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Four reasons why Germany needs a better ecosystem for startups

Over the past three years, Germany has been making steady progress as a location for Tech and Fintech entrepreneurs. German startups, however, would still like to see more being done to advance their cause. A guest article.

03 Nov. 2017 Source: t3n Christopher Schmitz
Picture: Soeren Stache/dpa
Picture: Soeren Stache/dpa

A number of indicators point to Germany’s startup ecosystem shaping up well lately. In the first half of 2017, for example, about 2.2 billion euros in funding was raised – twice the amount as the year before.

Another ray of light on the horizon is the German government’s announcement that, starting in mid-2018, it will be providing two billion euros of startup funding via the Development Loan Corporation (KfW). Another notable development: Online delivery service Delivery Hero had an extremely successful IPO (issue size: € 996 million), and is now listed in the S-DAX index.

So given these positive developments, where is the perception coming from that Germany still needs to play catch-up? The following four reasons are the most common ones cited by young entrepreneurs:

Reason 1: Germany has no real startup culture

A German startup ecosystem – i.e. an environment in which young companies can find and get targeted support from commercial enterprises, the public sector and educational institutions – has been in place for roughly 10 years, now. The country is clearly making progress, with Berlin, Hamburg, and the states of Bavaria, Baden-Wurttemberg, North Rhine-Westphalia and Hesse having successfully positioned themselves and produced a range of capable, internationally competitive startups. When it comes to digital business models, the IPOs of Zalando or Rocket Internet (2014) continue to be a beacon for young Internet and technology companies. Looking at Fintech, we are seeing rising consumer acceptance of innovative payment services, savings and investment products and new models of online credit financing. In the first six months of this year, investors and venture capitalists were prepared to invest more than 330 million in Fintech startups.

The question that arises: Are these just isolated successes, or perhaps indicative of a greater plan? Is there any systematic, institutionalized collaboration, for instance, between multinational corporations and dynamic German startups? Clearly, the new generation of German entrepreneurs is casting envious glances at the startup ecosystems already in place in the U.S., Great Britain or Tel Aviv: California, alone, boasts as many as 65 startups worth a billion U.S. dollars or more. And in the United Kingdom (and London in particular), startup founders are currently enjoying the active support of more than 600 accelerators and incubators. The Israeli government is busy courting global tech companies, with 20 incubators already active in the publicly funded National Technological Incubators Program and an entrepreneurial culture boasting 1,150 high-tech startups founded in 2015, alone – proof positive of the effectiveness of Israel’s ecosystem.

In the bid for bright minds, Germany finds itself pitted against such high-powered international competition, and is well advised to find more ways of encouraging them to set up shop on German soil.

Reason 2: German startups need better funding options

Although the number of successful fundraising efforts has risen a bit lately – also for early-stage companies – it is still an uphill climb for startups to obtain liquidity. Germany needs more private investors (e.g. family offices) and institutions with a greater readiness to invest in order to keep startups from going abroad, tempted by greener pastures in terms of initial funding.

It therefore comes as very welcome news that, starting in 2018, business angels and venture capitalists will be promoting startup investments via a KfW subsidiary. In this context it is also worth taking a look at Great Britain, where lawmakers have set up an Angel CoFund and a Venture Capital Catalyst fund providing much-needed support to early-stage companies.

Reason 3: Germany’s tax system is not very favorable for entrepreneurs and investors

Another object of criticism (beyond the general shortage of available funding) is inadequate tax breaks for venture capitalists and corporate venture funds, making it less than attractive for potential investors to lend financial support to startups. Other nations (e.g. Israel) reward financial backers for their willingness to assume risk, thanks to a tax system that allows for losses on startup investments to be written off. The German tax regime, unfortunately, is rather inflexible – not only for potential investors, but also for entrepreneurs in general. Although several promising ways of creating entrepreneurial incentives have been proposed, they have often not made it past the political hurdles involved.

Given the outcome of Germany’s recent parliamentary elections, the formation of a new government may well turn out to be a long process. But quick advances might still be possible, e.g. by means of tax credits for innovations and tax incentives for R&D projects. Also worth discussing would be tax breaks for income from patents and deductions in the case of capital gains.

Reason 4: Overly high costs for company founding and the associated red tape

Germany scores points with its affordable office rents, for the most part favorable transportation system and infrastructure, and a qualified and mobile labor force. But at the same time, the World Bank’s latest Doing Business report unfortunately also documents that starting a company in this country is complicated, and takes a long time compared to other OECD states. Thus Germany comes in only at number 114 in the OECD rankings. To establish itself Germany as startup-friendly country, lawmakers should therefore review regulatory burdens, capital requirements and licensing costs. Especially for Fintech companies, the British model provides a valuable blueprint: There Fintech startups can initially test their business models in a so-called "regulatory sandbox" without immediately needing to meet all regulatory requirements. This model is also being emulated elsewhere in the world, e.g. in Singapore, where the regulatory authority MAS has likewise set up a regulatory sandbox.

Conclusion and outlook

Young companies are become more and more important to Germany’s economic prosperity. With regard to Fintech businesses, in particular, we have been witnessing the potential for young, creative thinkers to create new jobs and trigger new growth.

Market players in the realms of business, government and higher education should step up their financial support for German startups and give them more support in overcoming the hurdles they face. Then the chances will be good that many more startups can flourish and grow into medium-sized companies or even so-called "unicorns" (companies valued at over a billion euros).