Investment behavior of German Single Family Offices and Foundations towards Venture Capital with a focus on the life sciences sector

A qualitative analysis

Master's Thesis, 2018

119 Pages, Grade: 1,7


Table of contents

List of figures

List of tables

List of attachments

List of abbreviations

1.1 Background
1.2 Problem Statement
1.3 Purpose and Objective
1.4 Research Question
1.5 Delimitation
1.6 Thesis Structure

2.1 Family Office
2.2 Life Sciences Sector
2.3 Venture Capital

3 background AND Literature OVERVIEW
3.1 Financing of Life Sciences Start-ups
3.1.1 Life sciences – a challenging sector
3.1.2 Financing Models
3.1.3 Active VC investors
3.1.4 Financing Landscape in Germany
3.1.5 Entrepreneurial Ecosystem
3.2 Investment behavior of LPs – a literature review
3.3 Strategic Influence of Investment Companies
3.3.1 Agency Theory
3.3.2 Specialization and Success

4 Methodology
4.1 Research Design
4.2 Data Collection
4.2.1 Sample
4.2.2 Semi-structured Interviews
4.3 Inductive Analysis
4.4 Limitations of the Methodology
4.4.1 Validity
4.4.2 Reliability

5 results and analysis
5.1 Summary of the Inductive Analysis
5.2 Analysis of the Investment Behavior
5.2.1 Framework Conditions
5.2.2 Allocation
5.2.3 Motivation
5.2.4 Criteria
5.2.5 Risk
5.2.6 Entrepreneurial Ecosystem
5.2.7 Governance

6 Discussion
6.1 Investment Behavior of SFOs and Foundations and its Implications for Life Sciences VC Investments
6.2 Classification of the Investment Behavior Categories

7 Summary and conclusions
7.1 Summary of Results
7.2 Theoretical Implications



List of figures

Figure 1: Schematic of the Thesis Structure

Figure 2: Degree of involvement and funding provided by individual types of investors

Figure 3: Entrepreneurial ecosystem model

Figure 4: The role of VCs within the relationship between LPs and EVs

Figure 5: Investment process utilized by LPs

Figure 6: Development of decision-making power for different types of LPs

Figure 7: Question formulation process for an interview guide

Figure 8: Extended investment process framework for SFOs

Figure 9: Extended investment process framework for foundations

List of tables

Table 1: Differentiating characteristics of VC and PE

Table 2: Profile of information asymmetry according to Küpper (2008) for the principal agency theory

Table 3: Interview sample

Table 4: Summary of the central categories and sub categories

Table 5: Investment behavior #1 Framework Conditions

Table 6: Investment behavior #2 Allocation

Table 7: Investment behavior #3 Motivation

Table 8: Investment behavior #4 Criteria

Table 9: Investment behavior #5 Risk

Table 10: Investment behavior #6 Entrepreneurial Ecosystem

Table 11: Investment behavior #7 Governance

List of attachments

Appendix A: Standardized Inquiry E-Mail

Appendix B: Interview Guideline

Appendix C: Interview Protocols

List of abbreviations

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1.1 Background

The life sciences industry is one of the high technology sectors in Germany. As such it is a driving innovation force which creates economic growth, jobs but also entire new industries. Besides the economic impact it has a high relevance for society and contributes to solving the major challenges of the 21st century, especially in the fields of nutrition, the environment and medicine. To meet these challenges, life sciences companies rely heavily on research and innovation activities in order to keep pace with the required rapid technical progress. With new trends such as the digitization of the life sciences industry to a more data driven, patient centric approach and old structures breaking up, the necessity of above-mentioned activities have increased even more.1 In contrast, there is a high demand for capital in order not to lose Germany's competitive position through financing bottlenecks that can hinder the innovation process as a whole. While life sciences research in Germany is being conducted at the leading edge, young companies encounter funding scarcity in the after-seed phases where pubic grants cannot cover the accrued costs for further growth. In such cases Venture Capital (VC) is able to fill the gap and provide fresh capital. VC is a relatively young method of financing which has only gained importance in Germany since the middle of the last decade. Since then, VC has become the most important type of financing for young, innovative companies especially in the life sciences sector.2 According to Bundesverband Deutscher Kapitalbeteiligungsgesellschaften (BVK) EUR 1.82 billion was invested in the German life sciences sector in 2017, of which EUR 181 million was VC. In sum this accounts for 17 percent of the total investment volume. While across all industries VC investments into German companies increased between 2010 and 2017 with a CAGR of 5.39 percent, investments in the life sciences sector evolved in the opposite direction with a CAGR of -5.59 percent.3

