Founders in a gold-rush mood
Prof. Dr. Christine Volkmann on investing billions in German start-ups
The amount of money invested in German start-up companies must first be savored slowly. We are talking about no less than 7.6 billion euros, a mega sum for German founders this year. Where does the money actually come from and who invests at all? Prof. Dr. Christine Volkmann, Head of the Chair of Entrepreneurship and Economic Development & UNESCO Chair of Entrepreneurship and Intercultural Management in the Faculty of Economics at the Schumpeter School of Business and Economics, explains the opportunities that open up for innovative start-up projects in the Transfer Interview.
Central banks flood the markets
"The ECB's key interest rates are at zero and commercial banks are charged negative interest rates for their deposits, which they partly pass on to their customers," Volkmann begins. "In addition, the central banks are flooding the markets with money. Investors, with a currently high investment demand, can actually no longer generate a return with fixed-interest investments. However, generating a return is necessary," she explains, "otherwise, with a comparatively high inflation rate, there will be a loss of assets." But the money is there and must be invested. "Stock markets and real estate are opportunities. We can currently see that, despite the Corona pandemic, in the rising share prices and real estate prices. Another possibility for professional investors are investments in start-ups. The need for alternative investment opportunities is enormous against the background of the current interest rate environment, the scientist explains. How long the central banks will continue the expansive monetary policy is currently not foreseeable. She also sees this approach as a kind of experiment, because, she says: "The extent to which this spiral can continue in the long term is unclear. At some point this high liquidity would actually have to be gradually withdrawn from the market, and therefore we do not know how this experiment will end." With regard to the situation on start-ups, the current mood is predominantly positive. The investment sums are high, but at the end of the day you also have to see how these start-ups develop.
Even unusual start-ups find a sponsor
Many German start-up concepts that were, are few years ago, not considerd, are now being financed. According to Volkmann, this is also due to progressively developing start-up culture and infrastructure for start-ups. "There are many incubators or innovation labs that house and support start-ups, such as Freiraum here in Wuppertal (Freiraum is an innovation lab at the University of Wuppertal, editor's note). Accelerators, such as the Circular Valley Accelerator in Wuppertal, have emerged, to expedite the growth of start-ups.Today, there are coworking spaces, such as Codeks in Wuppertal, and Maker Spaces in most German cities. In addition, start-ups are supported through a variety of measures at a very early stage. Both financially, e.g. through funding programmes, and in an advisory capacity, e.g. through coaching or mentoring. In the last few years, start-ups have also become significant drivers of regional structural change. Here, the start-up culture is changing in the direction of the model of the American start-up culture." The overall positive developments in Germany encourage international investors, especially from the USA. And these investors are not altruistic, as Volkmann knows, since the valuations of start-ups are currently very high in the USA. Therefore, they are looking for favourably valued alternatives in other European countries, i.e. start-ups that are expected to have high growth potential.
Berlin's investment volume triples
According to the international consulting firm EY (Ernst & Young Global Limited -EYG-), Berlin's investment volume more than tripled during the last year from 1.2 to 4.1 billion euros. "There are probably several reasons for this. Firstly, the capital city effect probably has to be taken into account," Volkmann says. "If we look at the other big cities such as London and Paris, we see that 'venture capital' flows, at first, to the capital cities in a high volume (venture capital, also known as VC for short, is a form of financing a start-up or young growth company by means of equity capital - editor's note). On the other hand, these are likely to be a few, very large investments, which are currently, primarily concentrated in Berlin and Munich. At the same time, the VC market in Germany is still very small, compared to the US, for example." From the point of view of many young people, Berlin is also still a cool, dynamically developing city. There are about 100 coworking spaces in Berlin alone, according to the coworking guide. Not only do these offer founders attractive spaces but they also offer opportunities to network with stakeholders such as media and sales partners or investors. In addition, many multiple founders are active in Berlin, who can convince with their know-how and media experience. "But other regions also have their charms, which international investors could focus on even more. For example, it is worth looking at NRW, the federal state with the largest number of universities and colleges, which have a high spin-off potential," the expert says. The opportunities for cooperation are the state's main advantages over other locations in Germany. Not only with the possibility of multiple founders, but also with well-known large companies and innovative "hidden champions" from the strong SME sector.
