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PROCEEDINGS 117
Panel VI:
Early-Stage Finance and Entrepreneurship
Moderator:
Alexander Kritikos
Research Director
German Institute for Economic Research (DIW Berlin)
Dr. Kritikos welcome participants to the session on early stage
financing and entrepreneurship. He reviewed some of the reasons it may be
expensive to explore and develop innovations, including the need to pay high
wages, the cost of an expensive laboratory, or the desire to patent the invention
on which an innovation is based. In sharp contrast to large firms, startups
usually do not have the revenues needed to underwrite such costs. Therefore,
entrepreneurs who wish to be active innovators need access to risk capital. This
capital is far more abundant in the United States than in Germany, he said. In
2010, German firms or individuals invested some 650 million Euros in small
firms and entrepreneurs. In the United States, this figure was about $12 billion.
In the year 2000, the figure for the United States reached about $100 billion,
while in Germany investment in risk capital was near zero.
What are the reasons for this difference? he asked. Researchers have
investigated many possibilities. In the United States, venture capital firms have
existed since World War II, while in Germany the first firms were not founded
until the 1980s and 1990s. “And we know that in the United States it took 35
years before venture capital became a force.” Other hypotheses, he said, were
that Germans are less willing to take risks than Americans; that German
entrepreneurs are less likely to get a second chance from their peers, or from
society; that the capital markets are larger in the United States; or that the
regulatory climate in the United States is more favorable to venture capital.
“There are so many questions,” he said. “I hope you will be able to
answer a few of them as we hear from some of the experts in this arena.”
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118 MEETING GLOBAL CHALLENGES
NEW INITIATIVES IN EARLY-STAGE FINANCE IN GERMANY
Peter Terhart
Chairman
German Private Equity and Venture Capital Association (BVK)
Mr. Terhart said he would comment on several aspects of the German
financial system, beginning with the statement by Dr. Kritikos that only about
0.1 percent of Germany’s GDP is dedicated to venture capital. How could this
be? he asked. An important reason is a condition that “fundamentally sets us
apart from the United States: we do not have pension funds. This means that a
very big player is omitted from the venture capital market.” One reason this is so
important, he said, is that a pension fund “thinks in terms of generations, in
terms of long-term and stable investments,” and knows that a nation must invest
in its future if is to continue to develop. In Germany, pensions are for the most
part paid by labor.
Another feature of the financial system needing attention, he said, was
the banking sector. After World War II, the government compensated for the
lack of a “financial economy” by creating a large public banking sector. These
public banks were intended to finance the “real economy,” including companies
that needed capital for early-stage activities, growth, and expansion. During the
1950s and 1960s, he said, all sizes of companies were financed by the banks,
which, in principle, had surplus funds. The scarcity of private funding for
companies, such as angel investors and venture capital, had little consequence as
long as the banks could fill the needs. This changed with the beginning of the
current crisis, however, and banks that had had enough money for decades were
no longer willing or able to provide venture capital.
A second aspect of the financial system was its long-term orientation.
This has allowed sustained corporate development in the “real economy.” After
the war, this financing nourished the small and medium-sized businesses and
“hidden champions” mentioned earlier. The real economy and the financial
economy developed hand in hand, supported the number of companies that
constitute today’s SMEs, as well as the heavy legacy industries. Thus,
innovation and the creation of new companies took place within existing
companies. In other words, he said, “the reinvention of the economy was not
happening by way of entrepreneurship and start-ups, but rather through
incremental steps in the small and medium sector, heavy industry, and other
established organizations. This lead, he said, to more conservative, step-by-step
change, rather than more radical or disruptive innovation.
Third, Mr. Terhart said, the legacy of support for long-standing,
successful companies influenced the career choices made by young potential
entrepreneurs. A young engineer, for example, who may contemplate starting a
new firm, will also be offered positions with SMEs and large firms of the
existing economy. They will face a difficult choice: Should I take the risk of
establishing myself independently with my own firm, or should I go to Siemens
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or a successful "hidden champion" where the salary and employment are secure?
The lack of venture capital and concern about the risks of entrepreneurship may
often persuade a young person to make the conservative choice.
The federal government understands and wants to change this situation,
he said, and knows that to do so it must provide more incentives or competitive
support for those interested in entrepreneurship. Some effective programs have
been implemented for this purpose, he said, and they are essential in avoiding a
continuation of overly conservative behavior. Many incentive projects have
received initial funding, he said, and the next step is to sustaining their funding.