1.2 Problem Statement

VC plays a fundamental role in the financing landscape of young life sciences companies. Hence its availability is a crucial catalyst which can either promote or inhibit the whole development of an industry branch. VC funds are financial intermediaries which raise capital from either institutional or private investors to invest it further into the economy in the form of start-up financing. While there are young, capital-seeking life sciences companies on the demand side, VC funds with their investment capital stand opposite on the supply side. The investment decision process and relationship between the Venture Capitalists (VCs) and the entrepreneurs are well covered research subjects e.g. Fried/Hisrich (1994); Mason/Harrison (2004); Gupta/Sapienza (1992), whereas the decision process and interaction between VC investors or limited partners (LPs) and VCs or general partners (GPs) are left on the sidelines4 ;5 ;6. Looking at the entire VC supply chain, research has so far almost omitted the supply side topic of the investment decision process of institutional or private investors towards VC. BARNES/MENZIES (2005) identified that VC firms do not sit at the beginning of the capital supply chain and instead act as intermediaries who provide an interface between LPs who provide capital and entrepreneurs who utilize such capital in an attempt to create successful new ventures.7 For this reason, they have conducted an exploratory study to understand the decision processes and criteria utilized by LPs in the selection of the VC funds. With regard to this work, the study provides a useful point of orientation but leaves out foundations and family offices which represent an important group of German LPs. In addition, the study was conducted at European level without focusing on any particular industry. Another relevant exploratory study by Fried/Hisrich (1989) examined the attitude of US LPs to investing in VC funds and their role after investing in the fund.8

1.3 Purpose and Objective

Building up on the study by Barnes/Menzies (2005) and Fried/Hisrich (1989), the aim of this thesis is to analyze the investment behavior of German LPs in the form of single family offices (SFOs) and foundations vis-à-vis VC. The objective is to fill a gap in the research on the supply side of VC, specifically in the life sciences sector, through qualitative interviews with a group of institutional and private investors which have been subject to little research to date. Finally, a framework will be developed which seeks to portray the main findings and bridge to applicable economic theories.

1.4 Research Question

This research seeks to complement to previous studies by focusing on the German equity market and the life sciences sector with the following research questions: RQ 1: What are the main investment criteria of German foundations and private investors in the form of SFOs which lead to the investment decision vis-à-vis VC?

RQ 2: What are the predominant barriers and risks which deter German private investors and foundations from life science venturing?

1.5 Delimitation

This study focuses exclusively on the investment behavior vis-à-vis VC of German SFOs as private investors and foundations as institutional investors. In a second stage this work is investigating the investors’ risk associated determinants of VC investments, specifically for life science venture investments. Thus, the findings cannot be considered to represent the population outside the German equity market and is neglecting other VC investor groups e.g. banks, insurances or pension funds. Also, due to the small sample of the study, the collected data might not apply fully for other market participants. Further this work has an explorative, qualitative research approach and does not quantify the investors’ investment behavior by any means.

1.6 Thesis Structure

An overview of the thesis structure can be seen to acknowledge that this figure is simplified in order to present an overview.

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Figure 1: Schematic of the Thesis Structure9


The following definitions can be helpful in understanding the vocabulary of the upcoming chapters.

2.1 Family Office

The term “family office” is not defined by law. The Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) understands this as companies, irrespective of their legal form, which deal with the bank-independent management of large private assets.10 Single family offices (SFOs) manage the assets of one or more members of a single family, while multi family offices (MFOs) do the same for several families or high net worth individuals (HNWI).

2.2 Life Sciences Sector

Life sciences is a broad term with no fixed definition and used interchangeably with terms like biosciences, biopharma, biotech and healthcare. In this study the life sciences sector definition of STÖCKEMANN (2016) is applied: “The life science[s] sector is roughly divided into three clusters [...] Pharma/Biotech, Diagnos-tics/MedTech and Digital Health, which combines parts from the first two sectors with new digital technologies to create innovative business models.“11

2.3 Venture Capital

While in Germany Private Equity (PE) and Venture Capital are often used as synonyms, in the US a distinction is made between early-stage financing (VC) and late-stage financing (PE).12 Further characteristics of the respective financing methods are shown in table 1. In this thesis the main definition follows the subdivision between late- and early-stage financing.

Table 1: Differentiating characteristics of VC and PE13

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3 background AND Literature OVERVIEW

3.1 Financing of Life Sciences Start-ups

Germany currently has a flourishing start-up landscape that plays an important role in the competitiveness of its economy. Most of these young companies are still traditionally financed from the founders' own resources and their closest environment. However, if capital requirements were high from the outset, as is the case with technology-oriented start-ups especially in the life sciences sector, business angels and VC investment companies play a decisive role, as these companies generally do not have the collateral for classical loan financing. This chapter will highlight the special and challenging conditions of the life sciences sector regarding venture financing. In the further course different financing models and the German financing landscape with the key active investors will be introduced to finally build a bridge to existing research.

