
managers who were willing to take the risk were more likely those who had not achieved a high
level of success in the corporate world.
III. EXPLOSION OF VENTURE CAPITAL IN THE LATE NINETIES
This situation changed abruptly in 1997 when German venture capital exploded. Why? Clearly
the emergence of venture capital cannot be explained by a single factor, such as the introduction
of the Neuer Markt. We will show that there were multiple factors that complemented each
other. To structure the analysis, we group these multiple factors into four main groups.
1. A sharp rise in entrepreneurial opportunities and entrepreneurial activities, the Internet being
the most visible component.
2. A new breed of progressive, less risk-averse entrepreneurs with more affinity toward Anglo-
Saxon funding models.
3. Increased necessity to fund ventures through equity rather than debt or retained earnings.
4. Increased availability of funds for investing in start-ups and stock markets
A.The Internet and deregulation bring about new opportunities
The Internet opened a large number of new business opportunities promising to transform entire
industries. In the United States, public access to the Internet and commercial applications first
became prevalent around 1995. User-friendly browsers made the Internet accessible to anyone,
regardless of technical know-how. Once the general public started adopting the Internet as a new
communications medium, and the user group reached critical mass, the development of
commercial applications became economically viable.
Obstacles in infrastructure and more conservative consumer behavior, Europe’s adoption of the
Internet lagged behind the United States. Most industry experts estimate that this time lag
spanned one to two years, hence it was not until 1997 that Internet euphoria really spilled
eastward across the Atlantic Ocean. In 1997, 7% of the German population had access to the
Internet—approximately the same percentage as in the United States 1½ years earlier (see
Figure 3). But once the euphoria swept across Europe, savvy entrepreneurs quickly realized the
opportunities to be harvested.
Figure 3: Internet User Penetration (in Percent of Total Population) viii
40% 1 ½ years
1995 1996 1997 1998 1999 2000 2001 2002
It is important to recognize that the Internet had some unique characteristics that made it a
relatively “safe” platform for new entrepreneurial activity in Germany. Earlier waves of
entrepreneurial innovation, such as the computer hardware and software revolution in the
eighties and early nineties, had thrived on technological breakthroughs and proprietary
developments. The Internet, on the other hand, was marked by the emergence of new business
models (such as reverse auctions, consumer-to-consumer transactions, communities, etc.) and the
application of old business models to a new medium. Business models were built on new, but
highly transparent business processes rather than proprietary technology. These could easily be
copied and applied to new target audiences. Not surprisingly, a majority of the Internet start-ups
springing up in Germany were essentially copycats of U.S. concepts (see Figure 4 for some
prominent examples). Taking proven business models that already had been scrutinized by U.S.
venture capitalists, and transplanting them into the German market, was perceived as an easy,
low-risk way to start a venture.
Figure 4: Prominent Copycat Examples of German Internet Start-ups
US Model German Copycats
eBay alando, ricardo
epinions dooyoo, ciao
In addition to the Internet, privatization and deregulation of the German telecom market created
further opportunities for entrepreneurs. Obviously telecommunication played an integral part in
the exploitation of the new Internet media, so deregulation created particularly exciting
opportunities in the German market. As network access became liberalized, and emancipated
customers demanded innovative new services, a broad spectrum of competitors emerged. While
some represented divisions or spin-offs of established industry conglomerates (e.g. Mannesmann
Arcor and VIAG Interkom), others were entirely independent ventures (e.g. Mobilcom, QSC,
Primacom, Strato Medien AG). Clearly the combination of a new technology and
communication platform(the Internet) alongside the deregulation of the telecommunications
market opened the door for tremendous entrepreneurial opportunities.
B.A new generation of entrepreneurs emerges
Who were the entrepreneurs who could take advantage of these new opportunities? The more
conservative Mittelstand mentality hardly lent itself to exploiting these technological
breakthroughs. A new generation of entrepreneurs needed to step up to the plate and take a
swing at the new economy.
And a new breed of entrepreneurs did emerge. Most were young, highly educated, and had been
exposed to a dynamic professional environment in their short previous careers. A fairly large
percentage had earned a business degree as part of their education. A study of one thousand
start-ups in the German Internet and e-commerce industry conducted at the European Business
School (EBS) illustrates this picture (see Figure 5).
