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Germany on the rise?

21 Nov 2017

Germany on the rise?Hauke Stars compares the global start-up landscape

Thomas Edison, who many see as the greatest American inventor, submitted more than 1,000 patents over the course of his life. More significant than the number of his patents was the influence of his inventions, such as electric light or motion pictures. Edison once said that “our greatest weakness lies in giving up. The most certain way to succeed is always to try just one more time.”

Founders of start-ups are today’s inventors as they disrupt established business models across all industries and implement innovative ideas. Some studies estimate that nine out of 10 business ventures will fail and the start-up behind them ceases to exist. Indeed, founding a start-up is risky. Accepting failure and a “let’s try it again” attitude are all essential parts of the entrepreneurial spirit; founders need a high level of perseverance.

While the US start-up culture is built on this motto and start-up founders readily share their experiences, there is still a huge stigma in Europe. Failure is perceived as a negative trauma that has to be avoided at all costs. Removing this stigma would be a step in the right direction of encouraging greater entrepreneurship.

In terms of innovation and an entrepreneurial culture, the US is clearly a role model. Silicon Valley are the magic words in the ears of investors, start-ups, and incumbents. No other region in the world is better known for its very own entrepreneurial spirit and scientific development. The San Francisco Bay Area has been the breeding ground for major tech companies such as Apple, Intel, and Google. Today, California is home to over 65 so-called unicorns – start-up companies with a value that exceeds US$1bn.Managers and employees of incumbents flock to Silicon Valley, hoping to share in the entrepreneurial spirit to trigger change within their companies.

New valleys around the globe

The vibrant flair created by a large number of fast-growing high-tech companies and innovative start-ups in one place is certainly inspiring. However, Silicon Valley also stands for economic growth and competitiveness. California’s rise has a long history and owes its success to many different factors. Its proximity to the elite university Stanford plays a vital role as does a conducive economic, tax, and regulatory environment. The combination of these and other factors has contributed to the development of the world’s leading start-up ecosystem that attracts founders and investors alike.

Therefore, it comes as no surprise that other locations are eager to create a similar environment to foster an entrepreneurial culture. More than 600 accelerators and incubators are active in the UK – while Israel even has its own state authority for innovation, and Germany’s capital Berlin, is always  ranked among the best of the world’s fastest-growing start-up ecosystems. Those international hubs are on their way to building healthy and growing start-up ecosystems, some of which are already quite advanced.

Germany is improving its ecosystem for start-ups

Within the European start-up scene, Germany plays an essential role and attracts international attention. Its start-up ecosystem has experienced extraordinary growth over the past 10 years and is  built on a stable infrastructure, comparatively affordable rent, governmental support, and a solid base of highly qualified workers. With some unicorns and a growing number of successful start-ups, Germany can compete with other international start-up locations such as Israel, the United Kingdom, and California.

However, a comparative review of the start-up scene in Germany and other industrialised nations reveals significant differences. In a joint study, Deutsche Börse Group and EY have undertaken a detailed comparison of this field taking into account the economic, tax, and regulatory attractions of start-up ecosystems. (Deutsche Börse Group/EY: The economic, tax and regulatory attractiveness of start-up ecosystems. An analysis for Germany, Israel, the United Kingdom and California (USA), June 2017). The goal was to understand what Germany could learn from Silicon Valley, Israel and the UK.

Germany has made considerable progress in some areas but its start-up ecosystem still has potential to grow. The stigma of failure is one aspect; another key factor is the lack of sufficient capital. Financing is an issue in Germany, which could ultimately put the innovative power and the competitiveness of the country at stake.

Our assessment goes beyond an analysis of the current situation – together with EY, we have identified four recommendations for action that can help further develop Germany’s start-up and investment culture:

Strengthen financing landscape

In 2016, German early-stage companies received US$967m in financing. This is a significantly lower number than the early-stage investments in the US (US$13.2bn), the UK (US$2bn) and Israel (US$1.03bn). Over the past years, various public initiatives (e.g. EXIST, Coparion, ERP Venture Capital Funds) and public-private partnerships (e.g. HTGF) were launched to provide capital, especially for the early days of a business lifecycle.

However, a strong backing from the public across the entire chain of venture financing is crucial for a start-up ecosystem to thrive. In the UK, specialised funds, such as the Angel CoFund and the VC Catalyst Fund, encourage investments by business angels or venture capitalists during different phases of a start-up. Similar initiatives could certainly be a way of strengthening financing options in Germany.