Despite the lack of an established venture capital industry, Mr. Terhart
said, some new projects are presenting opportunities for raising funds as well.
For example, many family businesses—even though they are not included in
official figures—and branches of larger companies are strongly dedicated to
forming or joining venture funds to support young or beginning firms. In
addition, foreign funds, such as some French funds as well as some non-
European funds, show interest in investing larger amounts of money in private
equity or venture capital funds. “We are seeing that, as a whole, there is a
greater enthusiasm in approaching this matter in earnest,” said Mr. Terhart,
starting with early steps taken by the Ministry of Science and Technology and
the Ministry of Economy.
“These are demonstrating today,” he concluded, “a willingness to
create the conditions necessary for the establishment of a venture capital
industry. We see that our own equity industries are now stepping into the
breach, as they have seen that the banking industry—the old players—can no
longer do so.”
THE CLASH OF INNOVATION CULTURES:
THE UNITED STATES AND GERMANY
Eran Davidson
Managing Partner
Hasso Plattner Ventures
Mr. Davidson introduced himself as an Israeli who had making venture
capital investments for 16 years, the past six of them from his current base in
Berlin. Having invested in Israeli, American, and German companies in many
fields of technology, he said he would present some comparisons among the
investment and entrepreneurial cultures of the different countries, especially the
United States and Germany.
He said he had chosen the title of his short presentation, “The Clash of
Innovation Cultures,” because of a peculiar situation. He said that “Germany is a
funny country in many ways, especially when it comes to innovations,” because
it invents so much and profits from its inventions so little. He showed a chart of
fundamental inventions made in Germany, including the light bulb in 1854, the
telephone in 1859, the television in 1930, the maglev train in 1934, the computer
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120 MEETING GLOBAL CHALLENGES
in 1941, and the MP3 in 1987. “Guess what?” he said. “For all of those
technologies and more, revenues are generated by American, Japanese, and
recently Chinese companies. Why is that so?”
Mr. Davidson asked his audience to imagine meeting someone who had
a great idea and wanted to share it with a colleague at a start-up company. “If
you go to an American guy in Silicon Valley, he’d say, ‘Let’s try to do it today.’
If you ask the same question of a developer in Germany, he would say, ‘It can’t
be done.’”
He also offered another set of responses to indicate how different the
cultures in the two countries are. In Germany, he said, a new proposal might be
greeted with the following replies: “I don’t buy it. I just don’t get it. How
boring. I’m too busy.” The same new proposal to a developer in the United
States might elicit this sequence: “I don’t understand it, but it sounds interesting.
Tell me again. I enjoy hearing about your idea; let’s do lunch and talk it over.”
Different Values in the United States and Germany
Mr. Davidson said there were also different sets of values in the two
cultures. In Germany, perfection is valued with an almost religious fervor.
Perfection in Silicon Valley, on the other, is likely to be regarded as time-
consuming and inefficient. Longevity is important in Germany, where an idea
must be assigned to a long-term plan of at least 20 years. In Silicon Valley,
quick wins are important. “While a culture of thinking dominates Germany,” he
said, “Silicon Valley has a culture of just doing.”
In Germany, he went on, “we accept the way things are; we don’t ask
too many questions. In Silicon Valley, we want to try new things every day.” In
Germany, there is great pride in ingenuity and originality, in starting a project
from scratch, he said. In the United States, there is pride in practicality, of
making a project work. He said that Google, when it was first released, was one
of several search engines, with no clear advantage. “They just kept working on it
and doing it better than anyone else. In Germany, we beat on others who try to
do something differently.” He also raised the example of Groupon, a
methodology for group buying. “There’s nothing new about it,” he said, “but to
do it in a better, more efficient way is the culture of the Americans.”
Another distinction Mr. Davidson saw was in the design of products. In
Germany, he said, products are capability driven. “Think of a German car,” he
said. “You have so many buttons, so many features, and 90 percent of them are
not needed. In the United States, products are market driven. Let’s see what the
market wants, and that’s what we’re going to make.” In Germany, he said, the
managers tend to be engineers, and an engineering mindset tends to dominate
corporate decision making and corporate culture. The financial management, he
continued, was sound, but was given more importance than it should have. “In
the United States, managers are business oriented people, and marketing is the
dominant theme of every company: marketing, marketing, marketing.”
