GERMANY: An Introduction to Private Equity: Venture Capital

A year that changed the game 

2021 has been nothing but exciting for the German venture capital market. While the past years have seen a constant rise in annual deal count, the overall value of the cumulated financing rounds prior to 2021 has failed to surpass the previous year’s figures.

According to EY’s Startup Barometer Germany, 2021 proved to be a game changer for the German landscape throughout all sectors. The numbers speak for themselves: more than 1,150 financing rounds drew in together an astounding EUR17.36 billion in fresh money, thereby creating sixteen new unicorns and pushing the total number in the current herd above 25. While Berlin cemented its status as Germany’s start-up capital, the local ecosystems of Bavaria, North Rhine-Westphalia and Hamburg all strongly outperformed themselves compared to previous years, with Bavaria ranking number 1 in the sectors SaaS and mobility ahead of Berlin.

More fresh capital also meant more international investors, with heavyweights including the likes of SoftBank, Tencent, Sequoia and Tiger Global investing in a broad range of startups, such as Agile Robots, Gorillas, Moss and Trade Republic. As previously witnessed in the US, the German VC market experienced a vast number of megarounds for the first time, each surpassing the previous one, with Gorillas’ close-to-one-billion-USD financing round topping the charts.

Past trends such as e-mobility (e-scooters are now everywhere in Germany) were overshadowed by the enterprise software and B2C e-commerce sectors, most notably in the segments of grocery delivery and FBA (fulfillment by Amazon) aggregators. While Gorillas and Flink together alone raised close to EUR1.748 billion, the grocery delivery segment also showed strength in the seed stage with Yababa raking in USD15.5 million a mere sixth months after its formation. FBA aggregators such as SellerX, Berlin Brands Group and Razor Group, focusing on acquiring and consolidating Amazon shops, fiercely competed with each other all year on fundraising, with SellerX closing the year with a USD500 million blended venture debt and financing round.

Germany – a mature market 

These numbers are certainly reason to celebrate but are accompanied by the usual skepticism of whether the market is overheated. That said, a closer look at the numbers points towards a mature, rather than an overheated, market. When not taking into account the top ten megarounds, the average financing round volume in 2021 yielded new funds of EUR9.6 million in 2021 compared to EUR7 million in 2020. Thus, while the megarounds may overshadow the general status of the German market, the overall deal size has increased at a sensible and steady rate.

Another sign of a maturing market is the rise of alternative sources of funding for growth companies. Venture debt investments have left behind their previous niche status in Germany and are on the up. Notable players, such as Triple Point Capital, Silicon Valley Bank, and Kreos, alongside the European Investment Bank from the public sector, have further expanded the German market’s access to fresh (debt) financing. Not only driven by the overall increase in the amounts invested, but also by the emergence of specific business models that are eligible, if not destined, for such (such as aggregators, grocery delivery and hardware-as-a-service), German founders and investors have recognised the significant benefits that a combination of conventional venture capital money with venture debt can bring.

This year, the hot topics will likely be energy, mobility, and sustainability. While (green) energy was very much on the agenda due to an ESG and impact investment shift of public (especially EU) money even before the Russian invasion of Ukraine, the increasing demand of independence from Russia will increase funds flowing in the direction of disruptive startups in the energy segment.

Legally speaking: Room for improvement 

From a legal perspective, 2021 was discouraging from time to time. While the year started with great hope that the German government would offer more tax-attractive solutions for employee incentive programs, the resulting change in legislation addressed only a fraction of employee incentive programs and offered no solution to ESOPs and virtual (phantom) stock option programs, which are predominantly used in the market, with the proceeds under which still being taxed as income. However, the new government elected in autumn 2021 has promised to increase the attractiveness of employee participation and relevant discussions already started in March 2022.

Another notable legal topic was that of everchanging foreign direct investments (FDI) prohibitions. In May 2021, venture capital-relevant segments, such as artificial intelligence, robots and autonomous driving, amongst others, joined the category of business sectors under special surveillance and potential prohibition by the German government in the case where investments were made by non-EU/EFTA investors. Whilst the trigger for most sectors sits relatively high at a participation constituting 20% of voting rights, in some sectors a 10% stake is enough and the venture world - with its unique corporate governance – is not yet so familiar with FDI controls and its implications. As a consequence, the market saw an increasing number of financing rounds entering (and ultimately obtaining) FDI clearance in 2021, with more likely to come as an increased number of non-EU investors push into the German market. This will hold particularly true for investments in the defense (AI) sector, which will likely see more investment in light of the current geopolitical outlook.