German Startups Group — Specialist German venture capital investor

German Startups Group (GSG) is a Berlin-based venture capital investment company, primarily focused on providing investment to technology related businesses in German-speaking countries. The company was founded in summer 2012 by CEO Christoph Gerlinger, a well-established internet entrepreneur (biography on page 5). Since inception GSG has become one of the most active VC investors in Germany (sources: CB Insights 2015, Pitchbook 2016) and currently has 43 minority investments, including some of Germany’s most successful start-ups such as Delivery Hero, Mister Spex, Scalable Capital and SoundCloud.

While GSG primarily takes minority stakes in its investments, it holds a 50.5% stake in Exozet, a digital media and software company. The decision to make an exception was driven by the potential strategic advantages that could be gained from a majority holding. Exozet is a creative digital agency with strong capabilities in brand development; software development, including creating apps for iOS and Android platforms; and digital marketing campaigns. It has a quality client base including Audi, ZDF and Deutsche Telekom. In GSG’s view, these services can be invaluable to start-ups and can materially enhance the success of its portfolio companies. Concurrently, GSG’s ability to give companies access to these services is a positive distinguishing factor to entrepreneurs.

GSG listed in November 2015, issuing 3.72m new shares at €2.50, raising €9.2m.

GSG provides venture capital with a focus on the following industry segments:

In particular, it looks for companies with products or business models with the potential for disruptive innovation; that are highly scalable; and backed by a strong founder and founder teams, preferably with prior history of start-up success (what it describes as serial entrepreneurs). 23 of GSGs minority investments are in companies where the founder has had such start-up successes.

For entrepreneurs, GSG believes it has a strong investment proposition, which distinguishes it from traditional VCs:

For VC investments, GSG’s strategy is to own a diversified portfolio of minority shareholdings. It does not ‘build’ companies, which requires significant time and resources, and it recognises the limited influence it will have as a small minority shareholder. GSG believes risk is best mitigated through backing entrepreneurs with a track record of previous success and investing alongside other capital providers sharing the same vested interests. Co-investing with others also enables the company to access a larger pool of potential investments and leverage off the niche expertise of co-investors.

GSG targets a return of 20-30% on average invested capital and a net return on equity of 15-20% over time.

GSG currently has 43 active minority investments in its portfolio (as shown in Exhibit 1). Of these, 24 are classified as of ‘particular significance’ in terms of their size and potential, and account for 91% of the total portfolio value. Under the ‘investments not significant to us’ are very early and seed stage investments, which tend to be small in size and less likely to have an impact on the portfolio. Successful ones will move into early and then growth categories. Within GSG’s portfolio are some of the most well-known and successful start-ups in Germany, including Delivery Hero, SoundCloud, Mister Spex, Scalable Capital and Onefootball. The company believes 13 of its investments are ready for exit, although, as it is a minority shareholder with no influence on the companies, the timings of these exits are unknown.

Most of the portfolio, in terms of IFRS fair value, is in the growth or early stages, at 61% and 37%, respectively (Exhibit 3). B2C internet services is the most important segment of the portfolio at 59%, while B2B internet services represent 30% of the portfolio and hardware & others 11% (Exhibit 2).

GSG recently announced 2016 results, which reported a loss of €3.3m (€3.8m profit in 2015) due to several write-downs and an exceptional loss. These are discussed further in the financials section of this report (page 6).

Since the start of 2017, GSG has had a number of profitable transactions.

Two profitable sales were announced in January (Pyreg and realbest) at values representing annual internal rates of return (IRR) of 7% and 27%, respectively. Together, the sales proceeds of €800,000 will help bolster the company’s cash position.

In April, GSG announced several transactions1 including the sale of one of its ‘of particular significance’ category companies, realising proceeds of nearly €1m, representing an exit multiple of 2.5x capital invested, an annual IRR of 60% and capital gains of €550,000. It also made a partial sale in a company in the same category, which will allow it to book capital gains of €60,000 and receive a cash inflow of over €350,000. The remaining shareholding has been written up in value and, in aggregate, these transactions are expected to generate over €700,000 in gains on the income statement (realised and written up).

At the end of the Q117, GSG held investments in 13 companies it deemed ready for exit. It intends to do more sales this year to demonstrate its ability to add value and highlight the hidden value in its portfolio, which, in turn, should help narrow the discount to its NAV. In addition, the sales proceeds would allow it to repay early around €3m of a loan facility granted by major shareholders.

