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We spoke with Marc Penkala to pick his brain on the ins and outs of running a VC fund in Germany.
And he knows a thing or two.
Marc has spent the last 10 years as an angel, investing in early-stage venture capital around the globe. Then going on to build his own vehicle – Minimal VC – where he currently has around 30 investments in his portfolio. Marc is also a founding partner at āltitude – a fund that works together with Angels to supercharge their deals by up to €100K.
Most recently, Marc has been spending his time consulting emerging fund managers on legal and organizational structuring and is currently in the process of building his own fund.
The very first thing you need to do is pick a location to domicile your fund. If you haven’t done that yet, we recommend you do.
If you’re ready to set up and run your fund here on German soil, keep reading.
The legal stuff
So here’s how it typically goes down:
You and a group of peers – with a background as VCs, angels or founders – get together and decide you want to start a fund.
So, you go to a lawyer and make your intentions known. The lawyer says “great, happy to help. It’s gonna cost you €150K”.
As soon as that money changes hands, the process begins.
The first part of the process is agreeing on the summary of terms. This is basically the 30,000 foot view of the fund strategy. It’s going to include all the details of your investment thesis (fund size, sector, stage, etc.) plus all the admin stuff like, management fees, carry, admin responsibilities, bookkeeping, etc.)
If you haven’t got this far yet, check out this article on the 5 decisions you need to make before setting up a VC fund.
From there, things get more granular.
The lawyers will incorporate the various entities you need to raise, manage and distribute capital. In Germany, that would be the complimentary limited company (GmbH), a management GmbH, and a limited partnership (KG) for each of the limited partners (LP) that connects them with the management entity as the general partner (GP). In this way, all liability is with the GmbH.
All three companies can be created at the same notary appointment. Then you pay in the shared capital (€25,000 to form the GmbH) and get everything noted in the trade register.
With the entities founded, your fund’s fate is in the hands of the German authorities – BaFin. You’ll need to show them your documentation and file your application to register your fund.
Once that’s done, you’ll go back to your lawyers and get them to draft all the documents – like the limited partner agreement (LPA), GP agreement, and subscription agreement) – and now you’re ready to start your fundraising journey.
Preparing the back office
One of the strangest roadblocks Marc hit when setting up his German fund was getting a bank account. We’ve heard this from multiple fund managers as well, so can confirm this is ironically one of the biggest stumbling blocks. When a bank provides an account to a fund, they’re obliged to carry out Know Your Customer (KYC) checks. That’s pretty expensive and not very desirable for a bank, even if you’re going to be a long-term customer because there’s none of the back-end sales (loans, savings, etc.). Of course there are online business banks that you can use but it’s something to consider.
Apart from the bank account, there’s a lot of other stuff you need for the day-to-day running of a fund. First and foremost, you need a fund administrator to manage the back office.
There’s the accounting, bookkeeping and tax side of things; you’ll also need to generate reports for the LPs, Environmental, Social, Governance (ESG) reporting, and generally making sure your paperwork is spotless.
There are a couple of options for this, the best way is using an agency or SaaS solution. You’ll find many on the market (see our article on Venture-as-a-service providers), some are more specialized but others like Berlin Agency and Ace Alternatives are more of a one-stop-shop for all your fund’s back office needs.
Raising Capital: Closes and Capital Calls
You’ll approach investors to raise capital and sign up to your fund as LPs in various stages – called closings.
You can do a pre-closing, which is an informal closing where you meet with potential investors and try to get some early commitments. After that, you’ll do a first closing to officially launch the fund and kick off the fundraising period. You’ll be aiming to raise about a quarter of your overall fund in the first closing.
From there either a rolling closing or second, third, etc. until the final closing when you stop accepting fresh capital to the fund. Ideally by this point, you’ve raised your fund target. If not you’ll probably have to rethink your investment strategy, which could mean losing some of your LPs (but it doesn’t happen often).
In terms of timing, from the first closing until the final closing it will usually take 12 to a maximum of 18 months. Which makes sense when you think about how a fund works. You raise the money, invest for 4-5 years, then invest for another 5 years so you can’t really spend more than a year raising funds and getting all that into place.
When an LP has closed, your limited partnership agreement (LPA) means you can ask for contributions up to the pledged amount by making capital calls.
It’s possible to request 100% of your LP’s pledge straight away but it can damage your fund metrics. So, you’ll want to make an internal decision about how much capital you call at closing, and then make additional capital calls as you need them.
