The German venture industry is under fire from all angles, with the regulatory environment, a shortage of serial entrepreneurs, and a lack of support from domestic LPs posing formidable challenges. One of the core problems within the segment, however, is structural. Mareen Goebel investigates.

The seed capital part of the German venture industry is dominated by state-backed entities such as High-Tech Gründerfonds, the KfW bank and a handful of other regional funds - usually government sponsored or local initiatives by savings banks ("Sparkassen").

Formal, privately managed venture capital firms have historically taken only a small percentage of all seed financings. This has been especially true of the last 18 months, which has seen many formal venture firms focusing on "later early-stage" deals. In these cases, the backers have been looking to eliminate the "risk" from the term "risk capital" by investing in already profitable companies that merely need an injection of growth capital to continue their development.

Meanwhile, High-Tech Gründerfonds has funded more than 174 companies and invested in more than 135 follow-on rounds, investing more than €190m between its inception and February 2010. It provides €500,000-1m per company to achieve proof-of-concept or proof-of-market. In this way, High-Tech Gründerfonds plays a vital role in the seed phase in Germany.

But it is disheartening that this segment is so reliant on state-sponsored capital, with only a little extra support coming from a handful of other corporates. Part of the problem is that German LPs continue to shun venture as an asset class, even though, as one venture capitalist commented, "the later stage bias has eroded now that so many buyout firms have seen such significant meltdowns. Venture is back on the map as part of a diversification strategy to protect against the downside."

Paradoxically, although they may shun local and European venture, German LPs such as insurers and pension funds are more than happy to invest in US venture offerings, despite the fact that US venture has not significantly outperformed its European counterpart in the last 10 years at least. Consequently, this LP behaviour has left German venture comparatively under-funded and local venture specialists receive only a fraction of their total LP commitments from domestic LPs. In the case of Wellington Partners, German LPs account for 10% of total commitments to its latest fund generation.

What this means is that German companies that received (modest) seed financing from state-backed sources are suddenly faced by a yawning chasm when it comes time to raise series-A rounds. There are simply not enough financially strong venture firms that can fund the later stages of young companies' development. "Many start-ups run out of the initial seed capital that state-backed sources can provide, and then can only hope to be taken on by one of half a dozen venture firms in Germany - if that - which do not have the means to take on everything that the seed financers fund. Many only have the choice to more or less silently expire," remarks Rolf Christof Dienst, founder of Wellington Partners.

Of course, this scarcity of local investment talent has not gone unnoticed. After several French GPs opened offices in Germany, Finnish venture firm VNT Management Oy has also entered the market and closed its first transaction, a €2m investment in dilitronics GmbH. Similarly, Dutch venture firm Forbion Capital Partners opened in Munich just last month to strengthen its presence in Germany. These are just two of the latest moves of international investors beginning to fill the gap in German venture, a segment that, according to one VC, "is very much a buyer's market."