Commentary

Germany Shortfalls in VC

The more entrepreneurs I meet from the APAC, Israeli or US ecosystem, everyone is asking me how the ecosystems in Germany are doing and everybody has a sound opinion that it is terrible. Time to talk about it honest and in the face.

The LP environment sucks

Working in institutional asset managmeent for a company with more than 600 billion AUM gives you a pretty idea on why things here suck. Needless to say that the German T-Aktie Crash, the general investment sentiment towards equity is low compared to the US. Then we have our over-regulated government social security system that is failing and highly risk-averse following disciplined asset allocation to ensure sufficient absolute return and draining money out of the system. Underexposure to alternative assets and buyout PE and VC is one thing. But if you are so underexposed and need to deploy highest Risk-Reward, of course you put you money into global Tier 1 capital if it is about exposure to VC. Higher fund volume increases OPEX capacity for doing disciplined capital allocation strategy – most EMEA funds are too small for this. Nobody runs a decent tax-optimimized and disciplined investment approach with superior managers, solid reporting under US, DE, X Gaap with a 50 million fund volume. So a drain to German or EMEA VCs from LP money.

Given the circumstance that public life insurance companies competed against state systems and had to provide excessive absolute return promises for their customers, and given terrible interest rate environment, also cut down on exposure on the segment. Forget the insurance players. Corporate specific pension schemes suffer the same problem. Either morons run the pension systems of their corprotaes internally and don’t get alternative invesments or they push their obligations to asset managers who are over-regulated from their life insurance business and who just don’t focus on alternative investments that much, as it appears to not sell to the conservative Corporate pension systems.

So all in all, government and corporates fall into an overly risk-adverse regime with underexposure to alternative invesments and focus on non EMEA vehicles.

Tax treatment is another thing, Germany particularly sucky compared to UK and France. Almost nobody gets the benefits of Luxembourg or other typical countries for structuring investment vehicles. And with fund sizing small and small fund manager management fee focused to keep their carry – given below market average IRR – in check adds to it. The tax issues are reducing appetitte for structuring fund operations and getting ready for larger LP tickets. So funds stay small – large players like discipline, quantitative and risk-driven investments and they also know that small fund sizes and small OPEX won’t get attractive salaries for tier 1 investment managers.

Family offices are more concerned about strategic interest of their publicly traded portfolios and also more interested in tier 1 diversification of their asset allocation mix. So they also don’t add to the equation. Giving tickets that are too small, being too risk averse and mistrusting in undisciplined asset manager investments.

Government sucks

Another stupidity we see particular in Germany is that the federalist system is preventing Germany-wide tech clusters from emerging. Every city state and local state has to run its own innovation clusters. So we have the most retarted states compete with others on government subsidies and trying to compete on tax income with their fellow states. Instead of having a German cluster on innovation in one or two hubs – such as South Korea – we have car folks in the south, ecommerce and trade guys in the north, fintech everywhere, and so forth. The localism translates into an even worse pattern of professors and local universities breeding their own breeds of university spin-offs. So we have a bunch of weird AI start-ups in Saarland, a cyber security hub in Bremen, egineering clusters in Munich, Aachen and and Karsruhe. It’s a shitshow. Global talent attractiveness is completely not in line with the localism in ecoystem design. Is this all a 68 generation issue of going against elite systems or is this pure result of “F√∂deralismus” ? WHo knows .Who cares. It sucks.

But the worst here is that the LP mix isn’t de-risking the government risk. With lower performance on government investments, the ROI of deploying more capital gets deteriorated. Knowing, too, that federalism reduces potential scale makes the government also scepitical of deploying massive tickets. Gearing their Investment Committee fudiciary duty towards managing the size and scale of the ticket and gearing the investment case towards job creating in the “small”.

Founders suck

If you look at Tel Aviv, you have massive government funds going into R&D and serial entrepreneurs hopping with the valley and their local ecosystem to spin out company after company. EMEA is full of first timers who want to build empires and don’t manage to exit a company within 3 – 5 years. After they cash out, they go surfing and build weirdo companies. Or if they don’t cash out, get a full load of blame and go back to corporate jobs. So the founder ecoystem sucks.

On top of that, because you don’t have the talent density in one area – due to the F√∂deralism – the bargaining power over equity shifts to founders. Who become maniac ego-driven morons who buy expensive cars and ride bikes. Or after their first exit start a venture fund. Congrats! This view adds to the inclination to write too little checks on equity, ESOPs suck, founder bargaining on ESOP plans in every round suck. Adding to this “greed” on equity participation for employees – which is in line with the excess diluational bleed from small founding tickets at low valuations – you get that equity over-exposure of founders leads to uncoachability and lack of investment into the mindset and skills of hires. After all, if you pay low salaries – due to low tickets raised and cash restraints – and low equity particpation – due to high diluation and low valuations – you don’t trust neither into the incentive nor the skills of a underpaid and under-equitied hire.

