In Germany, A Seed Fund Helps Start-Ups Bloom
Venture investors have historically favored early-stage deals, at least in medtech investing, willingly embracing greater technology or market risk for the larger returns that come with being first into a company. But as the challenges surrounding medtech have grown – challenges such as longer regulatory times, greater payor resistance, and uncertainty around present and future financing – fewer and fewer investors with appetites for early-stage deals remain. Many are moving to later-stage deals, where returns are lower, but come more quickly and with greater certainty; some are leaving medtech investing altogether.
The lack of early-stage investors has some worried: where will the next generation of late-stage deals come from if no one is investing now? Indeed, ideas for new device companies – and device companies themselves – are still plentiful. What’s been lacking is an efficient and effective way to translate early-stage ideas into viable companies.
For venture capitalists, the issue is less about access to capital than about de-risking deals with companies that are too early to justify a venture investment; LPs are, after all, more interested in a reasonable return in a reasonable amount of time than in discovering innovative technologies per se. For VCs and start-ups alike, seed stage funds are less about alternatives to venture capital than about bridges to VC.
In Europe in particular, perhaps because both conventional venture capital and angel investing have historically been less widely available, at least compared to the US, seed stage funds and incubators have begun to spring up to create just such bridges. (MD Start is an example of one such incubator; see (Also see "MD Start – Can Medtech Incubators Work In Europe?" - In Vivo, 26 Mar, 2012.).) Many seed funds have roots in government initiatives, where goals around promoting company creation, and building local industry and tax bases, are perhaps even greater than the desire to generate returns.
One such seed program – and with nearly 300 companies launched to date, one of the most successful -- is Germany’s High-Tech Gründerfonds (HTGF), a quasi-governmental initiative designed specifically to help foster and promote not just technological innovations, but the company creation around them, without which the ideas too often fall by the wayside. Says Michael Brandkamp, PhD, director of HTGF, “In Germany we have a lot of great science, especially in the medtech area, and the government invests a lot of money in it. But we’re not as good at turning these ideas into business.”
Founded in 2005 and funded in early 2006, HTGF is an investment fund with a goal of investing “in seed stage companies in order to create opportunities for venture capital by transferring high profile ideas from science to business,“ according to Brandkamp. The ideas can come from anywhere – industry or academia. HTGF has close relationships with a number of Germany’s leading research institutions, including the institutes of the Max Planck Society, Helmholtz Association, and Fraunhofer-Gesellschaft. Individuals – for example, in the case of medical devices, physicians or engineers with ideas for new technology – can also appeal to HGTF for investments.
HTGF’s first fund raised €272 million (about $350 million), a huge amount for a European seed stage fund. Investors included the German government, which was HTGF’s main investor, as well as six private groups, among them large industrial concerns such as BASF SE, Daimler AG, Robert Bosch GMBH, Siemens AG, and Carl Zeiss AG. HTGF made its final investment from this fund late last year and raised a second fund in October of 2011, this one €293 million (approximately $375 million).
Investing that kind of money can be “demanding,” notes Brandkamp, especially given HTGF’s focus on seed stage deals. The fund’s goal was to make between 40 and 50 investments per year and it has, to date, invested in 285 companies across a wide spectrum of technology sectors. He estimates that around 25% of HTGF’s investments are in life science companies, split somewhat evenly between medical device and biopharma firms. As of earlier this year, 12.7% of all investments were in medtech firms (about 33 companies); an additional 7.9% (18 companies) went to biotech firms and 5.1% (or 13 companies) went to pharmaceutical ventures. (HTGF’s biggest share of investments has gone to Internet-based ventures, with almost 22% of all investments, or around 56 firms.)
Brandkamp says HTGF has heavily weighted medtech investments because Germany has a particularly good infrastructure for medical devices. The fund’s strategy is to put €500,000 into a company at seed stage, and then to seek out a venture partner to help fund the company’s continued growth. HTGF will invest an additional €1.5 million in a company in a later round of financing.
An HTGF portfolio company is required to set up operations in Germany, though the founders and their ideas can come from anywhere. A large number of HTGF’s early-stage, tech-oriented companies are located in Bavaria, Brandkamp notes, because of the strong tech culture and infrastructure there; Berlin is also an up-and-coming geography for business and technology in Germany.