3.1.1 Life sciences – a challenging sector

The life sciences sector is facing a tremendous change which is driven by several forces such as the digitization and the resulting disruption of established business models, the demographic change or the emergence of new competitors. This paves the way for future start-ups which can play a significant role in key areas like immunotherapeutic gene therapy, regenerative medicine or oncology. While oncology remains as the most important growth market, the demand for healthcare services are gaining in importance.14 Another challenge is the increasing unwillingness of financiers to fund discovery or early stages of clinical development phases. The start-ups which suffer most from this circumstance are those who are in a critical development phase to get a proof-of-concept. At the same time proof-of-concept constitutes the most important decision factor for a successful investment decision. This in fact has to do with the risks associated with life sciences projects in general – particularly pharma or biotech projects. For example, a drug in the biotech industry takes an average of 15 years from research to market launch, while the chances of success are rather low with a failure rate of 95 percent.15 According to the German Biotechnology Report 2015, more and more start-ups in the field of high-risk drug development today come from spin-offs of existing commercial companies or from incubators in the transition area between academia and industry. However, in Germany the predominant share of new start-ups continues to come from the academic environment in the immediate vicinity of established clusters in the Munich region, followed by the Rhine-Neckar region, the Rhineland region and Berlin.16

Not to be neglected is the emerging field of digital health in the life sciences sector which developed through the merger of the life sciences with other areas such as information technology. Digitization of clinical trials or therapies, health trackers, virtual doctor consultations are just a few potential use cases of this irreversible progress.17 Digital health will push the life sciences market to a consumer-driven market with new business models which enables potential investors to diversify their risk portfolio. At the same time, established companies will face increased competition from new, emerging ventures that can adapt more quickly to these changing market conditions, which in turn will lead to innovation pressure on the former. This will be mutually reinforcing as long as there is sufficient funding for new ventures.

Overall, the financing situation in Germany for life science start-ups, especially for companies from the medical technology and red biotechnology sectors, has improved. In the timespan from 1999 to 2016 VC investments into the German biotech sector grew with a factor of 1.9. However, when comparing this development with the USA, there are still dimensions lying between these two countries in the biotech sector. Within the same time period the US biotech VC investment volume grew with a factor of 8.9 making it 49 times larger than the German one.18 It can be argued that the US VC market is further developed and thus a few steps ahead of the German VC market but on closer examination the gap between these countries has even widened over time. The VC gap could also be demand driven meaning that there is a scarcity of fundable ventures and therefore there might not be a real financing gap. The development of VC investment volume in the biotech sector essentially reflects the development of VC investments in the life sciences sector as BVK but also European Private Equity & Venture Capital Association (EVCA) data suggest.19 ;20

According to BECKER/VILLINGER (2017) follow-up investments are the major problem in the life sciences, as there are too few specialized funds on the market. However, the so-called “Valley of Death” does not pose a problem for all life science start-ups. Young companies that follow current trends such as digital health or offer services in the healthcare or in biotechnology sector have it easier due to their business model. Also, platform technologies have a comparative advantage. Despite the necessary studies and high risks, diagnostics companies are considered attractive investments. According to the German Biotechnology Report 2015, the large double-digit million euro rounds in 2014 were occupied by diagnostics companies. Investors are particularly interested in innovative technologies with market-relevant applications, which not only lie in the life science sector but also in interfaces to digital health.21

The last life sciences initial public offerings (IPOs) on a German stock exchange took place with BRAIN AG in 2016 and WILEX (now Heidelberg Pharma) in 2006. Regardless of this development, German stock exchanges have so far not been attractive enough for life sciences companies. Meanwhile, there is a lack of competent analysts who are able to assess and recommend newcomers to the stock market on a sound basis.22 For this reason, IPOs in this sector take place particularly on the American NASDAQ and on the Euronext in Europe or in on the SIX Swiss Exchange in Switzerland. Only a few German life science start-ups found their way there: e.g. Curetis AG went public in Amsterdam on the Euronext stock exchange and Pieris, Inc. on the NASDAQ in the US.

3.1.2 Financing Models

“Starting and growing a new business […] consumes a considerable volume of financial resources.”23 This applies all the more to life science start-ups, which are usually known as resource-intensive businesses as they have high R&D expenditures and patent costs and a long time to market. Lack of financial resources is one of the major problems which these companies face.24 For each development phase of a start-up company specific financing models with different kinds of investors are existing. Depending on the type and amount of financing, this also involves different concessions such as relinquishing some of the company’s influence in favor of the involvement of outside investors as can be seen in figure 2. At the beginning in the pre-seed or seed phases financing comes usually from one’s own savings or the “three F’s” (family, friends and fools) but also

Abbildung in dieser Leseprobe nicht enthalten

Figure 2: Degree of involvement and funding provided by individual types of investors25

from government grants like EXIST26 or grants from other government funded research institutions like the Helmholtz Validation Fund (HVF)27 from the Helmholtz Society in Germany. In the further course angel investors, early-stage VCs and banks are able to provide necessary capital. In later stages of the development strategic alliances with corporate investors are crucial cornerstones for future success, as are deals with late stage VCs.28 At the end of the financing chain, there is usually the exit option in form of an IPO, a trade sale or a management buyout (MBO).