Sourcing Deal Flow
It’s not only sourcing deals. It’s sourcing… picking… and winning the deals.
So if you find 1,000 potential deals in your stage, sector and geographic location, you now have to whittle that list down to 10 gems.
And once you have those gems, you need to get an allocation – you have to persuade the founders that your fund is the one that’s going to help them succeed.
If you’ve done the work and put together a rock solid investment thesis, used that to assemble your team and all the back end stuff – generated sufficient PR, and positioned your fund as an authority – this part of the process will be much easier.
The same will be true when you have your long list of potential deals and you’re putting together a short-list who you want to pitch. You’ll need to look at every one through the lens of your investment thesis to find out if they’re a good fit.
So if you receive 1,000 deals, you may end up with only 500 where it actually makes sense to work with.
From there you’ll narrow down the list further based on other criteria. There are a lot of ways to assess startups; whether they have a strong founding team, industry know-how, complementary skill sets, leadership, etc.
You can look at the market that they want to operate in; size, growth, product market fit, trends and opportunities in the market, etc.
Then you can look at the financial level; unit economics, profitability, general traction, revenue growth, whatever KPIs are relevant for you and your investment strategy.
And, of course, the product. What’s special about it? Is it defensible? Does it actually create value for the user? Is it a good tech stack or is there a lot of room for improvement?
In a nutshell, you’re looking for the unfair advantage that company has.
When it comes to actually valuing startups in a more objective way, there are multiple ways to do that. You can have an investment committee (IC), where you look at the investment analysis of the startup and make a decision based on your governance procedure.
You can also work with score cards. Decide what factors are most important to your fund and give each startup a score for each key factor.
The advantage of this is that it avoids falling into the trap of confirmation bias. This happens when you find a deal you like and start to subconsciously ignore all the red flags that tell you not to take it.
But interestingly, some of the most successful deals are also the most controversial. That makes sense when you think about it though. The more controversial a deal is, the higher the associated risk and the bigger the returns when the deal pays off. These kinds of deals are very binary – either they crack the nut in this market and hit a homerun or they’ll be filing for bankruptcy within a year!
But that’s basically your day-to-day job as a VC. Mitigating risk without compromising the upside and looking for the outlier that’s going to bring in the big returns. We see that all the time with funds being driven by the power law: 3% of the investments they make will drive 97% of the returns.
Getting US investors into Berlin Startups
The question is how many investors are you going to get from the US?
Getting US investors into a German fund is pricey from an administration point of view. If the fund is big enough it’s not really a problem as the costs are small compared with the overall expense of running the fund. But for smaller funds it’s unattractive to have investors from the US as they’re very expensive to onboard.
From a US perspective it’s not attractive to invest into a German fund because the moment you do that, you have to file your taxes in Germany. Even though you’re not a German citizen so most US investors will avoid that like the plague.
One workaround is to set up a feeder fund registered as a Delaware company in the US. The American investors then pool funds in the Delaware company which acts as an LP in the German fund. In that way, the investors avoid double taxation.
The downside is that the administration process and set up costs are very high. So, you have to be bold and commit to raising a high amount in the US for it to make financial sense to operate that vehicle.
As you can imagine, that also comes with additional risk and cost so it has to be very well-thought through. It comes back to the fundamental question you need to ask before even starting your fund: where are my LPs coming from? If the majority will be based in the US, you can prime your fund for that from the start and build the structure that’s the most feasible and suitable for your investor base.
Of course, it’s really appealing right now because the Euro has never been cheaper next to the US Dollar. The other reason is that the US VC market is very saturated so it can be difficult to get on board as an LP – it’s still much easier in Germany and the funds also have better terms.
On top of that Germany has a mature market that’s proven to create companies with a global scope so it’s worth the extra administrative burden to invest here and diversify your international portfolio.
Another reason Germany is appealing to US LPs is the very strong emerging fund manager ecosystem here. We’ve seen many successful micro, nano and solo GPs who raised highly specialized small funds in Germany. By their very nature, these kinds of funds outperform more established lighthouse funds because they’re just more risk tolerant.
Special thanks to Marc Penkala of Minimal VC for helping us put this together and generously providing this Emerging VC Canvas – that formed the basis of this article and pretty much summarizes everything you’ve just read.
This article was created as part of the Skytrain investor network. Backed by Silicon Allee and the Berlin Business Office, USA, Skytrain’s mission is to demystify German bureaucracy around investing for early-stage LPs in the US and connect them with Berlin-based fund managers like Marc Penkala.
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