Figure 5: Profile of New German Entrepreneurs ix
Age of Founders at Level of Education of
Inception of Venture Founders
35-39 18% 14% 21%
Graduate 13% Col-
32% 30% 25-29
30-34 school 52% lege
Educational Degree of Professional Back-
Founders ground of Founders
Natural Science Industry Research/
Social 11% Media 12%
Science 10% Business/ 26%
13% 5% Consulting
The background of these “new” entrepreneurs stands in sharp contrast to that of the traditional
“Mittelstand” entrepreneurs, who were usually older and more likely held engineering positions
in established industries. These differences in backgrounds appear to be particularly relevant as
data from the EBS study suggest that founders with business backgrounds show more affinity to
venture capital than founders with more technical backgrounds.x One German venture capitalist
noted: “Today, the typical entrepreneur is no longer the cigar-smoking middle-aged Mercedes
driver who would rather die than give up control over his company. Today’s entrepreneurs are
young, enthusiastic and don’t shy away from risk.” Another venture capitalist added: “Today’s
entrepreneurs are much more money-driven. They realize that equity funding is the only way
they can grow their start-up quickly and attain high personal returns.”
Many of the “new” founders have had significant exposure to American culture, having studied
or lived in the United States, or having worked for U.S. corporations in Europe. As a result,
these entrepreneurs are comfortable following the U.S. model of starting businesses, including
giving up equity in return for funding and managerial support.
Inspirational success stories
New entrepreneurs’ affinity towards venture capital was reinforced by inspirational success
stories spreading through business circles and universities. These inspired young professionals
to try their luck at a start-up and helped boost boost both the image and prominence of venture
Many looked in awe to Silicon Valley icons, such as Jerry Yang of Yahoo, Marc Andreesen of
Netscape, or Jeff Bezos of Amazon. The fascination over Silicon Valley spilled into Germany,
so that major business magazines (Wirtschaftswoche, Capital, DM) introduced Silicon Valley
columns and special reports providing current information about the Californian “field of
dreams.” Aspiring German entrepreneurs were eager to follow the path of these role models, and
since venture capital seemed to have played an important role in the success stories of Silicon
Valley, new German entrepreneurs were more favorably disposed towards venture capital.
The inspiration for a new generation of entrepreneurs became all the more vivid when high-
profile German success stories emerged: German entrepreneurs, too, could make it in the Internet
world. Some of the most talked about examples included Stephan Schambach, founder of
Intershop—a world leader in Internet shopping applications—or Stefan Röver, who started
Brokat, an online bank. In some instances, such as occurred with the Samwer brothers, founders
of alando (now eBay Germany), television and the boulevard press elevated entrepreneurs to a
status of pop icons.
A point of debate is whether these role models inspired awe or greed. One partner of a large
German VC firm asserted: “Greed has been the major driver for many entrepreneurs over here in
recent years. They watch how some kids make millions in Silicon Valley starting their own
company, and now they want to do it too.” Whatever the motivation may have been, these
entrepreneurial idols paved the way for fledging new founders in Germany. They created
awareness in the general public, they established credibility and legitimacy for entrepreneurs,
and they validated a business model where venture capital played a central role.
It is worth noting the extent to which established organizations changed their attitude towards
entrepreneurship. German universities are hardly known for institutional change, but almost
every major University began launching its own business plan competitions. Ironically, these
events were frequently co-sponsored by established companies such as BMW, Siemens,
Deutsche Bank, McKinsey, Deutsche Post, or the Frankfurter Allgemeine Zeitung.
Shifts in the labor market
Start-up fever also reached German employees, who historically showed little job mobility. For
the first time a large number of employees “jumped ship” from traditional jobs, especially in
banking and consulting firms. One former IT consultant who had joined an Internet start-up
noted: “People fleeing from consulting firms’ doors have worn out their hinges…. There were
probably only a few years of this madness left, so it was now or never.”xi
Other factors reinforced this movement. In the late nineties, Germany faced a grim labor market.
