Earlybird misses the worm

Earlybird, one of a handful of German venture capital houses with an international reputation, closed its fourth fund – and the first it had managed to raise since 2000 – at €127 million on August 12, despite having initially targeted €200m. The fund-raising also took longer than expected, with a 12 month gap between first and second closes, instead of the customary six months.

Rolf Mathies, co-founder and managing partner of Earlybird, has admitted he was happy to have closed the fund at all. “I would love to have closed the fund sooner, but it takes time before the official statistics show the good returns that venture capital offers,” he said.

The €73m shortfall came despite a strong track record, which includes Earlybird floating six of its portfolio companies on various European exchanges in the past two years. These included Interhyp, an online mortgage broker, which returned fifty times its original investment.

However, if there is an aversion towards venture capital among limited partners, the venture capitalists must shoulder some of the blame themselves. At the height of the dotcom bubble, they attracted just under half of private equity inflows in Germany, peaking at €3.7bn in 2000. However, amid the techno-euphoria of the day, much of the money was squandered on ill-judged investments. Subsequent disappointing returns gave rise to an enduring scepticism among limited partners, which was only starting to evaporate when the credit crunch kicked in.

Last year the venture capital sector raised just €840m, 19.1% less than in 2006. The figure represented 20% of the total private equity fundraising in Germany. “Venture capital has been quite a difficult segment in Germany,” says Karsten Hartmann, a partner in HgCapital. “It has been very difficult since the internet bubble burst and it hasn’t really ever recovered. It is now raising a much smaller amount than prior to 2000.”

The timing of Earlybird’s second close was unfortunate. Nine months ago Europe’s largest economy still looked resilient. Indeed on January 17, Munich-based Wellington Partners managed to raise €265m for its Wellington Partners IV Technology fund, beating the €250m target in just six months.

However by August, the eurozone’s beating heart had started to look more anaemic. Investors became more pessimistic about both prospects for early-stage and start-up companies – even those with superb technology – as well as exit routes.

Peter Laib, managing partner of Zurich based Adveq, says another reason for the challenging fundraising climate is the way in which Germany-based LPs allocate their cash. “Local institutions put their core venture capital allocations though funds of funds, which forces venture funds down the international route,” says Laib. He adds that the funds of funds generally have quality benchmarks that most indigenous German players struggle to meet.

In Laib’s view, there are only six venture capital firms in Germany capable of competing on the global stage: Earlybird, PolyTechnos Venture Partners, Target Partners and Wellington Partners, with TVM and Global Life Science Ventures focusing in the life sciences sector.

Weakening investor enthusiasm for the asset class is good news for valuations. Instead of 200 funds chasing deals, there are now only about 40 actively scouring the German market. This means that, even in the most attractive sectors – life sciences, information technology, clean-tech, laser/photonics, nanotechnology and wireless applications – deals are less intensely fought. “It means that about 80% of the deals we want, we get,” says Mathies.

Having recognised the role that venture capital can play in creating a sustainable economy, the government is keen to give venture capital greater impetus. Regional pilot funds for venture capital investing have been established, led by state development bank KfW Bankengruppe, and the Federal Ministry for Education and Research (BMBF) is steering €430m into various biotech-related initiatives and an additional €800m into health research between 2006 and 2009.

This comes against the backdrop of above average research and development spending in Germany. The country currently spends 2.5% of its GDP on R&D and the German government wants to raise this to 3% by 2010. This should ensure Germany continues to produce a stream of high-tech companies with proprietary technology capable of being rolled out internationally.

The government gave further support for with recent changes to the Renewable Energy Law. The revised law, effective January 1, substantially increases the “feed-in tariffs” for onshore wind farms and added an extra incentive for offshore farms on which construction starts before 2015.

The Act for the Promotion of Venture Capital Investments (Gesetz zur Foerderung von Wagniskapitalbeteiligungen (WKBG)), intended to improve the tax status of venture capital funds, is likely to have lesss impact on the sector. The new tax breaks would appear to be of marginal appeal and experts widely regard it as a “missed opportunity”. A recent survey for the private equity and venture capital association BVK found that less than 10 of its member firms intend to make their funds subject to the provisions of the WKBG.