3.1.3 Active VC investors

In this section selected German investment companies will be examined with regard to their investment strategy. The selection of investors aims to give an approximate picture of VCs in the German life sciences sector. The member list of the BVK served as the basis for the selection, whereby after a further research step the list was narrowed down to the recent most active investors or co-investors in the German life sciences sector.

High-Tech Gründerfonds 29

The High-Tech Gründerfonds (HTGF) invests in high-tech companies with growth potential in the fields of automation, optical technologies, energy and cleantech, life sciences, media and information technology. The HTGF focuses exclusively on investments in the seed phase and deliberately takes higher risks than private investors. Investors in the public-private partnership include the Federal Ministry of Economics (BMWi) and Energy, KfW, Fraunhofer Society and 18 industrial companies. With a total volume of EUR 892.5 million spread over three funds (EUR 272 million Fund I, EUR 304 million Fund II, EUR 316.5 million Fund III) and an international partner network, the HTGF has already formed over 500 start-ups into companies since 2005. The investment volume amounts to up to 1 million euros in the seed round, with a total financing volume of up to 3 million euros per company.

According to crunchbase, HTGF is the most active VC investor in Germany with 48 investments in the last two years of which 10 were life sciences investments. Portfolio companies worth mentioning are NUMAFERM, Cardior Pharmaceuticals, heartbeat medical solutions and TolerogenixX.30

Peppermint Venture Partners 31

PVP is a private VC investor based in Berlin, investing in early-stage healthcare companies across Europe with a focus on medical device, digital health, and platform technology companies. As part of a cooperation with the university clinic Charité in Berlin, PVP has managed a fund volume of around EUR 50 million under the name of Peppermint Charité Biomedical Fund (CBF 1) since 2010. In addition to managing the CBF, PVP has the mandate for the external management of the in 2011 established HVF on behalf of the Helmholtz Association. Through these cooperations PVP has privileged access to the respective research networks. PVP invests up to a maximum of EUR 3 million per company. However, through active syndication, it is possible to achieve financing rounds of more than EUR 10 million. The current fund currently comprises eight companies: Emperra, Implandata, Caterna Vision, Labfolder, Cevec, Cryotherapeutics and Miracor, representing a broad spectrum of the life sciences sector.

SHS Gesellschaft für Beteiligungsmanagement mbH 32

SHS is an independent investment company founded in 1993 in Heidelberg with a focus on investments in the medical technology and life science sectors. Currently SHS manages its fourth fund (SHS IV), which has more than doubled to EUR 125 million compared to the third fund. The strategy of SHS aims to develop young companies from the life science sector with market-ready products and technologies to market leaders while generating high, stable returns for their investors. In this respect, SHS does not see itself as a technology scout, but as the developer of its portfolio companies. SHS invests up to a maximum of EUR 20 million and as a co-investment up to EUR 50 million with per company.

The current portfolio consists of 23 life sciences companies e.g. Biosolutions, Miracor (co-investment with PVP) and AMW GmbH, which was recently acquired by Yunfeng Capital, the PE company of Alibaba co-founder Jack Ma and Target Media founder David Yu.33

Wellington Partners 34

Wellington Partners is one of leading VC firms in Europe and is investing in early- and growth-stage life sciences companies which are active in the fields of therapeutics, medical technology, diagnostics, digital health and industrial biotechnology. Wellington proactively source deals and lead or co-lead financing rounds which will typically range from EUR 1 million to EUR 10 million or higher. Currently they manage two funds (WP III and WP IV) and have more than EUR 200 million assets under management. 4SC, AYOXXA Biosystems, ImevaX and iOmx are a few of Wellington’s active German life sciences investments.

NRW.Bank 35

As the development bank of the state of North Rhine-Westphalia, NRW.BANK, headquartered in Düsseldorf, invests growth capital in small and medium-sized enterprises through several PE and VC funds as part of its corporate financing activities. The investments are made as direct and fund investments in the seed, start-up, early and later stage phases as well as in buyouts and spin-offs. With the EUR 100 million NRW.Bank.Venture Fund 3, NRW.Bank can invest up to 49 percent in a start-up company. Further, NRW.BANK can invest EUR 100 million in external VC funds managed by third parties. In addition to established medium-sized industrial sectors, the investment focus is also on high-tech companies from the IT, software, media, life sciences and cleantech sectors.

