How to Set up a VC Fund to Deploy Capital in German Startups

By Silicon Allee | Investment

This article is published as part of Skytrain – a transatlantic investor community bridging the gap between investors and VC funds in the US and Berlin. Join the network or learn more about what we do here.

5 Essential Decisions You Need to Make Before Setting up Your Venture Capital Fund

We already discussed 5 things you need to know before setting up a venture capital fund in Germany in another article. But there are some fundamentals that will apply no matter where you set up your VC fund.

Before you commit to setting up a VC fund, you’ll need at least two things:

  1. A track-record as an investor (either investing your own money as an angel or working in an established VC fund). 

2- A network (in the VC game, it’s more about who you know than what you know).

You may also be a serial entrepreneur or successful executive and you can provide the guidance and professional network needed to raise funds and help startup founders succeed. If that’s the case, we’d recommend first partnering with an “established” VC. Basically, someone with hands-on experience putting investment capital to work.

However, if you’ve done the due diligence, you (or your partner) have a proven track record in an existing fund or as an angel – and you’re ready to set up your VC fund to take advantage of the lucrative and growing VC market in Germany, then keep reading. 

Here are 5 essential decisions you’ll need to make before setting up your fund:

1. Find your “Special Sauce”

While there are some businesses fighting for the democratization of venture capital, the VC industry remains a small, close-knit community, hence the importance of building your network. And, like every small market, VC is incredibly competitive. The best way to succeed in a high-competition market is to differentiate yourself from everyone else offering the same thing to the same group of people.

The first thing you need to do to stand out is to get very specific and create your investment thesis. According to Fred Wilson at Union Square Ventures, a thesis-driven investment strategy can be a big benefit for smaller VC funds as it means they attract the kind of startups they want and serves as a filter for assessing potential deals.

Essentially, your investment thesis should cover; fund size, number of deals, investment stage, domicile, industry sector, geographic focus and the added value you can bring to the table (experience, network, mentorship).

Another tip to help you stand out is setting up content marketing strategy on platforms like Twitter and LinkedIn. When you’re starting and joining conversations in your startup niche, you’ll quickly become recognized as an authority in that space. 

2. Decide on a Sector

Germany has been the European leader in tech innovation for a long time. We’ve seen dozens of unicorns like Personio, Celonis, N26, and Flink, to name just a few. It may be slowing down a bit now, but on the macro level it’s not changing anytime soon.

According to EY’s Startup Barometer from July 2022, the fastest growing startup sectors in Germany right now are Software & Analytics, Energy, Mobility, and FinTech / InsurTech. Each of them received funding totals above the €700 million mark in the first half of 2022.

Of course, bigger isn’t always better. Especially as a new smaller fund, there’s a lot to be said for niching down and going for a very specific – yet still profitable – sector.

There’s also a big trend towards Medtech and Healthtech startups. As of July 2022 there were 2,817 HealthTech startups in Germany. Not all of them will find product market fit, but the sector raked in €479 million in funding in the first half of the year so it’s definitely worth considering.

In July 2022, German finance minister, Christian Lindner, went on the record saying: “I want to make Germany a founding republic” when introducing a new plan to inject €30 billion into German startups by 2030. That money is earmarked for companies investing in deep tech and climate solutions including artificial intelligence, hydrogen technology, quantum technology and sustainable mobility. So now is the perfect time to jump on that particular bandwagon.

Aside from the trends, it’s also important to focus your fund’s investment thesis on areas where you have passion, specialist knowledge, and experience to ensure you’re bringing something more than capital to the table.

3. Decide on a Financing stage (pre-seed or seed? early or  later stage?)

In Germany, funding rounds are very similar to what you’ll see in the rest of the world. From pre-seed to late-stage, depending on the maturity of the startup. The stakes are very different depending on the stage of financing that a startup is entering. While it’s important to be a specialist, especially when your fund is in its infancy, there are pros and cons to focusing on one particular stage so let’s take a look at them.

Pre-seed and seed stage

This stage has the most accessible buy-in, which is why it’s the most common for new, smaller funds. At pre-seed stage you can expect deals anywhere from €50,000 to €1 Million for a 5 to 10% equity stake. So, small deals with a smaller stake in the company. In essence though, you’re providing a startup with enough runway to develop a minimum viable product (MVP) and get their business off the ground and ready for seed funding. 

