Venture Capital/Opinion/

Big shot or baby steps? Germany’s new startup plans

Germany is introducing new plans to encourage its startup scene. What could these new measures be — and will they work?

Berlin, Germany.
Philipp Herkelmann

By Philipp Herkelmann

When it comes to supporting startups, many European politicians seem to have their heads in the same place: invest in deeptech, slash bureaucracy and improve employee benefits. But sometimes that’s easier said than done.

Europe’s three largest startup hubs have recently committed to revamping their startup ecosystems. Though former UK chancellor Kwasi Kwarteng’s “mini-budget” was publicly chastised, several elements — including planned reforms to the Seed Enterprise Investment Scheme and the Company Share Option Plan (CSOP) — will be taken forward by new chancellor Jeremy Hunt.

In France, President Emmanuel Macron has set the nation a goal of producing 100 unicorns by 2030 — which, as a policy, has its issues. And this year, in Germany, the Green-led Ministry of Economics weighed in with a grand new plan to boost the country’s startup sector, although it raised a fair few eyebrows.  

Germany’s startup policy has never been particularly progressive. But the country has made some moves to encourage entrepreneurship that other countries are looking at, like its 2019 Digital Health Care Act and potential to be a cannabis market leader in Europe.

The new plan looked to take that further, and included:

  • Better facilitating the influx of top international talent;
  • Adjusting tax legislation to (finally) make employee ownership easier;
  • The idea with the biggest potential impact: introducing a minimum investment quota for institutional investors, such as pension funds, which would flow into (domestic) venture capital.

But after the plan was discussed with the two other coalition parties, the end result was somewhat diluted.

So, what does the new draft mean for the German startup sector? Here are the key takeaways.

Strengthening funding

Minimum investment quotas for institutional investors in VC would probably have been the most promising, as well as the boldest, solution to quickly funnelling large sums of capital into the startup system. After all, these funds manage trillions, and VCs know the startup world like the backs of their hands. 

Sadly, however, the latest draft suggests that thanks to legal concerns, this isn’t an option for the time being as a large number of pension funds in Germany are made up of public money.

The legislator wants to review IPO requirements, introduce dual-class shares and simplify capital increases

Instead, the current package pushes for the strengthening of existing, as well as new, funding pots. A future fund, for example, is to be endowed with up to €10bn by 2030. A further €30bn is to flow into another growth fund — with the support of private investors.

In addition, the government is planning a so-called Future Financing Act. The state wants to use it to streamline the initial public offering (IPO) process in Germany. To this end, the legislator wants to review IPO requirements, introduce dual-class shares and simplify capital increases.

Better access to (international) top talent

Every fourth employee working in a German startup comes from abroad, and half of employees come from outside the EU, according to the Deutscher Startup Monitor. And though that suggests that Germany is an attractive place for international talent, startups across the continent are battling for the same candidate pool — especially when it comes to in-demand IT talent.

To make Germany a more attractive destination for startup talent and compete with the likes of Paris and London, the Ministry of Economics wants to simplify and speed up the immigration of skilled workers. However, the paper remains very vague as to how it intends to do this.

Employee share ownership (at last)

To attract local and international talent, the German government also wants to encourage employee share ownership

Many international startups use this as a tool to incentivise skilled staff and align company goals with employee personal wealth-creation goals over time, by potentially increasing the overall value of an employee’s compensation package if the company is thriving. This reduces the salary gaps between startups and industry giants. In Germany, however, this is rarely used in the battle for talent — not because startups don’t want to, but because of complicated German tax laws imposed on these employee stock options.

Startup employees can usually only sell their holdings at IPO, merger or buyout, and in most countries any profit made is only taxed then. In Germany, however, employees have to pay tax on their shares beforehand, based on their current value or the company’s most recent valuation. That’s despite the fact that the company valuation could be higher than it is when it exits, and potentially before employees can access the money to pay this tax in the first place. This phenomenon is called dry income taxation and leads to employees not being able to exercise their options. In other ecosystems, this tax is only due once cash hits the account via a liquidation event, such as an IPO or exit, and not just when there is paper value created.

The government, therefore, wants to increase the tax allowance for employee share ownership, and at the same time tighten the amount, timing and thresholds for taxation (which creates dry income taxation). The effect of these measures is controversial.

Improve the opportunities for spinouts

Many universities make it difficult for their students to successfully commercialise their intellectual property (IP) into a spinout company. If an innovation is developed within the framework of a university, patent protections and intellectual property rights on the part of the university often take precedence over the students’ efforts to found a company. That can result in universities themselves owning the IP and then licensing it back to the startup for a fee, or taking a significant stake in the company — which can put VCs off when it comes to raising.

In future, startups will be able to launch exclusively digitally and within 24 hours

The federal government wants to facilitate easier tech transfer by providing more support in the transfer of intellectual property. For example, IP for virtual shares and an arbitration board for disputes would not bind massive financial resources during the seed phase of a startup, but still allows the university to profit proportionally to the value generated in future.

Additionally, it wants to improve and digitise the process of starting a business for everyone. In future, startups will be able to launch exclusively digitally and within 24 hours — a process that, right now, takes several weeks to months in Germany.

More diversity

In 2021, just 17.7% of all founders were female, as seen in the Deutscher Startup Monitor 2021. Plus, according to Atomico’s State of European Tech report, just under 1% of all venture capital in Europe went to female founding teams last year — and this has been the case for years.

Using the aforementioned Future Fund and the EXIST programme (a programme to promote science startups), the German government also wants to offer more support to women and underrepresented groups founding startups.

More public contracts for startups

The federal, state and local governments in Germany award contracts worth more than $100bn every year. It’s a huge market — from which startups have rarely profited. The Covid warning app, for example, showed that contracts often goes to the old players — in this case, SAP and Deutsche Telekom. But that’s about to change. In future, the state wants to award more government contracts to startups, and thus open up access to a new source of funding.

To make this possible, the federal government wants to establish a marketplace through which companies will have access to tenders and all the necessary information to participate. Innovative, economic, social and ecological projects will be weighted more strongly in tenders in order to improve the chances of these sectors participating. It’s unclear to what extent the latter will affect startups, or whether this might even interact with EU laws on public procurement tenders.

A (small) step in the right direction

The plan also includes measures that are supposed to democratise access to crucial data for startups and make laboratories where startups can test their products more accessible. It remains questionable, however, whether these many small steps are sufficiently supporting the German startup ecosystem. Is simply raising tax thresholds enough to solve dry income taxation, for example?

The German government should act on its plans, as not doing so would be missing a huge opportunity. The draft, though, still needs to be passed through the Bundestag (the German parliament), so I imagine it’s a discussion that will keep us busy for months to come. One thing is certain: Germany is finally taking a step in the right direction. However, there remains a lot of work to be done.

Philipp Herkelmann is the partner and general manager of Germany at Entrepreneur First. 

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