And even if it is obvious. But maybe worth mentioning. First timers or second timers hardly raise 100 million A rounds. They don’t know how to deploy and manage that much capital. And 100 million VC funds don’t know how to support that shortfall. If you don’t know how to deploy 100 million in three years, nobody is going to give it to you. And if you don’t get 100 million, you won’t get a 500 million and upward valuation. It is that simple,

Exit markets suck

Who invests in IPOs in Germany or EMEA ? Guess what. With real wages stagnating and government social security and rental systems, no individuals are investing individually. And with equity market participation low, the business case for pooling agencies sucks. With that in mind, you have corporates, pensions, goverments and family offices left. Just recap the above and you get why nobody really likes getting their hands dirty in IPOs in Europe. Add that consistent pattern, you get why M&A and IPO adivors suck. And add the below, you understand everything here sucks.

With bad exit markets, what are you going to do with exit valuations. They will under-perform. And even if the exit market was there, you still have have VC investment structures destroy incentive systems, founder and talent access issues (all below) destroy value.

Venture Capital Sucks

When you look at venture capital firms, you have some old dudes that made it with Government money when we saw a contraction in capital supply and they fail to return on their capital deployed. You have ex-bankers who don’t get anything about operational side of the business and fail to build value-added networks and who fear of bad tax treatments if they start to actively support their portfolios. Because they suck at getting good investments – which are rare in the ecosystem as described above – they spent too much time fundraising and lobbying and playing the “I am important” card trying to network with family offices and corproates for LP relations. You have former one-time or two-time entrepreneurs who think they can compete against the PE and banker guys and also don’t want to lose their tax treatments.

All in all, you have people who are too greedy to join forces, they all raise ridiculously small funds, don’t value add and write ridiculously small tickets that are only good for getting a low 3 digit or even below 3 digit exit. Everyone structures investments wrong, because nobody expects 200x exits and prefers to capure the maximum economic rent with micro tickets that cripple the execution of their portfolios – given that also founders cripple their execution and don’t know how to deploy capital and they don’t find the talent to execute on capital deployment.

Last, but not least, haven’t seen a venture fund that wasn’t under exposed with tier 1 engineers. Somehow they either don’t stick of VC funds don’t care about engineering. MBAs alone don’t make create VC funds. So even when looking at a 10 billion dollar company in theory, if nobody knows how to execute on the opportunity and take the market, what’s it worth trying. You won’t take a 1 billion market with a 20 million Series A ticket.

Talent access sucks

Because everything is defunct, from government subsidiaries, talent density in critical areas, incapable VCs, unmanagable LP environments and lack of exit potential. you have basically no chance to attract really good talent. Wait, except: really cool deep tech start-ups with nice offices in Berlin find tier 1 tech talent, but they lack the sales and strategy guys and founders are uncoachable ego-maniacs. Mmh.

Yes, nobody leaves his excellent career at a global fortune 500 company to go to Germany and join a company in this environment. And that is why talent supply adds to the death kiss of the ecosystem. Add again the greed of founders and the ridiculous equity tickets you see here in EMEA and the quality of talent, it’s clear you lack incentives, upside and talent.

Banks suck

Believe it or not, the idiotic behaviour of local banks – much lauded by many – that over-exposed themselves to global risks they didn’t understand and the scandals around Deutsche Bank and the likes also kind of lead to issues. Balance sheet issues, pressure from FinTechs, market cap crunches, lawsuits. The whole thing led to a crunch in debt financing for risky businesses. Making companies more reliant on nun-functional equity ecosystems in Europe.

“Conservative” Accounting practices add to the problem of less than optimal balance sheets. Balance sheets being a driver of risk-averse banks taking this as a reason for dipping credit for start-ups. Add this to regulated leasing and general financing environment, you have another distadvantage.

Summarizing the suckyness

So we underperform on every metric. The key drivers being regulation, risk-aversion, fragmentation of ecosystems and the lack of accepted life-style entrepeneurs.

Are we going to heal this quite soon? Probably not. The good thing is, because the global ecosystem knows about this all and also being sceptical about talents from here, we will not suffer too much talent attrition.

I think France is doing a good job at working on this issue. Maybe Munich does. Southern countries try to run initiatives, but their real wage discrepancy makes them a joke in comparison – think of Portugal and Spanish salary levels being 50% that of France or Germany. Eastern states still have a credibility challange, which they try to overcome, but which are counter-acted by nationalist sentiments in politics who deteriorate the political environment.

The solutions could be simple. Killing federalism in Germany, or even nationalism. ANd building joint ecosystems. Playing out well-thought-out subsidies systems on regional hubs and transportation to connect isolated and fragmented hubs, building and fostering truely immersive and integrative entrepreneurship programs, accepting the concept of elites and putting them in one or maximum 3 places. Changing regulation and providing tax incentives on insurance and pension systems and local vehicles to change asset allocation behaviour of LPs and operational support of venture capital. Discriminating hard against moronic angel and venture capital vehicles to drive opportunist “first time founder and tired banker” out of the market and consolidate talent pool in the investor environment.

But what is simple in the end. What we shouldn’t forget is that we are looking at 2.2 billion people in EMEA and Africa, 508 million people in EU with a GDP of 16 trillion (31.5k per capital GDP). Nationalism and federalism is the only reason we suck.

Leave a Reply