Brandkamp says HTGF relies on the typical sources in looking for companies in which it invests; it also uses what he calls “coaches” who both recommend early-stage projects for investment and also help vet or assess the viability of ideas presented at a very early stage. Such coaches are often drawn from the ranks of the venture capitalists who will, hopefully, fund the project later on. These VCs will, in turn, bring HTGF opportunities that the VC considers too early or immature to warrant a venture investment. Individuals seeking HTGF funding come through one of the coaches. If individuals appeal directly to the fund, they are referred to a coach who helps them write a business plan before a formal decision is made on whether to invest.
Once one of the coaches writes a recommendation on behalf of the company, the company goes through a four-stage screening process that culminates in a review by an independent board, which includes a serial entrepreneur and a representative from TechnoVenture Management (TVM), a Munich-based venture firm. The board makes the final recommendation as to whether to invest or not.
A Multi-Stage Process
HTGF has access to expertise from a great variety of industry insiders. As part of its second fund, HTGF received investments from a group of 14 large German corporations, including in medtech, B. Braun Melsungen AG and Carl Zeiss, as well as high-tech firms such as BASF, Daimler, and Bosch, investors who, as part of the due diligence, often offer a very practical assessment of the value of the project. Because of the volume of deals HTGF sees and also because of the early stage of the companies, Brandkamp notes that “it was important that we developed a well-defined selection mechanism to make sure that the quality [of the technology] is at the highest level.”
Indeed, HTGF sees something like 1,000 business plans a year. Still, notwithstanding the multi-stage process, Brandkamp says a decision on whether to invest can usually be made within three months, because everything begins with a well-written business plan and a recommendation from a coach. “We don’t do pre-seed stage,” he notes. “We need to see a good business plan.” HTGF would also like to see a management team in place, Brandkamp goes on, “because without that, it will be hard to get the company to the next stage.” The goal, he says, is to use the initial €500,000 investment to “get some data and have a well-performing company. That should be enough to raise a follow-on investment.”
Interestingly, as venture capital becomes more and more scarce, investments by HTGF become attractive to companies that, on their own, are well past the business-plan stage. Thom Rasche, a veteran European medtech venture capitalist and partner at the Berlin-based venture capital firm Earlybird, is one of HTGF’s coaches. When, in 2007, Rasche was approached by John Yianni, PhD, CEO of CryoTherapeutics GMBH, about a Series A, Rasche was interested and even drafted a term sheet. But Rasche also saw that CryoTherapeutics would require substantial follow-on financing and made Earlybird’s participation contingent upon getting at least two other VCs to join the Series A. It was almost impossible to find a funding partner, Yianni and Rasche discovered. “The idea was very good; I liked it a lot,” says Rasche. “The problem was John was really early, pre-animal.” Rather than the €4 million that he was seeking, Rasche suggested Yianni “start small,” with the kind of seed-stage funding that HTGF provides.
Yianni soon began to explore similar kinds of seed programs, some government-sponsored, some not, and considered places like Ireland and the UK. Germany and HTGF won out because unlike other programs, it isn’t a matching program; companies don’t need to raise private capital first before the HTGT matches it. Notes Rasche, “Most of these [matching] programs are doubling programs, but that doesn’t really help the start-up because it’s not the second dollar that’s hard to get, it’s the first dollar.” Getting that first €500,000–€1 million “helps companies survive for a year or a year and a half and to the point where they have something real that can be shown [to venture capitalists],” Rasche adds.
For VCs themselves, HGTF is about enabling venture capital to come in at a more comfortable stage. Thom Rasche notes that he doesn’t necessarily see HTGF as a feeder to Earlybird; most of its deal flow comes from universities, entrepreneurs, and corporate spin-offs. Rather, he says, “What I see in HTGF is a significant de-risking opportunity for us.” Beginning with HTGF funding allows VCs “to sit back, watch how the project develops, how the management team performs, how the technology evolves,” he goes on, before the VC puts his or her own money into a company. In turn, relying on VCs like Rasche as coaches, HTGF gets a flow of “pre-due diligence deals,” deals that are too early for venture capital, but for whom the VC has done significant market analysis and technology assessment.
To date, HTGF’s 285 companies have gone on to raise an additional €415 million in 346 follow-on funding rounds, 70% of which has come from private investors, especially venture capitalists. (Additional capital has come from family funds, high net worth individuals, and other sources.) For a small company, Rasche notes, “€500,000 is a lot of money; you can go pretty far with that.” It’s precisely that progress that attracts VCs to the companies for the next round of financing.
