October 6, 2020

Financing for German Startups: Traditional & Alternative Options

What Type of Government Support is Available and Who Qualifies? 

For the most recent German Accelerator “Pass The Mic” series, we hosted a webinar to explain the traditional and alternative financing options for German startups during COVID-19. Alex von Frankenberg (High-Tech Gründerfonds, HTGF), Angela Kerek (Morrison & Foerster), and German Accelerator Mentor Christian Janson-Euterneck (NeueCaptial Partners) brought different perspectives to address the current challenges German startups face, along with an overview of the public and private financing solutions they can tap into.

To open up the discussion, Angela can you provide a general overview of current financing options for startups?

Angela Kerek: Depending on which phase of company you are in, you will have different financing needs and options. To frame your financial decision-making process, the first step is to carefully think about your capital requirements and formulate a strategy for how you want to finance your startup idea. This strategy will vary depending on the type of business, your burn rate, your fixed assets, and whether or not you have a turnover from the beginning. Some financing sources that may be available in Asia, Germany, and the U.S. include governmental grants or subsidies. Depending on who these capital providers are, they will either require to have some equity or will be non-refundable funds.

Fundamentally, there are two financing options: Operational Sources, if you already are seeing revenue, or External Sources, where you must raise funds from VC investors or Angel Investors. Funds from these shareholders are referred to as equity financing. Focusing on equity financing, the first option you would want to explore is non-institutional equity known as 3Fs ‘family, friends, and fools’. This is where you would begin developing your idea of wanting to start a business and pressure-test it. Once you are confident your business idea will work, you would then look towards Angel Investors and then ultimately VCs or strategic investors.

Slide showcasing the stages of startups compared to risk of capital

Credit: Morrison & Foerster

Here is an indication of volumes that you will have from different investors. Starting out, you will find investors who help you place your first product and give you the required capital. Once you hit the growth phases, you will have investors who will support your actions to engage a new customer base. In the exit scenario, you are looking at adding a strategic value to what you already have or developing a new core business. The more you move towards the right of this visual, the less risk of invested capital you will have.

Line Graph showcasing the capital providers vs. financing types

Credit: Morrison & Foerster

On this curve, you can view the stages and capital providers from the founding of your company to its maturity. Before break even, you have equity and convertible loans along with the capital providers who are interested in this kind of risk. The further you move up the curve, the more sources of capital become relevant. You find that in the startup world, most are focused on equity rounds rather than looking at alternative options. In short, the more mature you become, the more access to capital you will have.

Given that any company can face economic difficulties, how do you restructure or add capital in the time of crisis?

Alex von Frankenberg: High-Tech Gründerfonds(HTGF) was established in 2005 at the end of the crisis that followed the dotcom bubble and has survived the most recent financial crisis of 2008. Therefore in a way, a crisis is nothing unusual. There will be constant “crises” during the life of a company through either missed sales or having valuable team members leaving the company. The very first thing I would like to express to founders is “don’t panic”. Looking at the Coronavirus crisis, the next thing founders should do is cut costs – there are always some unnecessary costs. You will want to review your operational, marketing, or personnel budgets to see what can be cut. It is also very important to try and increase sales, and right now there are many companies who are using video capabilities to do just that. During this time, existing shareholders should support the founders and if possible provide additional funding. There is also a possibility of acquiring new shareholders. At the end of March we (HTGF) had an internal meeting where one company just closed a significant funding round without ever having met the Business Angel in-person. Ultimately, if you cannot save the operation and are not able to find new investors, then the government is stepping in as their goal is not to let companies die because of the crisis.

List of options for companies to help stabilize the economy, provided by the German government

Credit: High-Tech Gründerfonds (HTGF)

From the German government’s available options, some will not be applicable due to a startup’s size. On this list, #5 short time allowance (Kurzarbeitergeld) is worth pointing out because it reduces the time employees can work, therefore it reduces costs and prevents significant loss of income over a defined period of time. Then #6, the €2B Startup Program was designed for typical startups that cannot sustain themselves. This program consists of Pillar 1.) Where the government gives money to accredited VCs (this excludes corporate VCs, Business Angels, single family offices) and Pillar 2.) For startups that don’t have access to Pillar 1 since they do not currently have any investors. The maximum amount allowed under Pillar 2 is €800,000 and is a combination of federal and state money.

