That’s why start-ups are having a hard time at the moment

Frankfurt/Berlin For many years, the mood on the German venture capital market was excellent. The venture capital funds, supported by the low interest rates, reported new records in raising new money and the valuations of the start-ups shot up to dizzying heights. But the boom is over, and the business climate on the German venture capital market has deteriorated extremely by the end of the year. After the downward trend briefly stopped in late summer, there was another slump in sentiment in the final quarter.

The investor barometer drawn up by the KfW development bank and the BVK industry association fell by 25.6 points to minus 42.9 points. Apart from the unprecedented corona shock in the first quarter of 2020, the mood among investors investing in young growth companies was last worse around 20 years ago.

“At the end of the year, a storm of various factors was brewing, which pushed the venture capital mood further into the basement,” says Ulrike Hinrichs, executive board member of the BVK. Together with the further clouding of the economic outlook, this is weighing on the funds’ willingness to invest.

The new start-ups, which are therefore currently stranded, have to keep their money together. “The focus for start-ups this year is certainly on ensuring survival. Everyone has to maintain strict cost discipline and secure customers very efficiently,” says the boss and co-founder of the freight brokerage platform Forto, Michael Wax.

That’s why Forto still has most of the capital from the last round of financing in the account and hasn’t put it into the business to be on the safe side. “We don’t expect anything to change that quickly in the cooling financing landscape,” Wax explains his caution.

There are several reasons for the slump in sentiment at the end of 2022:

  1. Institutional financiers such as insurance companies and pension funds are once again finding more attractive interest rates on government and corporate bonds. Therefore, they reduce the funding commitments for venture capital funds, which are comparatively riskier.

    There is also a technical aspect: Due to falling share prices, the relative share of venture capital in the asset management of professional investors was higher than was permitted in some cases by the specifications of the supervisors. As a result, new venture capital commitments were put on the brakes. The technical term for the phenomenon is the “denominator effect”.

  2. US investors became more cautious in the fourth quarter. This applied above all to the realized investments. This in turn restricted the investment opportunities for domestic investors, since US investors were missing as financially strong partners. This is also evident from the “State of European Tech Report”.
  3. The bankruptcy of the crypto exchange FTX in November was a shock to the tech scene, weighing on sentiment in venture capital markets worldwide. Several professional investors and venture capitalists were affected by the bankruptcy. This is likely to have increased the investment reluctance of US investors.
  4. The negative development of company values ​​over the course of the year presumably led to increased accounting value adjustments in the course of the annual financial statements.

Climate technologies, armaments and artificial intelligence are the new playing fields

In addition to the significantly cooler business climate, the market is also facing structural changes, and the investment focus of the funds is shifting towards new technologies. “The main focus of investors is on sustainability and here in particular on climate technologies,” says Julian Riedlbauer, Partner at GP Bullhound. Last year, more than 50 billion dollars were invested in climate tech start-ups worldwide, and a quarter of every venture dollar invested worldwide now goes to climate technologies.

Numerous venture capital funds have specialized in the topic of climate, including the World Fund, Extania, and Aenu. “This shows the beginning of a fundamental rethinking by many financial market players towards an expanded concept of investment success, which also includes climate-related and society-related results in addition to financial key figures,” says Aenu partner Fabian Heilemann.

According to Riedlbauer, another area with a lot of potential is the defense segment. NATO announced a €1 billion fund in 2022 to invest in early-stage defense tech companies.

>> Read here: How the Biden administration is targeting crypto firms

For other venture capitalists, too, the topic is no longer as taboo as it was before Russia’s war of aggression against Ukraine. However, the appetite is currently limited to dual-use technologies that do not have an explicitly offensive character and are also used for civilian purposes.

According to Riedlbauer, another interesting area is artificial intelligence. The investments by Microsoft in OpenAI or by Google are only the most visible developments. And software companies with products for corporate customers are still in high demand because the sector is less susceptible to economic activity.

Forto co-founder Michael Wax

Freight brokerage platform Forto has yet to touch most of the capital from its latest $250 million funding round.

(Photo: Forto)

There is a strong focus on the profitability of the business models. The partner of the VC Fortino Capital, Philipp Remy, also sees opportunities here: “The crash in US tech stocks has created a buying opportunity for new investments in software companies as the market has now returned to moderate price levels.”

New funds have a hard time

“In the current market situation, it can be observed that the trend towards quality is increasing among institutional investors and that existing investors are playing an important role as anchor investors,” says Jörg Goschin, co-managing director of KfW Capital. Venture capital funds with strong teams and good track records continued to receive capital from institutional investors.

Conversely, according to Cavalry Ventures co-founder Claude Ritter, this also means: “New funds managed by partners without a track record or funds with average performance cannot collect capital.”

>> Read here: Founders need to know these tips from investors for the next round of financing

With the slump in the fourth quarter, there is a growing danger that the gap between the European or German market and the US market will widen again, believes Steffen Pauls, head of Moonfare. In fact, US fundraising for venture capital funds is proving more resilient than European fundraising in the current market environment.

In the US, one sees an increase in the funds collected for VC funds from 2021 to 2022. In the EU, on the other hand, the effects of the economic downturn are clearly noticeable: According to Pauls, VC fundraising went from $25 billion in 2021 to $23 billion 2022 (status: 3rd quarter 2022).

Part of the explanation for this is that investors turned to established markets and managers in a downturn, with the US leading the field. Added to this is the proximity to the war in Ukraine. Heilemann does not expect a trend reversal until the second half of the year, or early 2024 at the latest.

>> Read here: EU Commission gives the green light for grants for start-up investors

Gloomy growth prospects for Europe and thus also for Germany – as the largest economy – could ensure that less capital flows here, says Goschin from KfW Capital. Conversely, this represents an opportunity for European venture capital funds to position themselves as a reliable partner for start-ups.

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