The majority of the present life sciences portfolio companies have emerged from co-investments with other established German life sciences VC investors. For instance, in 2015 together with PVP, NRW.Bank participated in a EUR 4.5 million worth venture round of Cevec Pharmaceuticals.36

IBB Beteiligungsgesellschaft 37

IBB Beteiligungsgesellschaft (IBB Bet) was founded in 1997 on the initiative of the Investitionsbank Berlin (IBB) and the state of Berlin as a wholly owned subsidiary of IBB. Two funds are currently in the investment phase: Tech Fund II with a volume of EUR 60 million and Kreativ Fund II with EUR 40 million. The IBB and the State of Berlin each make half of the funds from the European Regional Development Fund available to the European Union. As a classic early-stage investor, IBB Bet's initial investments are typically seed or series A financing. IBB Bet invest in innovative technologies and business models in four industry sectors: information and communications technology (ICT), life sciences, creative industries and industrial technologies. In addition to a stake in Humedics, IBB Bet is currently invested in the life sciences companies Selfapy and Media4Care.

In summary, a heterogeneous number of investors is active in the life sciences sector in Germany. There are VC investors such as IBB Bet, NRW.Bank or the HTGF which use state funds to promote young technology companies. Also there are private VC companies such as PVP, SHS or Wellington which rely primarily on their industry expertise and their network in the life sciences landscape. It is also possible to distinguish between regional or national investors and international VCs such as Wellington.

3.1.4 Financing Landscape in Germany

In Germany, various parties play a role in the venture financing of life sciences companies. Traditional VCs, public-private or public (seed) funds, corporates, business angels and other entrepreneurial private investors, but also crowd investors represent an important source of funding for those companies. In addition to the actual financing landscape, different initiatives and programs make a decisive contribution to the development of the venture financing ecosystem. This section is intended to provide an insight into the given German financing landscape for life science-startups.

Traditional private VCs from Germany play a minor role for start-ups in the life sciences sector. Consequently, it is complained that there are not enough specialized private funds in Germany and that their investment activities are too small. Private VCs from abroad are therefore increasingly take on a greater role, because they ensure that big rounds of follow-up financing are possible in the first place.38 Public or private-public funds like NRW.Bank, KfW, IBB Bet or HTGF are further important supports for financing the highly risky start-ups in the life sciences and developing them to such an extent that they are attractive enough for private VCs. Since 2015 KfW has also been helping to close the supply gap in follow-up and growth financing for young innovative enterprises. Together with the BMWi, KfW has launched the promotional instrument “ERP Venture Capital-Fonds-investments”. This means that KfW does not invest directly but through selected VC funds from Germany and Europe in young German technology companies. In this way KfW can draw on the expertise of VC funds in the market and at the same time mobilize private capital as a state promotional bank.39

Beyond that German research institutions such as Fraunhofer Society or Helmholtz Association also finance German life sciences start-ups in the seed phase through their venture units or programs. In addition, strategic alliances between life sciences companies and pharmaceutical companies are increasingly being formed as part of co-financing.40 Another group of investors who have a vital role in Germany are business angels and other HNWIs who are increasingly interested in investing in VC as an asset class due to a lack of other investment opportunities. In many cases, they participate in the young companies even before the actual VCs and are often also involved operationally through advisory board mandates and establish important contacts to other investors, customers or other stakeholders.

Since 2011 crowd investing has established itself as a new alternative to financing start-ups. Crowd investing allows that any private individual is able to invest in early-stage companies such as life sciences start-ups and therefore is receiving shares in return. Investors become shareholders of the start-up and benefit from the profits or an exit. According to the crowd investing market report 2016 crowd investments into start-up companies has multiplied by a factor of 40 to a volume of EUR 18.75 million in the period from 2011 to 2016.41 For a long time it was problematic that the legal framework for crowdfunding in Germany was not regulated in detail but with the levelling of the small investors protection act in July 2015 the legal conditions for crowd investing were also created.42 The largest providers of crowd investing platforms in Germany are Seedmatch and Companisto. In Europe and the USA, there are also a number of specialized life sciences crowd investing platforms. In Germany, Aescuvest should be mentioned here.

Besides equity financing options, start-ups or founders of life sciences companies in Germany have a number of options to apply for non-repayable funding from the federal government, federal states or the European Union (EU). At the federal level start-ups from the life sciences sector can apply for EXIST grants as well as for programs such as GO-Bio43 or BioChance44. Also, life sciences ventures can take help from incubators which provide facilities and infrastructure, consultation, coaching and other services or often even capital in return for shares or specific rights. There are two life sciences incubator programs in Germany: The first one is Inkulab45, which addresses researchers or graduate students in their pre-founding or founding phase and offers free laboratory workstations but also prepares the team for the foundation of the start-up company. The second one is Life Science Inkubator46 (LSI) that welcomes founders to work on their idea within their research institute. The project and personnel costs will be fully covered during this period, while at the same time LSI employees will ensure a sustainable IP strategy and sustainable follow-up financing.

