German web sector set to take off

Over the last decade the vast number of online companies launched in Germany has changed the traditional business model and new forms of product and service providers around the internet and mobile sectors are evolving. Looking at the German market a large international founder scene is emerging in Berlin.

Among the booming new business models are app providers, cloud computing as well as social gaming businesses. Venture investors such as Wellington Partners receive 400 to 500 funding requests from start-ups a year, while Earlybird that opened a new office in Berlin earlier this year, counts around 2000 requests a year.

Little wonder then that Henrik Brandis from Earlybird is upbeat about the current market. "We have been active in early-stage for almost 15 years and I don't think the environment for investments has ever been as positive as it is now."

A reason for the overhang in supply is that many VC funds have disappeared from the market in the last ten years leading to high demand for early-stage funding that is only served by a handful of venture capital houses. Adding to the difficult funding situation for start-ups is also the isolation of the German early-stage market dominated by a limited number of regional investors - quite contrary to the later-stage market that regularly attracts international investors.

While this naturally offers the benefit of decreased competition hunting for investment opportunities, it also makes the selection process more important than ever. Identifying those businesses with the best prospects from a plethora of young companies is certainly challenging and Brandis explains that Earlybird is looking at three particular criteria. "First, the business plan should have identified a big enough market that provides promising growth potential. Secondly, it should demonstrate a sustainable competitive-advantage, and last but certainly not least the quality of the team is essential."

Clearly, in order to be able to asses such criteria local knowledge is of the essence: being able to speak the same language; understand the mentality of the budding entrepreneurs; while also having the necessary networks to drive the further development of the company. This in turn explains why the market is mainly served by regional investors.

Fundraising though remains a widespread woe for European venture capital houses. While the asset class has struggled to attract LP commitments ever since the burst of the dotcom bubble, investor appetite has waned since the onset of the economic crisis as Michael Brandkamp from High-Tech Gründerfonds highlights: "The venture capital industry is characterised by a continuing fundraising problem with traditional venture capital investors are facing problems to close their funds."

The latest statistics from the BVK show that while German investors provided €1.2bn in seed and start-up financing this year, VC funds were only able to raise €640m themselves This creates a massive lack in funding considering that fundraising in Germany has already been significantly below average for the last three years.

The German early-stage market has reacted to this situation by creating new forms of financing for example through business angels, government-funded institutions and private entrepreneurial investors. Brandkamp explains start-up companies do not rely entirely on classical venture capital any more in order to develop their business.

A currently reoccurring development is strategic investments of corporates in start-up companies and the revived interest of corporate firms further offers good exit perspectives for VCs. Although the economy is currently facing a crisis, Brandkamp describes the exit market as stable and notes that large enterprises remain key. "As long as the big players are doing well, demand for young companies persists," he explains.

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