GSG is planning to extend the scope of its business to enable it to generate more recurrent revenues and cash flows. It has identified a gap in the German market for a platform to trade secondary market shares in unlisted companies, noting that this has been successful in other countries (for example SharesPost in the US) and that there is demand for such a service. GSG proposes to do this with partners that have the required regulatory licences and aims to earn commissions from transactions. In addition, GSG has identified potential interest for investors to participate in the growth of individual start-ups within its portfolio. It proposes to issue participation rights for these companies, for which it would earn a carry on the profitability of the rights. Both these proposed new businesses will be subject to approval at the company’s next annual general meeting on 8 June 2017.

Venture capital investment in Europe has significantly lagged the US. In GSG’s view, this represents a structurally underfinanced sector, which creates opportunities. In 2016 venture capital invested in the US was $69bn, while in Europe it was $16bn2 despite Europe’s population size being double that of the US. Meanwhile, GSG’s base in Berlin is establishing itself as the hub for start-up activity in Europe. In 2015, Berlin became the largest VC investment city with €2.3bn invested, exceeding London (€1.9bn invested).3 According to GSG, more than half of all German start-ups are located in Berlin and it believes it is well-placed to leverage its network and brand to attract investment opportunities. Its 2016 pitches from over 900 companies attests to the vibrancy of the start-up community in Berlin and to GSG’s ability to attract opportunities.

German corporate law requires all public companies to have two boards: a management board and a supervisory board. The board of management is executive and responsible for the management of the company. The supervisory board is made of non-executives whose role is to oversee the board of management.

Management board

Supervisory board

The company recently reported a loss for 2016 of €3.3m (€3.8m profit in 2015). The main reasons for the loss were write-downs in the valuations investments of €6.3m (not offset by write-ups of €4.4m) and the booking of an exceptional loss of €1.5m.

The write-downs were largely attributable to four portfolio investments. The most significant was Auctionata, which filed for insolvency in January 2017. GSG’s investment was fully written-down (around €2.5m) and the company bears no further risks with this holding. Following the write-downs in 2016, GSG believes the valuations on its portfolio to be conservative.

The exceptional loss of €1.5m is the write-off of costs associated with a planned capital increase that was aborted last year due to unfavourable market conditions. The company does not want to raise capital at a significant discount to NAV.

Exozet was consolidated for a full year in 2016, which means the income statement is not comparable against 2015 (Exozet was consolidated for only the second half of 2015). This company continues to perform well and generated 17% revenue growth to €10.9m, EBITDA of €1.4m and EBIT of €694,000 in FY16.

Since the start of 2017, the company has had several sales and a number of portfolio company activities are likely to lead to write-ups. GSG announced in May that it returned to profit in Q117, generating a low six-figure net profit and management expects Q217 to also be profitable.

GSG’s balance sheet grew to €40.6m in 2016 (€35.9m in 2015), which largely reflects an increase in long-term investments of around €6.6m. Following the decision to abandon a capital raising during the year, the company arranged a one-year subordinated flexible loan facility from its shareholders of €8m, of which around €6.5m has been drawn down. Under the terms of the facility, half of the drawn funds need to be paid back within one year in order for the remaining €3.25m to be rolled over for a further year. It held cash and cash equivalents of €1.6m. Post year end, this position has improved following the sales of Pyreg, realbest (discussed above) and one other undisclosed company allowing it to repay early around €3m of its facility and reduce interest expenses. The cash position can be expected to improve further as other announced transactions complete.

Management is unlikely to raise capital for the foreseeable future as its current strategy is to realise portfolio gains through sales in preference to making new investments. Furthermore, it is reluctant to sell shares at current price levels, which it believes are at a significant discount to NAV. The company recently received interest from a potential buyer of its shares at €2.40, which is below the 2016 IFRS NAV of €2.45 per share. This was rejected by its major shareholders, which believe the NAV to be materially higher.

As at end 2016 the IFRS net asset value of the company was €29.5m (€30.5m in 2015), including goodwill and intangibles. The shares are trading at a 24% discount to NAV. However, the current NAV and discount are likely understated for the following reasons:

Earnings multiples and absolute earnings levels in any given year are less useful in assessing valuation given the volatile nature of VC investing. Shareholder value is created over time as underlying company growth and profitable realisations boost NAV.