Accelerators often provide the same services as an incubator but only for a predefined period of time. These programs support their participants with their infrastructure, network and consultations. Start-ups from the life sciences also benefit from the programs in that they act as a door opener for further investors. An accelerator which aids in such a way is for example German Accelerator Life Sciences (GALS). GALS helps German life sciences start-ups with their US market entry and connects them potential partners in industry and academia, key opinion leaders, investors, experts in legal and regulatory affairs, and other essential resources. In addition to the state funding instruments, several German life science companies such as Bayer or Merck also operate their own accelerator programs.

3.1.5 Entrepreneurial Ecosystem

The emergence of innovation and entrepreneurship is a wide discussed research topic and is often associated with the thematic of the entrepreneurial ecosystem (EE). The theory of the EE has emerged in recent years through the combination of entrepreneurship studies, economic geography, urban economics, economics of entrepreneurship (WELTER (2011), ZAHRA et al. (2014), AUTIO et al., (2014)) and has its fundamentals in the movement against the Schumpeterian conception of the innovation creation process. The concept of EE focuses on the external business environment and differs from similar approaches such as the industrial area, cluster or innovation system approach by moving the entrepreneur instead of the company into the forefront.47 IANSITI/LEVIEN (2004) see the EE from a geographic perspective which “focus on the culture, institutions and network that build up within a region over time rather than the emergence of order within global markets.”48 While classical models view knowledge as a spillover product of universities and research institutions, which can ultimately be commercialized externally, the EE concept sees knowledge, especially “entrepreneurial knowledge” as a shareable good between entrepreneurs.49 According to FELDMAN (2014) the EE approach views the entrepreneur as a “leader” in the creation of the ecosystem.50 As a leader the entrepreneur is the main protagonist in sustaining this ecosystem while the state or other institutions are mainly acting as financial supporters.51 For a successful EE, FELD (2012) mentions the importance of the interaction between the different players and the unhindered access to relevant human, financial and service resources in combination with an enabling role of the government.52 Additionally, supportive policies or laws which cover tax or investment topics should be present. All in all, a flourishing EE requires a deeply interlinked landscape of entrepreneurs and start-ups conjointly with committed investors, advisors, mentors and supporters.53 Research on EE is still in the early days but has already successfully shown how a thriving EE promotes entrepreneurship and value creation at a regional level e.g. FRITSCH (2013); TSVETKOVA (2015). In accordance with current research STAM/SPIGEL (2016) have introduced an extended model to the EE theory (see figure 3). The model consists of four layers and illustrates the interaction of the different elements in the ecosystem and between the different layers. While “upward causation” is the result of the interplay of systemic and framework conditions resulting in entrepreneurial activity as an output and ultimately value creation as an outcome, “downward causation” shows the reinforced feedback of the latter ones back to the system.

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Figure 3: Entrepreneurial ecosystem model54

The framework conditions comprise “social […] and physical conditions enabling or constraining human interaction” and an “exogenous demand for new goods and services”.55 Systemic conditions are the main drivers of the EE and their presence and interaction are crucial to its success. Here networks mean the effective flow of information between entrepreneurs which entails the efficient allocation of knowledge, financial and human capital. Leadership as a systemic condition implies the provision of role models for the EE which according to STAM/SPIGEL (2016) also involves a set of “visible” regional committed entrepreneurial leaders. Besides entrepreneurial leaders, talent and knowledge are one of the most important elements of an effective EE.56 Knowledge can effectively be found in public or private organizations according to AUDRETSCH/LEHMANN (2005).57 Lastly a profound supply of financing coupled with the presence support services can lower the entry barriers for entrepreneurial activities.58

3.2 Investment behavior of LPs – a literature review

“The creation of entrepreneurial ventures (EVs) is critically dependent on a supply of VC finance.”59 GOMPERS/LERNER (1999) define supply of VC finance as the