Unemployment rates, for example, had almost doubled since the beginning of the decade to more
than 10%. The unemployment figures partly reflected the stagnation in the traditional industries.
Those attracted to entrepreneurship often perceived traditional industry as lacking dynamism.
Closely related to this, the government supported venture capital as a means to reduce
unemployment. Initiatives such as the tbg (Technologie-Beteiligungs-Gesellschaft) and the KfW
(Kreditanstalt für Wiederaufbau) provided federal funds for new start-ups. Entrepreneurs and
venture capitalists gradually became recognized as leading facilitators in the creation of new
jobs. One VC partner commented on this new role of entrepreneurs and venture capitalists: “Just
five years ago, entrepreneurs and venture capitalist were seen as blood drinkers. Now, they are
seen as heroes creating new jobs. We don’t have yet the same go-for-broke culture as California,
but Germans really see the need for catalysts to pump up the economy here.”xii
C.New business models require equity financing
Traditionally, German business founders relied almost exclusively on personal wealth, retained
earnings, and bank loans to fund their new ventures. Few entrepreneurs knew about the
possibility of obtaining equity funding as a financing alternative, and in any case, German
founders resisted relinquishing control over their ventures. However, the late nineties brought a
clear change in attitude: new founders discovered and in many cases chose to rely on venture
capital. By 1999, the share of companies at the Neuer Markt that was venture capital financed
increased to almost 40%.xiii A central reason for this shift was that the new business models had
distinct financing requirements.
The models of the late nineties were capital-intensive, but not asset-intensive. This change
required a shift from bootstrapping and debt financing to equity financing. Traditional German
start-ups focused on the manufacturing industries. Besides the investment in property and
equipment, little additional capital was needed to start operations. Since the financing was used
mostly to acquire tangible assets, these assets could be pledged against the borrowed money as
collateral. In addition, these ventures operated in fairly stable market environments where rapid
growth was not critical to survival; and gradual growth, based on cash flow and borrowing
capacity—expanding in good years and consolidating in not so good years—was the norm.
Manufacturing operations were usually expected to turn profitable soon after the start-up so that
a gradual expansion could be financed from retained earnings.
The financing requirement for Internet companies was radically different. Internet business
models could not rely on gradual evolution but required aggressive expansion strategies. The
competitive challenge was to quickly acquire and then defend a market position. Capturing
market share early on, to dominate a segment, was deemed to be the key to success. The
performance of Internet start-ups was often measured in the “number of eyeballs,” i.e., the
number of users drawn to a company’s web site. Consequently companies tried to attract as
many users as possible, often by relying on free services. Internet start-ups anticipated losing
money for several years: their strategy was predicated on a willingness to sacrifice short-term
profits in the hopes of capturing a large user base in the longer run. These strategies required
extraordinarily large up-front investment. Bootstrapping was certainly not an option for these
At the same time, Internet start-ups possessed very few tangible assets against which to secure a
bank loan. This was especially true if companies invested heavily in marketing and customer
acquisition. Most traditional bank credit analysis was ill-suited to Internet start-ups; these
companies could never meet the standard criteria for credit approval, thus the banks considered
them too risky for loans.
Equity financing naturally became the only viable financing alternative for these kinds of start-
ups, providing the necessary cash to fund rapid expansion plans. Entrepreneurs had to give up
sizable stakes in their companies, something that the “Mittelstand” firms traditionally had
resisted. But the new entrepreneurs were more willing to accept this, in part because it relieved
them of the financial liabilities that could cripple a founder’s professional and personal life.
Given the high risk of the Internet, it was not surprising that the new generation of entrepreneurs
readily opted to finance their ventures by sharing ownership with their financial backers.
D.Equity funding becomes readily available
With more and more entrepreneurs looking to fund their businesses through equity, one could
wonder whether the supply of funds would be sufficient to meet the growing demand. Supply
depended heavily on investors’ perception of how attractive VC returns would be, as well as any
other investment incentives.
