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Summary Bullet Points
Overview of the Industry
The venture capital process in Germany is not that different from the process in other parts of the world. There are, however, several areas that are different.
Venture capital in Germany is quite a young industry. After a cautious beginning in the '80s, it began its first full cycle in the New Economy Bubble of the '90s. Founders of more mature industries have had a hard time accepting VCs as financial partners and have hoped to continue to rely on more classic credit financing. In reality, the time for this sort of financing is over in Germany, and more and more founders are now seeing VCs as an interesting financing alternative.
Germany lacks a networking culture for entrepreneurs. There are highly qualified entrepreneurs and world-class technology companies and universities, but they do not cross-fertilize as they do in other countries. Therefore, VCs have to play a more active role in networking and in the business development process of their portfolio companies. In the last few years we have also seen the formation of a league of serial entrepreneurs, who built their business successfully in the '80s and '90s and are now helping next-generation entrepreneurs to grow.
Big corporations play a major and active role in the founding of new technology companies. They encourage departments that do not fit into their core competence to spin out and give the resulting start-ups money and offer intellectual property.
Entrepreneurs seek government support when founding and growing. Also, a lot of early-stage research and development risk is borne by federal money. Consequently, we have seen a lot of co-financing between private and public money in recent years. Nowadays, privately held VCs are starting to dominate the business.
Syndication is the way German VCs make their investments. After the end of New Economy bubble, there were only a small number of matured VCs who invested through the tough times. In most cases, venture capital firms co-invest with other VCs, with corporate VCs or with VCs from other European countries. Recently, we have seen a trend toward partnering with U.S. VCs when it comes to global expansion.
There are several groups of major players in the venture capital industry in Germany. The first is a manageable number of professionally managed VC firms, which invest an average of 250 to 350 million EUR in an average of 100 deals in the early-stage segment each quarter. Second, there is a growing number of entrepreneurs with high-class educations and a strong will to succeed. Other major players are big corporations that actively initiate the founding and spin-off of technology companies that do not fit their core competence. Siemens and Deutsche Telekom are excellent examples of this. Companies such as BMW and DaimlerChrylser also cooperate with technology start-ups to hasten their innovation process.
In addition, publicly financed research labs such as Fraunhofer or Max-Planck encourage young scientists to found their own businesses. What's missing here is an equally entrepreneurial culture at German public universities, although they are starting to follow the lead of U.S. and UK universities. And the government is starting to accept entrepreneurs as one of the driving forces of GDP growth and future wealth. With new tax legislation and a new fund of funds, the government is now supporting technology start-ups.
Native investors are a weak link in Germany's VC industry. Because of Basel II, the revised international capital adequacy framework for capital measurements and capital standards, banks cannot invest in venture capital as they did in the late '90s. Also, insurance companies are constrained by regulation. Wealthy individuals invest in venture capital, although some of them had bad experiences in the late '90s and had to accept massive losses in the following years. Consequently, foreign investors with a long tradition of private equity investments dominate the German VC market.
Examining Business Concepts
Wellington Partners sees 100 to 150 business concepts a month. There are three main sources of deal flow: recommendations through our network, especially from other VCs; mailed business concepts from founders who know Wellington from the media or other sources; and proactive sourcing at entrepreneur fairs, business plan competitions and database research. When start-ups seem really interesting, we also contact them directly.
Well thought-out, unique business concepts from experienced executives and scientific experts who form a convincing team are the ones that most often receive funding. In the best-case scenario, we see serial entrepreneurs. What most people do not know is how many worldwide respected scientists and engineers work and live in Germany and are members of founding teams. This does not mean that other entrepreneurs have no chance, however. For example, we recently invested in a company founded by two German students who developed a security solution based on Linux.
We evaluate investment opportunities on the following bases: level of innovation and USP of the technology; uniqueness of the business concept; competition and market size; window to enter the market; significance of customer pain; and qualification of the team.
When developing term sheets, the main areas to watch are liquidation preferences, milestones, investor rights, down-round protection, drag and take along and founders' vesting. After full dilution, founders and key management must hold a significant stake - that is very important.
The boards of companies we invest in play a decisive role. Wellington is an early-stage investor that normally sits on the board. At monthly board meetings, we discuss all relevant decisions with management and help them to develop their business. Furthermore, as a board member, we play an active role in establishing contacts with potential customers and partners and even additional team members.
Making an Exit
Our usual timeline for making an exit is three to five years. Looking at the fund overall, we aim to earn 5 percent more than the average return on investment from the stock market during the lifetime of the fund. In terms of single investment opportunities, we look for companies that have the potential to achieve an investment multiple of ten.
When there is a window of opportunity for IPOs, we do our best to leverage the market situation and help portfolio companies go public. When there are strong M&A activities in one market and we have the chance to sell one portfolio company with an attractive IRR, we won't say no! On the other hand, if we recognize early that market conditions will change unfavourably, we don't wait and quickly seek a possible trade sale.
Looking at our exits in the last two years, there have been three different scenarios. The first is a portfolio company that starts as a first-mover on a new market. While this market is growing, big corporations start to invest in and take over the first movers. This was the case in the German WLAN market, and Wellington was able to sell its stake in WLAN AG at a very attractive ratio.
The second scenario is a portfolio company that is established in a fast-growing, diversified market, when heavy M&A activities start and market leaders take over smaller competitors. For example, in January 2004, ISS Inc. acquired our portfolio company Cobion, a content security specialist.
The third scenario is when a portfolio company alone does not attract enough customers but forms an interesting part of a larger business case. Wellington Partners recently merged a German specialist for electronic patient records with an Italian competitor, for example. In doing so, we formed a fast-growing European leader in this attractive market.