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The Motivation of Innovators
He turned to motivation, and the importance of understanding what
motivated people in small and large companies. He showed the results of a
survey of thousands of employees who were asked by an American university to
answer the question “What motivates you to do something?” Over 50 percent of
respondents said that they were motivated when they found something
challenging, when it made them curious, or when the activity seemed fun and
entertaining. Another 40 percent said they would do something if it would help
others, make the world a better place, bring new ideas to life, create unique
events or activities, or increase their status. Of the responses, the fewest said that
their primary motivation was money—both in the United States and Germany.
What pattern do good entrepreneurs follow? Mr. Davidson asked. First,
they don’t do it right the first time. ”Some of the greatest entrepreneurs I’ve met
in my life,” he said, “billionaires today, made so many mistakes before they got
it right. The culture here in Germany is not so tolerant of mistakes. Secondly,
entrepreneurs dream big, and dare to fail. In the United States, we see lots of
young guys, and small companies, and each one of them wants to be a billion-
dollar company. Here, if you take the same guy, just as talented, coming out of a
university with entrepreneurial spirit to start a company, he’ll imagine making a
10 million Euro company, that’s good enough for him. To break even, get a
good salary, go home at five, kiss the wife, and go have beer with friends. They
don’t dream as big.”
Using Courage on Different Paths
To illustrate the gap further, he assumed that “we all have courage—all
those acting as entrepreneurs, early-stage investors, even executives of large
firms. But we use it in different ways.” In the United States, he said, such a
person would arrange to “work first in a factory, build a prototype, take it to
market, talk to friends and potential customers, and make a decision about
whether this is the final product, meanwhile gaining knowledge throughout the
process.” The same person with courage in Germany would “first learn the
subject, read books, do some research, gain a lot of wisdom, then after one or
two years probably go and study the market carefully.” The two entrepreneurs
might finally end up at the same place, he said, but their paths would be quite
different.
“What we [at Hasso Plattner Ventures] are trying to do is to combine
these two cultures into one,” he said. The firm works with a variety of actors:
German companies, many German people with American roots, American
CEOs—and they are trying to meld the international cultures to improve
performance. After five years, the firm has invested in 20 companies, and
several of them are profitable. It has 740 employees, a portfolio of $82 million,
and 5 investors, in the EU and United States. It works in hands-on fashion with
each company. “We work with the entrepreneurs, we have our own technology
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park, a beautiful work place, a young and dynamic management team, and
whatever we do, we do with passion.”
Mr. Davidson closed by recalling when he began to invest in Germany;
he talked with many local entrepreneurs, students, and professors about how to
start companies. “I told them, ‘Whatever you do, do it with passion.’ That was
actually the first word I learned in German, “— litenshot,” he said. “And when I
said “litenshot,” they all looked at me very surprised, because you’re not
supposed to have fun when you’re working. “Litenshot” is my model in life and
in business, and that’s what I’m doing here in Germany.”
TRENDS AND CHALLENGES FOR VENTURE CAPITAL
IN THE UNITED STATES
Arati Prabhakar
Partner
U.S. Venture Partners
Dr. Prabhakar said she would talk about venture capital in the United
States through the lens of one sector—clean energy technologies—“which I am
passionate about.” This is a sector of great entrepreneurial progress and, at the
same time, great risk. She reiterated Ms. Lew’s observation that
entrepreneurship “is all about a culture of celebrating success, but also tolerating
failure; of dreaming big, and daring to fail.” She said that she had been “allowed
to dream big” in Silicon Valley for the last 14 years, and previously in
government for 13 years, in Washington. “I dared to fail, and indeed I did fail,
and they were important experiences for me. Those are the lenses through which
I think about what’s happening in the clean energy sector today.”
The Focus on Energy Security
She gave a sketch of the overall energy system, which she said is really
two energy systems: transportation, driven primarily by petroleum, and
electricity, driven by many sources. There are huge challenges for this system
globally, just as there are in the United States, she said, and it is often forgotten
that not all of those challenges align. In the United States, for example, a major
focus is energy security and energy independence, because so much petroleum is
imported, especially from OPEC nations. Therefore, energy independence and
overall energy strategy begins with reducing dependence on imported oil.
However, Dr. Prabhakar continued, energy independence says little
about coal, of which the United States has vast stores. While this resource
increases energy independence, those who wish to tackle the global warming
and greenhouse gas issues see it as a major source of CO2 and other pollutants.
Natural gas, which is abundant and adds to energy independence, is a “mixed
story,” much cleaner than coal as a source of electricity but also a producer of
carbon, so that it is best viewed as a transition step toward a carbon-free future.