Figure 4: The role of VCs within the relationship between LPs and EVs60

desire of the entrepreneurs to attract VC investments into their firms.61 In this context VC firms act as an intermediary which filter information for the LPs to decrease agency costs in the form of adverse selection and moral hazard while providing access to exclusive investment opportunities.62 As BARNES/MENZIES (2005) stated, VC firms do not sit at the beginning of this VC supply chain but instead “provide an interface between LPs who provide capital […] and entrepreneurs who utilize such capital in an attempt to create successful new ventures”.63 Successful VCs decrease agency costs and identify, select and monitor EVs and ultimately distribute the returns to the LPs. In cases where the hurdle rate was exceeded, VCs receive a carried interest as a premium, which lies traditionally in the 20 percent range of the fund volume (see figure 4). While the decision-making process of VCs has been a popular topic within the literature e.g. Fried/Hisrich (1994), Mason/Harrison (2004); Gupta/Sapienza (1992), the decision process and investment behavior of LPs has been subject to little research so far. Since most VCs select their ventures based on a very detailed list of criteria and follow a strict decision-making process, this is also suspected for LPs.64 According to GOMPERS/LERNER (1999) past fund performance is one of the most important determinants of whether a VC is able to raise new funds, or to put it in another way, is one of the main criteria LPs consider when choosing a VC fund. Also, reputation in the form of firm age and fund size influence the investment behavior of LPs towards a VC fund positively.65

As already assumed from the findings of FRIED/HISRICH (1994), BARNES/MENZIES (2005) found that LPs use a structured approach to identify and select VC funds that reflects the approach used by VC funds to qualify potential

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Figure 5: Investment process utilized by LPs66

portfolio companies. LPs use a two-step decision process by first deciding whether to allocate their capital to the asset class of VC. If the allocation decision towards VC is positive, LPs identify and evaluate individual VC funds in a second step. Besides following a multi-step approach before entering into a limited partnership agreement, LPs rely heavily on consensus building within the investment team which is referred as “ratification” in the model of BARNES/MENZIES (2005) (see figure 5). LPs “examine broad and often intangible indicators of VC reputation to assess future performance”.67 For this this reason, LPs are tempted to invest in VC funds in which they have already invested in the past. This behavior allows LPs to use shortcuts in their investment decision process and to rely on their past due diligence and the trust they have built up with the VC. According to KOLLMANN/KUCKERTZ/MIDDELBERG (2014) trust and perceived controllability are the most important factors besides the VC funds’ track record. This circumstance supports the described investment behavior, since investing in an already known fund suggests a feeling of controllability and trust for the LPs.68,69

Abbildung in dieser Leseprobe nicht enthalten

Figure 6: Development of decision-making power for different types of LPs70

Additionally, they could show that the decision-making power of the LPs are not uniform between the different types of investors classified by their source of capital. “Balance sheet investors” manage internal institutional capital only and have the lowest decision-making power, while “specialist investors” who only manage external third-party capital sit on the other end of the influence scale. In between are “hybrid investors” who manage both, internal and external capital (figure 6).71

3.3 Strategic Influence of Investment Companies

Investment companies such as VC firms have developed to important financial intermediaries by providing capital to firms that might otherwise have difficulty attracting financing.72 According to GOMPERS/LERNER (2002) 90 percent of all start-up companies without VC backing are doomed to fail.73 By undertaking measures such as obtaining alternative sources of equity financing, monitoring financial and operating performance, serving as a board member and formulating the business strategy VCs try to increase the probability of success of these start-ups.74 Therefore VCs are not only seen as a source of capital for the young companies but more as a “smart money” investor. VCs have strategic influence on their portfolio companies by contributing with their know-how, network and general infrastructure.75 In addition, the function of valuation and selection are essential aspects of a VC involvement.76 VCs can undertake strategic initiatives by changing the management personnel to ensure the entrepreneurial success of an investment or by implementing contractual clauses to gain the necessary access to internal information within the portfolio company and to have a say in important strategic decisions.

The strategic involvement of a VC company is measured by the intensity of support according to MACMILLAN/KULOW/KHOYLIAN (1989). VCs can be categorized in three different distinct involvement levels. “Laissez faire involvement” has the least influence on the part of the investors. The founders and the management team are in charge of the operative business and are influenced little or not at all by the investors. In the case of “moderate involvement”, the management team of the portfolio company receives targeted support on strategic issues. The “close tracker” involvement is the most pronounced form of influence. The VC company interferes more in strategic decisions than the founders themselves.77 In practice, VC companies often have “moderate” or “close tracker involvement”. Strategic influence is exerted in order to sustainably increase the value of the company, which can however lead to increased agency problems.78

3.3.1 Agency Theory

Agency problems are a consequence of incomplete contracts between a principal and an agent who acts on the latter’s behalf. According to PRATT/ZECKHAUSER (1985) there are two primary informational problems within the principal-agent framework which are known as “hidden information” or “asymmetric information” and “hidden action” or “moral hazard”.79 KÜPPER (2008) extends this model by introducing two additional information asymmetry problems: “hidden characteristics” and “hidden intention” (see table 2).80 Hidden information problems arise when an agent is privy to something the client does not know about. The agent is then able to exploit this information advantage to his benefit, which is not in the best interest of the principal. Hidden action occurs in situations where the principal cannot observe the agent’s actions. If the agent is not appropriately incentivized by the principal, the agent could take measures at the principal’s expense that only benefit himself. Both hidden information and hidden action describe the information asymmetries after conclusion of the contract (ex post) and