At seed stage, the startups likely have an MVP, they have their first few customers and are looking to prove product market fit. You can typically expect to source deals between €1 million and €5 million (although we’ve seen seed funding rounds go much higher).

Startups looking for pre-seed and seed funding can really benefit from mentorship and industry expertise, which is why so many apply to incubators and angel investors to get off the ground.

A big advantage of buying in at pre-seed and seed stage is that you’re getting equity stake in the startup when it’s at its lowest valuation. But, especially before a company has started generating revenue, accurate evaluation can be very challenging. There are a few ways to valuate startups at this level such as Scorecard Valuation and the Berkus Method, but you’ll need to bear in mind the risks of investing at this stage. You probably know that less than 10% of startups make it past the first year of existence, so the risk of losing your investment at this level of funding is extremely high.

Early stage (Series A) 

At early stage, companies are often still pre-revenue (maybe less often in Germany) but typically have some product-market fit and are opening themselves up to further investments as they are looking to scale their business. Deals usually go from €5 million to €15 million for a 20-35% equity stake and those funds go towards optimizing the product and business for long term growth.

Founders and their teams can still benefit heavily from industry expertise and mentorship here, especially when it comes to business structuring and sales, so you’ll be competing against a lot of angels and smaller funds for the best deals.

Early stage funding is still very high risk – as the startups still have a lot to prove – competition for the best deals is also much higher and the deal sizes much larger. On the other hand, you’re also getting larger equity stakes while the companies are still valued relatively low so there’s a potential for bigger returns.

Late stage (Series B and C)

At later stages (equating to series B and C) you’re going to see deals anywhere between €15 million and €100 million for 20%-35% equity with “Megarounds” going up to €250 million and then some. Startups will be valued much higher than they were in the early stages having already proved product market fit and potential for long-term growth and being well on the road to the stock market in an initial public offering (IPO). 

At this stage is where the bigger more established funds as well as other private equity players are all wrestling for a piece of the pie. So, while the level of risk is generally lower, new, small funds generally don’t stand much of a chance at getting a seat at the cap table. Of course, in venture capital it’s all about the network so if you have the connections there’s still a chance to get in on larger, more advanced deals.

4. Get realistic on the fund size you need and want to raise

It goes without saying but the more capital you want or need to raise, the more difficult your job as a fund manager gets. 

So when you know which industry sector you want to get stuck into for the next 10 years, and you know which funding rounds you want to pitch in for, you have everything you need to figure out how much capital you need to raise to meet your investing goals.

At this point, it’s wise to create a financial plan for your fund. Start simple by looking at your capital budget (how much you can invest), portfolio plan (where you will deploy the capital) and expected returns (based on capital budget and portfolio plan). 

When it’s time to start investing, you’ll need an overview of cash flows over time so you can properly budget for your investments and plan for the future of your fund. In this way, you can clearly demonstrate to potential limited partners that you have a solid plan for how you will use their capital. 

Note: For a much more in-depth look at modeling fund economics, check out this article by Fred Wilson at Venture Fund Economics, Gross and Net Returns.

5. Choose the right legal structure

This may be a good time to have an informal conversation with potential anchor LPs in your network to validate your thesis and the need for a fund of your size in the market. As an emerging fund manager, you’ll want to be spending the lion’s share of your time on raising capital for your fund. But before you can do any fundraising, prospecting, or investing, you need to get all the legal bits and pieces in place. 

It can be tricky to time this process as you don’t want to set up the legal entities without knowing you will have some committed investors in your fund, but you also do not want to fall into the legal jeopardy of soliciting funds without having your company in place. Talking with other fund managers is a great way to get tips on how to walk this line.

One More Thing – Network Is Essential

When you have all of these things in place, it’s time to start raising capital and hunting for deals. Of course, one of the best ways to do that is to be plugged into a valuable network. Here at Skytrain, it’s our mission to foster collaboration and investment across the Atlantic — with the ultimate aim of bringing more US LP investment into the booming Berlin-based VC market. 

Backed by Silicon Allee and the Berlin Business Office, USA, we’re a community of LPs, GPs, family offices, angels, syndicate leads, serial entrepreneurs, emerging fund managers and operators who share a passion for the Berlin startup scene.

Interested in joining our transatlantic investor community?

Skytrain is funded by the European Regional Development Fund (ERDF) in collaboration with the Berlin Senate Department for Economics, Energy and Public Enterprises

Dieses Vorhaben wurde als Teil der Reaktion der Union auf die Covid-19-Pandemie finanziert.