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One point that draws general agreement, she said, is that energy efficiency is
wholly beneficial. “It continues to be staggering to see how much energy is not
constructively used in the system.”
Underlying all considerations for the energy system, she said, is the
importance of cheap, widely available energy as a driver of economic growth.
“Somehow we have to meet the energy challenge of providing supply while
maintaining ‘cheap and available’.”
Innovation will be essential in achieving a clean-tech energy system,
Dr. Prabhakar said, and “fortunately, the good news is that the tech pot is
bubbling. The number of new ideas is astonishing and energizing,” she said,
displaying a long list of current experimental sources: artificial photosynthesis,
wave power, metal-air batteries, compact modular reactors, electrofuels (CO2 to
liquid), flow batteries, algae, LED lighting, and fusion.
The Importance of Capital in Moving Toward Clean Tech
“This is the good news,” she said. “The next question is, what does it
take to get from these innovative ideas to real solutions?” To answer that
question, she turned to the importance of capital in moving toward clean tech,
and there she saw significant barriers. “We have to understand what’s happening
with capital at a deeper level than usual,” she said. “In the R&D community, the
assumption is, ‘We’ll do R&D, and by some miracle capital will be deployed
and this new technology will be commercialized and scaled.’ In fact, that isn’t
really happening.”
Dr. Prabhakar showed a graph based on investment data from the Pew
Charitable Trust on investments in clean energy technology. The investments
were divided into four categories of capital: VC/private equity, public markets,
asset finance,37 and small distributed capacity.38 The last two categories, she
said, are the two most important ways for stimulate deployment of technology.
“They are not about developing new technologies or starting companies,” she
said. “They are about markets and market pull. This whole set of investments
has to equilibrate and work as a system. That means if we don’t have adequate
capital to deploy these technologies, all the R&D investment and VC/private
equity will be no more effective than pushing on a noodle. That’s why I think
this is such an important context.”
The total amount of financing invested in clean energy in 2010 was
about $250 billion, she said, which was “a fairly healthy amount, considering
37
Asset financing is the use of balance sheet assets (accounts receivable, short-term investments,
inventory) to obtain a loan or borrow money. This differs from traditional financing that is raised
through the issue of debt or equity securities.
38
An example of investing in small distributed capacity is Germany’s federal support program for
photovoltaics, dispersed widely in the form of rooftop installations.
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124 MEETING GLOBAL CHALLENGES
that we spend somewhat over a $1 trillion a year on energy infrastructure. The
clean portion of that is now sizeable.”
Dr. Prabhakar turned to a graph illustrating how that investment was
distributed across nations. “For the United States,” she said, “this is a sobering
chart. China is outspending everybody. Germany has now taken second place,
largely through the large investments in photovoltaics. The United States is
third. We are not used to being third.”
The Need for a Private Market in Clean Tech
Even more important was the U.S. energy mix, she said. The U.S.
investments primarily take the form of VC and private equity. When these are
removed, the United States is “dramatically farther behind in what’s left—asset
finance and small distributed capacity.” She pointed to one more level of detail:
whether sources of this capital are public or private. In China, it is often difficult
to differentiate, “but it’s clearly largely publicly driven.” In the case of
Germany, she asked for feedback. In the United States, the Department of
Energy loan guarantee program is substantial, but it depends on public capital.
“How this chart develops will be important over the next few years,” she said,
“in terms of our competitiveness. If the private market for clean tech does not
continue to grow in the United States, these investments creating new push will
shift to other places.”
Turning to the topic of venture capital, Dr. Prabhakar said that clean
tech had grown to 15 percent of total VC, a “notable fraction” worth $3 to $4
billion a year. “A decade ago it was virtually invisible. This is a good sign,” she
said, “especially since most of the rest of venture capital is going into IT, and an
increasing portion is going to companies that don’t have core technology in
them, like digital media and ‘web 2.0.’ Those are building on a big layer of
earlier technology but not new core tech. And clean tech has to compete against
that for investments.”
Recent events are sobering, she said. Firms first entered this area with a
burst of enthusiasm and a sense that trillion-dollar industries were going to be
transformed, with venture capital as an important partner. Then, over the past
few years, a shift occurred in the way VC is approaching clean tech. This was
caused by both the technology and by manufacturing issues. Many early
investments in clean tech focused on photovoltaics, batteries, and other
technologies with “deep materials” components. Gradually, however, the field
“rediscovered” that materials “are a challenging way to make quick returns.” A
firm can often invest in a new material for many years “before knowing if it is
anywhere near the finish line. The amount of capital it can take before an end is
in sight is a daunting prospect for venture,” she said. “They think, ‘That’s the
material of the future.’ But too often the material remains in the future, and there
it stays.”