Profitable Exits, For The Most Part
As venture capital comes in, the new investors don’t buy out HTGF, which has the capacity to put €1–1.5 million more into the company. Across the entire technology portfolio (all sectors) there have been 19 exits, with several more pending, and an equal number (26) of companies have gone belly up. Brandkamp notes that the medtech sector has seen fewer exits because there the six-year old fund is operating in an industry where exits now average nine to ten years. But the life science exits have been largely profitable. Indeed, HTFG’s recently saw a return of 15x on CorImmun GMBH, a drug development company.
Among HTGF’s medical device portfolio companies: EBS Technologies GMBH, developers of a non-invasive brain stimulation device to treat functional disorders of the brain that result from stroke and traumatic brain injury; Transcatheter Technologies GMBH, which has produced a third-generation TAVR valve; CryoTherapeutics, which is developing a catheter to treat atherosclerotic plaque caused by heart attacks; fiagon GMBH, which has a surgical navigation system used in ENT and neurosurgery; and GILUPI GMBH, which is developing devices to detect and isolate rare blood cells, with a strong focus on the cancer and prenatal diagnostic market.
Since its inception, HTGF has accounted for around half of all seed financing in Germany; in 2010, for example, it invested in 46 of 81 such deals in the country. But HTGF executives note that the fund doesn’t behave like most government-sponsored seed funds; critical to the fund’s strategy is a focus on selectivity. Earlybird’s Rasche notes that many of the VCs originally approached about HTGF were skeptical. “We all know you can’t make money in seed investing, because most seed funds fail,” he notes, in large part because most spread their investments somewhat indiscriminately, seeing company creation rather than return on investment as the driving rationale of seed funding. “They basically fund every man and mouse,” he says. HTGF has instead focused “on the quality of the selection of the deals in order to get the company ready for venture capital,” Rasche says.
Similarly, Rasche argues that many government-sponsored grant programs, while non-dilutive, often fail because they too often don’t lead to the kind of follow-on venture funding critical to a sustainable effort. Indeed, he argues that the German government supports programs like that of HTGF because it recognizes that when it comes to truly fostering innovative companies, government research grants alone “just don’t work. You have to have [private capital] involved, whether that’s in the form of the High Tech Founders’ Fund or venture capital.”
In addition, part of HTGF’s selectivity is that the group works closely with the companies it funds, helping to build management teams and make connections to VCs and other funding sources for follow-on financing. Notes Rasche, “They’re different because they know that management and coaching of the deals is important.”
“We’re very active in creating the [management] teams,” says Michael Brandkamp, adding that HTGF has helped hire nearly 100 senior executives into the companies it has funded. “Much more important, we can help connect our companies to VCs and other investors who can help with the next round,” he adds.
Brandkamp notes that HTGF is also unlike other government-sponsored seed funds in that it, just like its VC partners, has to generate a strong financial return. “We have to generate an IRR,” he says. “We have to answer to our investors about the performance of the fund. That does matter to us.” Still, one major goal of HTGF is to stimulate Germany industry, creating employment and a tax base as witnessed by the fund’s requirement that companies receiving funding set up operations in Germany. Thom Rasche argues that despite – or even because of – its German focus, far from executing a local, parochial strategy benefiting German industry, HTGF plays into a more global trend: that of companies, particularly from the US, coming to Europe to take advantage of the favorable regulatory environment. He points to a recent analysis done by Earlybird that shows a large increase in medtech investments in Europe in 2011, 374 in total, up 38% over the previous year. The biggest part of that increase? US companies coming to Europe, says Rasche. “It’s not just about opening an office,” he goes on. “But if they do, they can get their funding organized more easily, and with, €5–7 million they can get to first-in-man and CE mark, which they wouldn’t be able to get in any other market.”
Indeed, HTGF’s deal flow reflects that supra-national character; some 10% of the flow comes from outside Germany, says Brandkamp, and HGTF is forming close relationships with VCs across Europe as part of its network to find follow-on funding for its portfolio companies. Brandkamp says he can see HTGF reaching out increasingly in the future to companies in the US and emerging markets like China and Asia, although right now that’s not a high priority.