Creation of new exit options
A prerequisite for an attractive venture capital market is the existence of highly liquid exit
options enabling investors to cash out. In Germany, the March 1997 introduction of the Neuer
Markt (NEMAX) significantly improved the options. Previously, investors were likely to sell
their shareholdings in trade sales to strategic investors or in buybacks to the original founders.
Neither option yielded a reliable source of liquidity, and in addition, given the limited number of
buyers, trade sales were likely to result in a lower valuation than a stock exchange. Most
interviewees agreed that an initial public offering (IPO) at a stock exchange is unquestionably
the “Königsweg” (literally translated as “kings route”) for an exit.
One may ask why German venture capitalists did not exit through placing their companies on the
NASDAQ. Most interviewees pointed to the extreme difficulty of listing a German company.
Indeed, they claimed that it was almost impossible to attract the interest of U.S. investors in a
German high-growth stock. Most U.S. investors found it cumbersome to evaluate the German
market, and investment banks were unwilling to provide analyst coverage for comparatively
small companies outside the U.S. Hence, NASDAQ placement was a viable exit option for only
a very select number of ventures that had attained global leadership in a significant market
segment. Since the inception of the NASDAQ only a few German companies (such as Rofin-
Sinar or Digital Telekabel) had pursued a listing on the world’s largest high-growth stock
Investors therefore welcomed the introduction of the Neuer Markt, and it quickly developed
beyond the wildest expectations. From 1997 to 1998, IPOs went from 4% to 16% of venture
capital divestments, a fourfold increase (see Figure 6). The number of listed companies on the
Neuer Markt more than tripled to 202 over a period of thirteen months spanning late 1998 and
early 2000. Its total market capitalization zoomed to $140 billion by early 2000, doubling in size
over just a few months,xiv though this growth turned out to be short-lived. At its peak, the Neuer
Markt’s NEMAX50 index had climbed above 9000; but it declined to under 3000 by the end of
2000. If the Neuer Markt were the extent of the German venture capital market, it would clearly
be in trouble. Our analysis, however, emphasizes that while the Neuer Markt is an important exit
option, it is not the only factor determining the viability and growth of the German venture
Figure 6: Divestments by exit channel
Gross Divestments by Exit Channel IPO Placement
Int'l. Capital Markets
30% Neuer Markt
1997 1998 1998 IPOs
Rising popularity of stock market investments
After the economic struggles following reunification in the early nineties, the German economy
enjoyed a period of prolonged prosperity. Between 1996 and 2000, the gross domestic product
(GDP) grew consistently, increasing overall by 8.3%. This provided start-up businesses with a
healthy environment in which to flourish and take advantage of the generally strong buying
behavior of consumers and corporate customers. National spending increased by 2.7% and
2.9%, respectively, in 1998 and 1999.xv
Economic prosperity was reflected in the performance of the stock markets, which witnessed
abundant value growth and overall stability. In this economic uptake, investors became less risk-
averse and more willing to invest in high-risk projects. Both institutional and private investors
increasingly sought the market’s high-growth segment, and with more money chasing high-risk
projects, market valuations for start-ups exploded. Ironically, the high valuations attracted
further investments, leading to a self-reinforcing growth cycle and the creation of an economic
Historically, Germany’s capital markets failed to attract the attention of the broad public. Capital
markets were tainted with an image of imprudent gambling. Unlike in the U.S., making money
by investing was not considered “serious business for honest people.” In the late nineties,
however, the public attitude towards stocks market investing changed dramatically. About the
time of the privatization of Deutsche Telekom in 1996 (the largest IPO in German history),
Germans seem to have adopted stock market investing as a new “hobby.” Between 1996 and
1998 the volume of stocks traded more than doubled, surging from DM2378 billion to DM5238
billion (see Figure 7). Throughout all segments of the population, the number of stockholders
increased rapidly, with more Germans invested their savings in the stock market (see Figure 8).
DM, a business magazine, enticed its readers: “Make your first million! Start getting rich today.”