Even if the materials problem can be solved, Dr. Prabhakar continued,
a factory has to be built, “and once you build a factory, your entire business is
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structured around filling it. That immense capital that has been deployed has to
be used efficiently, and if you’re not shipping at full volume, you’re burning
capital at a painful rate. A factory becomes an anchor around your neck. That’s
something we learned 20 years ago when semiconductors shifted to a fabless
business model and let Taiwan build the foundries.”
Market Restraints for Clean Tech
Dr. Prabhakar also described several significant problems on the
market side. First, VC in the United States is focused on finding markets that
“explode,” with investors hoping for $100 or $200 million in revenue within
four or six years .“Those are the rock stars of entrepreneurship,” she said, “that
make VC an exciting asset category.” But in clean tech, she said, industries
move much more slowly. For many years, the VC industry was reluctant to back
companies in the automotive industry because it moves slowly and faces heavy
pricing pressure. “Now we’re talking about selling to utilities,” she said, “which
make auto companies look fast.” Also, she said, VC firms prefer companies with
products and services so valuable to their customers that they can charge a
premium. That is the opposite of most energy companies, which deliver a
kilowatt-hour or some other form of energy in a market where they have to
compete on cost. “That is another killer,” she said. Finally, she pointed out that
VC was accustomed to industries where government policy is not a factor, or
where a sound R&D base has already been developed with government funding.
With clean tech, where the regulatory picture is not fully known, especially in
the United States, the risks of policy changes are substantial.
The fundamental question about the role of venture capital in clean
tech, she summarized, is whether VC will be a significant force in transforming
the energy system. “Many passionate investors wish for that,” she said, “but I
suspect that it may not be the case.” She cited several reasons. First, even though
a lack of capital is not the problem, the competitive pressures on the VC
industry cause many firms to avoid clean technologies that might require
expensive factories in favor of less capital-intensive business opportunities, such
as energy efficiency or IT-like products that are not manufactured. “I think
that’s healthy,” she said, “because it will allow VC to begin generating venture
returns in clean tech, and that has to happen. On the other hand, it makes it less
likely that venture will play a core role in the overall transformation of the
energy system.”
DISCUSSION
A participant commented that Dr. Prabhakar had presented a “rather
negative view of VC.” She responded that a more positive view for VC would
first require the creation of markets for clean tech. And to unleash enough
private capital to mobilize industries and create markets will take the alignment
of multiple policies. “No single policy, such as a price on carbon, is enough. We
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need renewable portfolio standards and the use of government procurement to
start the ball rolling.”
In addition, she said, there are still barriers in demonstrating and
scaling these technologies and in supporting early production. She agreed with
Dr. Wessner that there are “many valleys of death, in this sense.” A major one is
encountered between the point when a technology is proven and the point when
financing is available for the first commercial plants. “Commercial capital does
not know how to go after that problem,” she said. “Loan guarantees from the
government are needed.”
Dr. Neuhoff asked Mr. Davidson about his challenges in investing in
manufacturing capacity, and whether he had enough capital. Dr. Davidson said
his firm did have sufficient capital. VCs are short-term investors, he said,
“which means we invest long enough to bring the company to the next level
when it can raise money from external, much larger investors or hand over the
company even before it’s profitable. We can initiate this with relatively small
amounts, especially in Germany, because public funds are readily available. It is
more difficult to find the right people to deploy. Many of the best technologies
we see stay within the R&D groups of Fraunhofer, Max Planck, and universities.
Rarely do we find people who are ready to take risk, move out of their comfort
zone, and start a new company. Our biggest constraint is the lack of
entrepreneurs to start companies.”
He suggested that entrepreneurism should be promoted more strongly
by government policy, beginning early during education. “To become an
entrepreneur and to dare to fail is fine, and should be part of the culture, which
it’s not at the moment,” he said. “I see it in the Hasso Plattner Institute, which is
near Hasso Plattner Ventures, in Potsdam. The most talented students in
Germany, such as IT students, would rather start working when they’re 22 or 23
years old at Deutsch Telekom or Daimler Chrysler or Microsoft rather than start
their own company. In the United States, it’s exactly the opposite. Here they are
very old when they are very young because they don’t have the right education.”