Depending on what type of VC you are, you will either fall into the category Pillar 1a or Pillar 1b. Pillar 1a is for private VCs whereas Pillar 1b is specifically designed for the federal funds HTGF and Coparion. As we are a federal entity, the money received from the government cannot go into our fund but will go into our portfolio companies. In summary, Pillar 1a or Pillar 1b-Module 1 is a co-investment scheme following the guidelines of EU investment rules, with the rescue money not exceeding 50% of the investment round. Pillar 2 or Pillar 1b-Module 2 is a convertible loan with standard conditions, but it cannot be combined with anything else. The government is stepping in on many levels for startups and the first installment of money out of this program has already been paid out in July.

 Breakdown of €2B Startup Program from German government

Credit: High-Tech Gründerfonds (HTGF)

Having heard of the support coming from the German government, Angela can you tell us what financial resources are available to startups in the U.S. and in Singapore?

Angela Kerek: Building off of what Alex was explaining, it is important to note that the money is never given directly to the startups, but rather comes through a co-investment scheme to help investors raise funds. In the U.S., the government has decided they will not step in on the equity side, and rather will only finance on the debt side. The main program through which they are financing is the Paycheck Protection Program (PPP), which is a loan that will partially be forgiven if you invest this loan in paycheck payments within a certain period of time. In Singapore, the government has resources on both the equity and debt side for Singapore based startups. Similar to how Germany has structured their equity relief programs, Singapore offers co-investing options.

Christian, what is your view from an investor’s perspective?

Christian Janson-Euterneck: The VC market has not dried out and is still relatively active, it is not as dramatic as it is being made out to be. With that being said, you have to become cash flow break-even so that you can weather the current situation, if you cannot raise new funds. As a startup, you want to manage what you can influence (i.e. costs or forecasts). A helpful step would be to transfer your fixed costs into variable costs where you can, for example, variabilize sales costs by reducing the salary component and increasing commission for sales reps. The ultimate goal is to become cash flow positive. For those startups with investors already onboard, it is imperative to maintain excellent relationships with existing investors as they are the ones who are able to support you further.

List of options to raise new funds if the venture capital markets dry up in Germany

Credit: NeueCapital Partners

Should the VCs become more risk-averse and we witness the VC markets drying up, the ultimate solution will be to present a compelling and competitive product or solution. These are must-have products, such as anything that assists with digitalization, communication, or security. You want to have revenue coupled with solid customer references.

Looking specifically at the U.S., currently I would say the country is a bit behind Europe as it is a very muted environment right now with everyone only recently coming back. However, I still believe the U.S. is the go-to market for any product or device and is the most lucrative and commercially attractive marketplace. But before expanding to the U.S., you must make sure that you are extremely competitive. The best way to show your competitive advantage is through customer references. For those companies who are pre-revenue with no customers, I would advise to wait until the Coronavirus crisis is behind us and use this time to prepare for international expansion. When you finally set-up a location within the U.S. I would strongly recommend hiring a senior U.S. startup manager to oversee the U.S. operations. Don’t make the mistake of not having an experienced local onboard since the language, marketing, and sales process is very different.

What are the pros and cons of working with an investment bank or boutique?

Alex von Frankenberg: Investment banks bring competencies and network to the table. Especially during an exit transaction, it is another negotiation line that helps you to get an aggressive deal. On the other hand, in the early stages of startups you expect the startup to do the fundraising themselves and when they come with an M&A advisor it is not a good sign.

Angela Kerek: In the early stages of startups, you really need to look out for the fees investment banks charge. In the later stages I agree completely with Alex, when you are speaking about exit scenarios you should work with investment banks.

As a German company (with a GmbH) is it possible to get a U.S. investor onboard? 

Christian Janson-Euterneck: This is an established stereotype – it may have been the case 20 years ago that U.S. funds had limitations to invest outside of the country. Today in our global world, 95% of U.S. funds have the right to invest outside of the country. However, I would always recommend that any EU based startup leave their headquarter and IP within the EU and establish a second headquarter in the U.S. in order to be more attractive to U.S. investors.

What recommendations do you have for German startups seeking Seed or Series A funding in the U.S.?

Christian Janson-Euterneck: If the German company is post-revenue there is some likelihood, but right now it is extremely difficult to raise funds from a purely U.S.-centric VC while the company is still in Europe if the company has below $2M revenue. NeueCapital Partners is one of the very few VC firms that sits in the U.S. and focuses on European and Israeli startups.

Alex von Frankenberg: From my perspective, U.S. VCs open up the local network so if there is a strong angle to the U.S. it makes sense to have a U.S. VC onboard. Very often they require some part of the management team to move to the U.S. If the investment goes into an “Inc.” then the laws are very different and it will be much easier and quicker to get washed out of the company. You do not have the protective regulation like you do under “GmbH” which makes it more difficult for aggressive investors to wash out those investors/ founders who cannot participate in the round.