Another leading newspaper, Die Welt, declared: “People have succumbed to a stock market
Figure 7: Volume of Stocks Traded xvi Figure 8: Growth of Shareholders xvii
Total Value of Stocks Traded
(Billion DM) Growth of Shareholders Since 1988
Blue-collar workers 157%
Office employees 93%
3.000 Professionals 40%
2.000 Managers 37%
Silicon Valley start-ups became a source of revelation to many entrepreneurs. Witnessing how
U.S. entrepreneurs grew their companies with equity investments opened the eyes of German
entrepreneurs, particularly the younger ones. Capital markets became a more common source of
funding for the newly invigorated entrepreneurial sector. The change in sentiment regarding
capital markets – by the public in general and by entrepreneurs specifically – thus also
contributed to the German venture capital boom.
Another related factor pushing money into high risk capital was the abolition of preferential tax
treatment for other forms of investment. In the past, many German investors reaped tax benefits
by investing in real estate funds or economic projects in former East Germany. In the late
nineties, however, many of these benefits were abolished and people sought new investment
alternatives, some turning to venture capital as a high-return opportunity. Yet another factor
was the trend away from the public pension system toward private provisions. Historically,
German society relied almost exclusively on an extensive public pension system. By the late
nineties, however, it was clear that public funds would not provide adequate support for retirees.
New government programs placed more emphasis on private pension provision (e.g.
Altersvorsorge-Sondervermögen-Fonds), and a public discussion ensued about liberalizing
regulations pertaining to the investment of pension funds.
High leverage through government programs
A peculiarity of the German venture capital market is the existence of various government
programs that foster investment in high-growth companies. The two main sponsors of the
subsidy initiatives are the tbg (Technologie-Beteiligungs-Gesellschaft) and the KfW
(Kreditanstalt für Wiederaufbau).
The tbg is part of the Deutsche Ausgleichsbank (DtA) and supports start-ups through a number
of different subsidy programs, e.g. “Beteiligungskapital für kleine Technologieunternehmen”
(BTU), “DtA-Technologie-Beteiligungsprogramm,” “Förderung und Unterstützung von
technologieorientierten Unternehmensgründungen.” The various programs are tailored toward
companies in different financing cycles (from seed funding to mezzanine financing) and in
different locations (e.g., special programs for former East Germany). All programs have some
fundamental investment principles in common. The tbg requires an outside lead investor in all
investments. It co-invests as a silent partner in portfolio companies, matching the funds of the
lead investor. The tbg itself plays a rather passive role in the investment, performing little of its
own due diligence, relying instead on the lead investor’s analysis. Most importantly, the tbg
funds are treated like a loan: there is a fixed payback rate associated with the tbg investment, part
of which is tied to the profits of the portfolio company. Hence, the VC firms use these programs
to leverage their own investments, and in case of a venture’s failure the tbg assumes half the
losses of the private investors.
The KfW has its roots in the post-war Marshall plan for restructuring the German economy.
Generally it does not invest directly in the portfolio companies, but instead offers refinancing for
VC funds at very attractive conditions. The most popular program, the “ERP-
Beteiligungsprogramm,” offers refinancing of up to 75% (85% in Berlin and former East
Germany) of the VC fund’s investment—though generally not more than EUR 500,000 per
company. The interest rates on the loans are set at the lower end of market rates and are fixed
over the duration of the loan. The KfW also covers part of the investment losses in case of a
venture’s failure. Its investments are capped at EUR 1.5 million per portfolio company. Overall,
the funds available through co-investment from the tbg and through refinancing from the KfW
can increase the leverage of the VC investment significantly.
The preferential treatment of start-up investments made Germany’s venture capital market highly
attractive. Most interview partners believed that these programs played an important role in
jump-starting the German venture capital market. However, some industry experts also
expressed concerns about relying on these programs in the future, particularly since they
engendered less scrutiny on the part of the investors.
IV. THE CURRENT STATE OF THE GERMAN VENTURE CAPITAL MARKET
The confluence of all the factors described above fed the German venture capital boom. Against
all odds, Germany developed a thriving venture capital market. This, however, does not mean
that German VC is identical to Silicon Valley VC. Next we examine some of the distinct
features of today’s German venture capital market.