By comparison, Germany also lacks a platform enabling efficient cooperation between incumbents and start-ups. California has a strong investment landscape with a focus on Silicon Valley, which is supported, among other things, by the leading tech companies. Creating more incentives for large tech companies could encourage investments in German start-ups as well.

Revise tax regulations

In recent years, Germany has made progress when it comes to a tax law that is conducive to creating a strong start-up climate by adopting some specific measures; measures which need to be maintained and expanded. Germany’s tax policy is still not as developed in allowing tax deductions on losses as Israel or the US. Also, taxation on capital gains – e.g. in the case of a start-up founder wishing to exit – in Germany is not as investor-friendly as in the US. Additionally, the taxation of earnings is significantly lower in the UK and there are special tax relief arrangements for research and development costs.

Germany’s discretionary ability to adjust its tax policy is limited due to binding EU legislation on some of the issues under discussion here. Fact is, tax policy is a complex subject that requires a detailed assessment. The goal is to make Germany more attractive from a fiscal perspective to company founders and potential investors.

Scale back bureaucracy

Setting up a legal entity in Germany can be a long and costly process. It takes up to two weeks and the fees are the highest compared among the group of locations under review here. The introduction of the UG (“Unternehmergesellschaft”, similar to UK’s ‘Ltd.’) in 2008 was a step in the right direction. However, a “one-stop shop” solution for company start-ups is still missing in Germany.
The high capital requirements for company foundings in Germany also have a negative impact on the start-up ecosystem. Additionally, complicated regulatory requirements and pre-costs for licensing in certain industries (such as the financial sector) pose a serious obstacle to start-ups. Looking at the UK, fintechs have the opportunity to test business models and products in a special live environment (or “regulatory sandbox”) without the full burden of regulation.

Foster entrepreneurial spirit

The start-up spirit in Germany is less pronounced than for instance in California or Israel. The Californian entrepreneurial mind-set is based on the founding DNA of the population, which is the tap root of the IT revolution. Compared to German culture, failure as well as the subsequent learning curve is all part of life in the business world. “Fail fast” thereby becomes a winning formula. Entrepreneurs should know that their risk taking is appreciated and that it is not a blot on their CV.

In order to establish such a culture and promote the start-up spirit in Germany, the educational system plays a vital role. Preparing future generations of entrepreneurs through education is one success factor, which has already proved itself in other countries. Programmes on innovation management and entrepreneurship in universities can have a very positive impact on the start-up spirit. The Technical University of Munich – calling itself the Entrepreneurial University – and the WHU Business School – whose graduates founded multiple successful companies – serve as role models when it comes to linking the academic realm with the start-up world.

Cooperation is key

A functioning start-up ecosystem creates jobs and generates wealth at an impressive pace, to say nothing of the rapid technological evolution it promotes. It is time for other places that have been lagging behind to catch up, as they will otherwise miss these tremendous opportunities. The reason why they are lagging behind is not that they lack the ideas or smart people to implement them. Rather, the framework is riddled with obstacles that block their path to success (or learning from failure).

Of course, there is no recipe for replicating Silicon Valley – and this should not be the aim. However, the points mentioned above can help to foster innovation within Germany, and may be applicable to some extent in other countries and regions. Building a start-up ecosystem is a task that can only be solved via joint forces; it takes various stakeholders to work hand-in-hand to succeed. It is our call – companies, politicians, regulators, stock exchanges and the education system alike – to work closely together to prepare the foundation for an ecosystem for growth.

Ecosystem: Contribution of Deutsche Börse

Deutsche Börse is playing a significant role in this ecosystem for growth. It is our mandate to provide funding and financing solutions to companies at different stages of maturity: start-ups, SMEs, established players. For that reason, we have already broadened our value chain, namely in the area of growth financing and tailored support way before companies actually consider going public.

We have established a Fintech Hub in Frankfurt, consulting fintechs and hosting some of them at this location. Our Deutsche Börse Venture Network connects companies from the early to the late growth stages with investors to enable financing. Deutsche Börse Venture Network was launched in 2015. It has been expanding ever since, with currently more than 400 members across Europe. To date, we have seen the first Deutsche Börse Venture Network companies going public in Frankfurt, amongst these have been va-q-tec, a provider of products and solutions in the field of thermal insulation; NAGA Group, a Hamburg-based fintech; and Delivery Hero, an online food ordering and delivery marketplace. Our efforts to build a vibrant and innovative start-up ecosystem are already bearing fruit.

Hauke Stars

Member of the Executive Board since December 2012, responsible for Cash Market, Pre-IPO & Growth Financing

The article originally appeared in the Equity Capital Markets Handbook 2018.

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