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Innovation in Venture Capital

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For those who want to have the full experience👇

What are we dealing with? → Quick facts

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In 2021 more venture capital (VC) was invested globally than ever before. In the first half of 2021 alone, more than $288 billion was invested globally, representing a growth of 95% compared to the same period in 2020.

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In Europe, growth has been even more rapid, with a 219% increase during the same period, from $18.5 billion to $59 billion. Overall, Europe accounted for 20% of the global VC market in H1 2021 and grew faster than US and China. Most of this increase is due to late-stage investments, with financing rounds of more than $100 million, mainly from non-European investors.

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A comparable trend can be observed in Germany. Foreign investors dominate the rounds for later financing and are also investing earlier and earlier. The detailed percentages with regard to investor origin by deal stage was given by a KfW study and can be seen here:

Investor Origins - Germany.png229.9KB

This development, coupled with crossover, private equity (PE) and hedge funds continuously investing earlier in private companies, increases the competition for German VCs.

Research Question

How do German venture capital funds innovate to defend themselves against increasing competition and adapt to new market dynamics?

The boring part

⚙️Research approach & methodology

The interesting part

As the final product of the methodology three key categories could be identified in which the result fall into:

1. Macroeconomic environment of the European venture capital ecosystem

The explosion of VC volumes within Europe in H1 2021 is related to factors such as the low interest rate policy, an overall more mature ecosystem due to successful exits, relatively low valuations of early-stage startups in international comparison and the Covid-19 pandemic in parts. Furthermore, inconsistencies were identified with regard to the development of European growth capital, which can be explained by a market correction and the "trickle-down" effect on the one hand and an extreme amount of "dry powder" on the other. Furthermore, there is a consensus that non-traditional investors are increasingly entering the VC market, that the general competitive situation has intensified enormously and that a market downturn scenario is considered likely, without being able to identify more specific scenarios or dates.

2. Fund-specific characteristics: Overlaps and differences

In the context of a comparison of the individual funds and fund-specific questions, it was possible to show that a large part of the deal flow of the individual VCs still comes via their own network, the pitches to founders are increasingly being questioned or adapted and the fund strategies are either moving in the direction of smaller funds with pointed sector expertise or larger funds with multiple sector orientations. In addition, insights were gained into the various fund structures, according to which evergreen funds offer some advantages, LPs at the same time become more open to new structures, but the implementation or enforcement of such a structure in the German VC ecosystem still has to wait a few years. Furthermore, perceived risks for German VCs were identified, consisting of an early and more competitive investment focus driven by higher valuations, traditional fund structures coupled with a potential market downturn scenario, lack of stage and sector focus, and finally a lack of sector expertise.

3. New innovations

Lastly, the perception of different trends and innovations should be addressed, with sourcing engines, crossover funds and strengthening one's own brand being mentioned as novel innovations of the VC business model. Apart from that, operational VCs and the need for strong sector expertise were increasingly pointed out as trends. Otherwise, different trends were mentioned by one interviewee each, which can be interpreted as subjective perception but not necessarily as actual innovation in the VC ecosystem.

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In a nutshell, it becomes clear that many German VCs have so far continued to follow their business model unchanged and have only made minor adjustments, although a kind of turnaround is perceived within the European and German VC ecosystem. For German founders, the current market environment is considered more attractive than ever to raise venture capital for the growth of their company. On the other hand, it is becoming more and more difficult for VCs that can only come up with capital to participate in exciting rounds and achieve their desired returns. Because there is enough capital on the market at the moment. In the event of a market downturn scenario, which is seen as inevitable, some VCs that have let innovation pass them by are likely to experience problems with their fund performance, which in turn may lead to investor consolidation in the market.

The enterprise that dies not innovate ages and declines. And in a period of rapid change such as the present, the decline will be fast. – Peter Drucker