A.Managerial and entrepreneurial labor markets
Despite recent monumental changes, German entrepreneurs still struggle more for legitimacy
than do their U.S. counterparts. Given the rich entrepreneurial tradition in the United States, a
significant number of high-technology entrepreneurs are former employees of large technology
companies such as IBM, HP or Cisco. Others leave one start-up company to found another. In
Silicon Valley, employees are exposed to the technology, the markets and the culture that propel
them to become successful company founders. Venture capitalists draw on a large pool of
management talent for starting and staffing their portfolio companies. In contrast, several
German venture capitalists noted that the majority of business plans they received came from ex-
consultants and recent technical school graduates. One VC noted: “Most of the business plans I
see are really nothing more than hot air. The founders have no experience and it really shows in
the business plans they put together.” This person also commented that a smaller, but growing,
percentage of the business plans were from more experienced managers with industry
experience. Not surprisingly, these plans tended to be stronger. He expected to see more such
offerings in the future.
Founder replacement is a frequent occurrence in the U.S., but German VCs have limited ability
to reconstruct their portfolio companies’ management teams. This is not only because German
founders resist such transitions, but also because it is difficult to recruit experienced managers
who enjoy their stable, high-status positions. Ten years ago the idea of leaving a good
management position at a prestigious company (e.g., Siemens) to join a start-up would have been
thought absurd. In recent years this has changed, but only slightly. Some venture capitalists
commented that the success of companies such as Intershop and Mobilcom, and the
extraordinary value of management stock options at those companies, made recruiting
experienced managers somewhat easier. One VC argued, “You can make a case for many
factors having contributed to the increase in entrepreneurial activity, but it really comes down to
one thing: greed. Potential entrepreneurs read about the huge sums of money made by the
success stories and that is the reason for the surge in entrepreneurial activity.” Nonetheless,
there is still no comparison between the U.S. and Germany in terms if the liquidity of managerial
B.Sources of funding
In the United States, pension funds are the largest source of VC funds; but in Germany, banks
are the largest source (see Figure 9). (German pension funds seem likely to gain in importance
as the federal government contemplates legal changes allowing them to invest more significantly
in private equity.) German banks have tended to view venture capital as a solution to the equity
gap (i.e., excessive leverage of bank-dependent private companies). They usually wanted funds
to go toward more established companies, which explains why expansion stage investments and
buyouts traditionally accounted for the majority of investments. This changed in the late
nineties, when seed and start-up stage investments began to boom. A related shift is also
apparent in the mix of companies receiving venture capital funding. Traditional areas such as
machine tool manufacturing declined in importance (from 16% in 1997 to 12% in 1998),
whereas investments in biotechnology and the Internet increased (IT investments increased from
7% in 1997 to 17% in 1998).
Figure 9: Source of funds
Sources of Venture Capital in Germany Comparison USA
Federal Funds Foreign
Pension Funds Corporate
1996 1997 1998 1998
C.Quality of venture capital
Several trends have become apparent for the structure of venture capital firms. With the
explosion in investment volume, there has been a rapid increase in the number of German
venture capital funds. In the years since 1996, close to forty new funds were founded each year,
approximately three times the rate of previous years (see Figure 10). By 2000, the German
Venture Capital Association totaled 178 members.
Figure 10: Number of New VC Funds by Year of Founding
New VC Funds
39 38 35
14 12 13 11
1992 1993 1994 1995 1996 1997 1998 1999 2000
and earlier year
This growth came from two sources: a plethora of local funds were founded by venture
capitalists with little entrepreneurial experience. At the other extreme, foreign funds decided to
enter the Germany market. Many venture capitalists worry about too much competition, and
there is a belief that a shakeout and consolidation lies ahead.
Interestingly, while many German venture capitalists commented about the inexperience of most
entrepreneurs, the same comment may apply to the VCs themselves. German venture capitalists
very often come from a consulting or investment banking background. They tend to have little
entrepreneurial experience and their business networks are not always relevant for start-ups.
Another concern is that as the size of German VC funds grows, new gaps may emerge. One
venture capitalist remarked that as the average deal size rose, a new equity gap was emerging in
the DM 1-5 million range. One response to this concern is an increasing number of incubators.