Hope for growth generates investment
Usually, start-ups do not make a profit at first. Nevertheless, investors risk very high sums. "It is the hope for sustainable growth," Volkmann comments briefly. "One invests in non-listed, innovative companies with scalable (high-potential) business models. VC firms subject these companies to a thorough examination beforehand, i.e. due diligence. If a start-up team passes this hurdle, negotiations take place on the basis of a company valuation. This leads to financing, typically with several successive financing rounds. "With their investments, venture capital companies pursue the goal of selling the company again after a period of time with a corresponding return," she explains. Then, the exit from a successful company can take place, for example, via an IPO or the sale of shares to other investors. Along the way, many venture capital companies also support the start-ups in their portfolio. E.g. through management know-how and contacts from their investor network, e.g. to facilitate market entry in sales or to build technology partnerships. All of this is done with the aim of significantly increasing the value of the start-up company and thus of their own investment during the involvement with the founders.
So much money... but where does it come from?
This year, the Munich-based software company Celonis received around one billion dollars. The online broker Trade Republic just under 900 million dollars and the insurance start-up Wefox still 650 million dollars. Here, the layman's question arises involuntarily: where does the money come from in the first place? "There are investors who give money to VC companies or VC funds, trusting that they are able to invest in such a way that the desired return is achieved in the end," Volkmann explains. "Venture capital companies act as intermediaries, collecting money from investors to invest in portfolios of different start-up investments. In private venture capital companies, potential investors are banks, insurance companies, pension funds and wealthy individuals who give money. The federal and state governments also sometimes invest together with private investors, e.g. through institutions like the Hightech-Gründerfonds. But these investments are always subject to certain conditions," she says with a smile, "since they are not allowed to gamble." Rather, she says, the state's priority is to support important future technologies or sectors such as biotechnological vaccine or medication development in the current Corona pandemic. In general, it always comes down to innovative, scalable business models that have to prove themselves. Volkmann personally trusts in forward-looking, innovative, digital business models rather than, for example, in currently booming delivery services and predicts: "The wheat will be separated from the chaff. But, in competition, this is a completely normal selection process, which is simply part of the process for start-ups in new markets.
Opportunities for Bergisch start-ups
And what does the situation look like for Bergisch start-ups? "We have a very good support infrastructure in the Bergisch Land. The start-up and technology centres do an excellent job, such as the Wuppertal W-Tec Technology Centre, the Solingen Start-up and Technology Centre and the Gründerschmiede Remscheid. Regarding the University of Wuppertal, we founded a university-wide start-up centre last year, that is operating successfully. Here, I expect that there will still be numerous exciting spin-offs from our university," Volkmann determinedly says. "Already a few years ago, high-growth start-ups that probably have the potential for VC financing today, emerged from the university. Since the start-up phase, these companies have been closely associated with our academic chair. They include, for example, IQZ, which I have already accompanied as a mentor in the Exist start-up scholarship, or 'Wijld' and 'Kita-Concept'. These companies may grow more slowly than VC-financed companies, but they grow organically, i.e. under their own steam". This is not a negative strategy for the well-versed scene maven, as she points out that VC investments are also associated with dependencies on the capital providers. VC financing could be an option if a start-up wants to grow quickly and meets the requirements. Therefore, she says, it is important to look into possible growth strategies and alternative forms of financing at an early stage as a founder team, and to carefully weigh up the advantages and disadvantages.
The business models are certainly multicolored, but certain sectors could benefit from the financing boom in particular. "Investors are focusing their attention on megatrends, i.e. disruptive changes that lead to promising innovations and new business models. Examples are digitalisation trends as well as trends in the context of health and sustainability," Volkmann explains. "Current investments by VC companies show that the area of digitalisation, e.g. fintech, software development, cyber security, robotics and artificial intelligence, is on the agenda." Reagrding the topic of health and the ageing of our society, e.g. pharmaceutical and medical technology sectors are relevant. Focusing on Wuppertal, there is, in the context of the sustainability trend, also the area of the circular economy. Volkmann describes this area as an important topic of the future. Every year, more than 350 million tonnes of waste are produced in Germany. This is a gigantic waste of raw materials and natural resources. Therefore, the topic of circular economy will also become more important in the future.
Volkmann does not yet see the peak of the investment volume, the Bergisch start-ups are well positioned. In conclusion, she emphasises, that the beauty of the start-up initiatives is particularly "that success creates a trust that can be built upon to jointly implement further entrepreneurial projects in the Bergisch region in the future."
Uwe Blass (Interview on July 22, 2021)
Prof. Dr. Christine K. Volkmann has held the Chair of Entrepreneurship and Economic Development at the Schumpeter School of Business and Economics at the University of Wuppertal since 2008. Since 2010, she has held the UNESCO Chair for Entrepreneurship and Intercultural Management at BUW.