In terms of the exits themselves, the usual route is an M&A deal. Sometimes it is a very attractive one, as in the case of the acquisition of our portfolio company Cobion by ISS Inc. Wellington has also accompanied the IPOs of three companies in the last five years: Actelion, a Swiss biotech company; Wavelight; and ACG, a chip broker.
Location of Deals
Sixty percent of Wellington's investments are located in German-speaking Europe, but we have also invested in countries such as the Netherlands and France. In foreign countries, we only invest when a strong local VC seeks Wellington as an experienced partner. Furthermore, Wellington Partners is a part of a strong network of European VC companies, so we are able to make French investments with Sofinnova and Dutch investments with Gilde.
Our firm has five investment areas: infrastructure technology, communication solutions, applied materials, life sciences and enterprise software. With infrastructure technology, applied materials and life sciences, we feel very comfortable in Germany. But we have made software investments in France and the Netherlands as we found fantastic opportunities there. Communication solutions are a European domain because of the early start of mobile telephony. We've also invested in Finland because of a strong local technology base there.
Global Strategy: Changes and Trends
From the beginning, Wellington Partners has been an early-stage investor throughout Europe, with a specific focus on German-speaking countries. What has changed is the way we look at new opportunities. In the '90s, we saw a lot of service-based business models with first-mover advantage. Nowadays, we focus on technology-driven models with high barriers to entry. This shift includes an end to an industry-wide preference for investing in business concepts that have proven successful in the United States.
Today, the majority of European VCs prefer business concepts that are based on the know-how and experience of European universities, research institutes and companies. Good examples of this shift can be seen in popular technologies such as mobile solutions, medical technology and security items. In all three of these areas, we found major labs and major players based in Europe.
Looking to the future, private equity is the form of investment that will shape the 21st century. In Europe and especially in Germany, we started much later than in the United States, but right now it seems that Europe's industry is heading towards a prominence similar to that in the United States. Successful exits are a key point in this shift, and in the last few months we have seen very successful trade sales and IPOs.
What we expect in the next 12 to 24 months is a shift back from buyouts to venture capital as more and more players concentrate on buyouts and more and more opportunities evolve in venture capital.
On the Horizon
We believe our key investment areas will offer great opportunities in the coming years, due to a tremendous potential to increase general productivity and to reduce healthcare costs. They include the following:
As the economy picks up, we expect to see an increasing deal flow (at an increasing valuation, unfortunately). It will become much easier to raise new funds as well as to exit, and the periods to exit will shorten. Coping with these developments is the most important task for VCs in an economic upturn. Firms must resist the beginning of euphoria while continuing to focus on their strengths, their investment strategy and their network.
Advice to VCs and Entrepreneurs
There are two key pieces of advice for VC firms: First, don't concentrate on copies of U.S. business concepts; instead, trust in the innovative know-how in Europe, with its long-standing tradition of entrepreneurship. Second, don't be afraid of missing an opportunity - but be afraid of choosing the wrong investment.
As for entrepreneurs, the best advice is to focus. It's hard enough to establish one product in one country and to form one team in one country, so focus on that. Align your resources accordingly and gather experience wherever possible.
Also, fund-raising is a central task for entrepreneurs who want to build a successful technology company. To get a perfect deal, entrepreneurs need to be more active in preparing their fund-raising, talking to all relevant players and finding a perfect time for closing. Fund-raising is much more than just asking for money.
Management teams looking to do VC deals in Germany should be careful with partnering. Establish trustworthy and long-time partnerships in the areas of development, sales and financing. You need an experienced VC in your specific market that is able to network and play an active part in business development. Most of all, a VC should be able to provide long-term financial resources or find suitable co-investors for future financing rounds.
Big corporations such as IBM and Siemens watch early-stage investors like Wellington Partners as gatekeepers to next-generation technology. VCs must focus on strengthening those partnerships and becoming long-term, fair and trustworthy partners. Partnering is also a crucial point in investment. So clever VCs will preselect syndication partners and intensify their interchange with potential co-investors.
Golden Rules for Successful VC Deals in Germany
About the Authors
Rolf Christof Dienst, Partner
Rolf Christof Dienst founded Wellington Partners in July 1991 in Munich. Some of his successful investments with Wellington Partners include MediMedia (sold to Vivendi), Telcare (sold to Sykes Enterprises, U.S.A.) and ImmobilienScout24 (sold to Depfa Bank Group). Rolf focuses his activities on investor relations and business development and currently manages the firm's investments in eCircle and Tinnitus.
Prior to setting up Wellington Partners, Rolf had been a Founding Partner and President of the Munich-based Matuschka Group for 22 years. When he left in 1991, Matuschka was an investment banking organization with 350 employees, including venture capital, real estate and M&A. In 1983to 1984, Rolf co-founded TVM - Techno Venture Management, Munich/Boston, one of the first privately held German venture capital firms.
Rolf holds a law degree from Ludwig-Maximilians University of Munich and has been a member of the Munich Bar since 1974. He is an Honorary Senator of Ludwig-Maximilians University in recognition of his initiative in forming Odeon, the university's Center of Entrepreneurship.
Miro Morczinek, Analyst
Miro Morczinek joined Wellington Partners in March 2002. As an Analyst, he manages and pre-screens the Wellington Partners deal flow and works together with the investment managers during the due diligence process. In addition, he is responsible for research and business development projects with portfolios in new technology areas.
During his studies, Miro gained operational experience through internships at blue-chip companies in various countries, such as Alcatel, IBM and Roland Berger in Germany, Infineon in the U.S.A. and Siemens in China.
Miro holds an M.Sc. in Management and Engineering from the Dresden University of Technology.