There are also signs that a more lively angel community is emerging in Germany, although this
segment is still much less developed than in the U.S. (see Cadenhead et. al., 2000).
V.OUTLOOK FOR FUTURE DEVELOPMENTS
After our detailed analysis of the history and current state of the German venture capital market,
we now consider the future prospects of the industry. With the Internet bubble now burst, the
German venture capital has entered a make-or-break phase that ultimately will show whether the
recent boom was merely a fad, or the beginning of a thriving industry. While there may be some
difficulty in the near future, we believe that the medium to long-term outlook of the industry is
actually very solid. Our analysis shows that the market’s growth was based on a number of
drivers. The current lull in the stock market should therefore not choke off this more
fundamental momentum in the German economy. However, in order to thrive three important
issues will have to be resolved: Will consolidation help the long-term survival of the industry?
Can Germany produce its own breed of real entrepreneurs? And will the industry generate true
A.Is consolidation a good or a bad thing?
The rise in venture capital in tandem with the booming capital markets led to the creation of
many new venture capital funds. In these exceptional times, attractive investment opportunities
seemed abundant, and the number of start-ups promising outstanding investment returns
appeared almost unlimited. There was money to be made for everyone—until the market
downturn in the spring of 2000. Not every deal is a winner anymore, and obtaining a good exit
event no longer seems a “sure thing.” In this environment, a natural selection takes place. The
best funds with the best skills and the best reputation attract the best deals. And the less
reputable funds are likely to end up with much less attractive deals. The likely result will be a
consolidation of venture capital funds, with the top-performing funds outlasting and taking over
While most industry experts expect such a consolidation to take place over the next year, the real
question remains what the more fundamental effects of this consolidation will be. Some industry
participants paint a more somber picture: the consolidation may lead to a stall in the development
of venture capital in Germany. As public investors lose confidence in the high-growth market
and less experienced funds start to crumble, more start-ups will find themselves searching for
continued financial support. Ultimately, failed start-ups and drained funds may cause such deep
scars with investors and entrepreneurs that the momentum could grind to a halt. Yet there is also
a more optimistic outlook, anticipating the consolidation will have an overdue cleansing effect,
separating the “serious” investors from the unprofessional “cowboys.” This view holds that the
industry will emerge healthier and fundamentally stronger than before.
B.Where are the “real” entrepreneurs?
The recent boom attracted many to start-ups with the prospect of enormous financial gain.
Witnessing entrepreneurial success, others compounded the snowball effect, leaving established
jobs to found yet more start-ups. It was hip and fashionable to be part of this booming sector.
However, with the market downturn the picture has lost its sharp focus, and new economy start-
ups are again viewed with skepticism. With the most opportunistic entrepreneurs fleeing the
scene, it remains to be seen how strong the “real” entrepreneurial movement is. How many
entrepreneurs are actually willing to build enterprises for the long term? Will the most talented
or the less talented people remain in the entrepreneurial sector? In this context, it will be
important for Germany’s start-up scene to nurture serial entrepreneurs who can contribute to the
maturation of the entrepreneurial culture. In the United States, serial entrepreneurs have become
an important stabilizing element in the entrepreneurial environment.
C.Do we have innovators or imitators?
To date, a significant amount of the entrepreneurial activity in Germany, particularly in the
Internet, has consisted of copycat models. It was relatively easy to take successful business
models from the United States and transplant them to Germany, but this is hardly innovative.
Copying successful business models may have been a convenient jump-start for entrepreneurial
activity in Germany, this cannot replace true innovation as the basis for entrepreneurship. The
window of opportunity for copying U.S. Internet business models was a passing phenomenon,
and with so many Internet models proving to be more difficult than anticipated, the wave of new
Internet start-ups has ceased in the United States. Copycat entrepreneurs may now have run out
of business models to copy, and this will force German entrepreneurs to become more innovative
in their business ideas.
Will German entrepreneurs will live up to this new challenge and build a culture of true
innovation? Experience over the last few years has shown that Germany is capable of
developing an entrepreneurial spirit. We believe that after the dust has settled on Internet and
stock market booms and busts, it is likely that Germany will sustain a lively venture capital
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