Latecomer becomes shrewd VC investor

Growing old will be tough for some of Germany's young venture capitalists (VC). The country's four-year old VC community is poised to undergo a big shake-up, reflecting a general trend in the industry as a result of the global dotcom shake-out and general economic downturn.

Yet there is one big difference: late to embrace venture capital, Germany is clinging to this financial tool as a means to kick-start new technologies. Money, say industry experts, will continue to flow to high-tech start-ups, but in different ways and in different areas.

The bad news, says Joachim Schlafke, chairman of Braintrust Media Consult, is that venture capitalists in Germany "will invest in fewer companies" in the months and years ahead, and many of these will not be in the "internet space". The good news is that they will invest "larger sums".

To be sure, Germany - once known as the "VC desert of Europe" - has become fertile ground for shrewd technology VC companies. Their numbers have soared to more than 250 from only around 20 in 1997, when the technology stock exchange, the Neuer Markt, was launched.

The exchange, venture capitalists agree, was key to their decision to set up shop in Germany by providing them with an "exit" opportunity for their investments. And high-tech Munich has attracted the biggest chunk of their investment, according to a study conducted by the German "e-start-up" research project, in conjunction with the European Business School.

Since then, a relatively small but steady stream of money has flowed to tech start-ups: around E4bn in pure VC last year alone, and several billions more from other private and government funds. Across Europe, VC investments in technology start-ups totaled E11.5bn in 2000, up 68 per cent from 1999, according to PricewaterhouseCoopers.

Overall, the European venture business is about one-eighth the size of the $84.8bn US venture capital market. But so far this year, the flow of capital in Germany, like most of Europe, has turned from a stream to trickle.

On top of this is a worrisome political debate about taxing venture capitalists with stakes in start-ups that exceed 25 per cent. In Germany and elsewhere in Europe, tech investors typically take stakes of between 30 and 40 per cent.

"Venture capital is far from dead in Germany, but the air is getting thin for a number of players," says Werner Schauerte, chairman of the German Capital Association (BVK). "We are definitely going to see consolidation in this young branch over the next two years." Industry insiders expect around one-third of current players to exit the market.

Many VCs in Germany are sitting on portfolios that are nearly worthless following the dotcom burn-out, and are finding it extremely difficult if not, in some cases, impossible to launch new funds in the internet sector.

"Now is really the time to be doing very select deals because there are some good companies out there, and you can literally name your conditions," says Trevor Bayley, director of HgCapital. "The problem is, too many VCs are still unwilling to pull the plug on their existing portfolios."

Burned by the internet, some VCs are shifting their focus to other areas, such as life science and nano technology. "The life science market in Germany is one of the best in the world not because of its universities, which are excellent in this area, but because of world- class enterprises, like Aventis, which nurture spin-outs," says Werner Dreesbach, managing director of Atlas Venture Capital Deutschland.

"Siemens is also a breeding house for tech spin-outs in the semiconductor component and optical networking areas," he says. But in the past two decades, he claims, Germany has been unable to launch "more than one major software developer - SAP - and software is what the net is all about."

This is not to say German software start-ups have little chance. "Germany has excellent engineers and talented programmers," Mr Dreesbach agrees. "But to attract financing, software start-ups will need to develop disruptive technologies that are 'essential to have' versus 'nice to have', which so many dotcoms produced over the past couple of years."

While some VCs are turning their backs on software and related telecom ventures, other groups remain committed. Business Angels Netzwerk Deutschland (BAND), for instance, continues to match start-ups with partners offering money and management expertise.

"We have fewer groups proposing ideas today - down to around 400 from an average 600 per year - but in the final process, we will still finance ten new enterprises a year," says Ute Guenther, a BAND board member.

"Even if the times are tough right now, a new entrepreneurial culture has emerged in Germany and is here to stay. We have many young, bright people who are willing to take risks and create something on their own. This was not always the case in Germany," she says.

Nor is the German government idly watching its admittedly late but determined efforts to create a new economy go down the tube. This summer the government-run technology incubator Technologie-Beteilugungs-Gesellschaft (tbg), together with the Federal Ministry of Economics and Technology and state-funded Deutsche Ausgleichsbank (DtA), launched a new program to finance spin-offs from university and institutional research centers.

Under the new program, tbg will screen up to 500 business schemes each year and award up to E150,000 each in seed capital.

Between 1997 and 2000, German universities churned out around 1,400 start-ups, while the country's research centres produced an additional 200, according to the German government.

"That is around 400 start-ups per year," says Peter Fleisher, tbg's deputy chairman. "Frankly, we see potential for up to 3,000 new high- tech companies to be spun out of our universities and research centers each year."

In fact, many VCs in Germany believe university-led start-ups should find it easier than non-academic rivals to secure funding during the current harsh climate because investors tend to view their technology as intellectually valid.

That said, spinning off from an academic environment into a commercial one is not without its challenges. Most academics in Germany, as in other parts of Europe, lack business experience. But here is where VCs, "business angels" and other private equity specialists could come in handy - by combining technology expertise with a good nose for making money.