Table 2: Profile of information asymmetry according to Küpper (2008) for the principal agency theory81

Abbildung in dieser Leseprobe nicht enthalten

ultimately can result in moral hazard problems. The agency problem of hidden characteristics exists before the contract conclusion (ex ante). A principal is in danger to opt for an unideal agent because it is difficult for the principal to judge whether the agent has the necessary characteristics to fulfill the contract. This risk is also associated with the term “adverse selection”. In the case of hidden intention, the principal does not know ex ante how the agent will behave in the course of the contractual relationship and which motives he is pursuing. In contrast to hidden action or hidden information, the agent's actions do not remain hidden from the principal but are revealed ex post. If the principal has made irreversible specific investments, he becomes dependent because he is no longer in a position to persuade the agent to act in accordance with his interest ex post. This results in the danger of hold up.

In the context of VC, agency problems exist in the relationship between the GPs, who manage the VC fund (agent) and the LPs (principal) who invest their capital in these funds or between the GPs (principal) and the investment seeking entrepreneurs (agent) with their ventures. The entrepreneur might have more information about the prospects of the venture, technology or management skills than the VC investor. Consequently, it is in the best interest of the entrepreneur to emphasize the positive aspects of the company while leaving out the bad information in order to achieve the highest possible valuation by the investors. Additionally, hidden action problems can arise during the normal course of business of the company when the investor is unable to directly observe the entrepreneurs level of effort. In the interaction between LPs and GPs similar problems occur. To mitigate this, the organizational structure of a limited partnership has become the first-choice vehicle for most of the active VC companies.82

SAHLMAN (1990) notes that both, the contracts between the GPs and the LPs and between the GPs and the entrepreneurs share certain characteristics83:

- dividing the commitment of capital in different stages with the option to abandon- using compensation schemes directly linked to value creation- maintaining the ability to force the management to distribute investment proceeds

Depending on the information assumptions, the contractual structure can change drastically. GOMPERS/LERNER (1999) therefore introduced four different principal-agent models to describe the underlying limited partnership contracts and key compensation schemes in VC. The learning model assumes symmetric information distribution in which neither the LPs nor the GPs know about the GPs’ abilities while the signaling model considers an asymmetric information level between those two parties when raising an initial fund. On the other hand, the costly contracting model describes that negotiating contracts between GPs and LPs constitutes a costly process, but renegotiating contracts is also not an affordable option. The fourth model is represented by the supply demand model. The presumption of this theory is that the supply of experienced VCs is relatively limited in the short term because VC fundraising generally takes place every three to five years after the initial fund has been fully invested.84

3.3.2 Specialization and Success

The choice of a specific organizational structure does not only affect the level of agency problems but also the behavior and performance of the organization. Referring to this, GOMPERS/KOVNER/LERNER (2009) found a strong positive relationship between the degree of individual specialization of VCs and their success. The organizational structure of VC firms is strongly heterogeneous. There are VC firms which are highly specialized and only undertake investments in a particular industry such as life sciences, while others take a more generalist approach. Of the generalist VC companies, there is a fraction consisting of a team of generalists, while others rely on a diversified group of industry specialists. The findings contradict the model of STEIN (1997) in the context of VC which states that highly specialized firms with poor investment opportunities won’t have any projects to invest in and therefore may ending up in investing in such which will result in a negative net present value. Yet, VC specialization increases the likelihood that VCs will find attractive industries and companies within these industries in which they can invest. Also, due to the financial focused incentive structure of the contracts, VCs have limitations on how much misallocation they can afford.85 Industry specialization is also commended by SANDBERG/HOFER (1987), since their findings suggest that industry structure has a greater impact on the performance of new VC firms than strategy or the characteristics of the entrepreneur.86

4 Methodology

4.1 Research Design

This study was conducted in cooperation with Peppermint Venture Partners and aims to investigate the investment behavior of German foundations and private investors in the form of SFOs via semi-structured interviews.

The choice of conducting semi-structured interviews was initially based on the explorative nature of the research questions, which focus on a two-stage qualitative analysis of the general investment criteria of the above investor groups vis-à-vis VC on the one hand, and on a subsequent more in-depth determination of criteria for VC in the life sciences sector on the other hand. Additionally, “qualitative methods are often found to be especially useful during initial stages of research because they enable investigators to acquire some understanding of issues, to obtain “pilot data”, or when there is too little previous research or absence of theory to allow for identification of hypotheses to be tested.”87

Furthermore, the gathered data was analyzed with a general inductive approach with the objective to generate a framework with which one can answer the research questions and eventually derive propositions which paves the way for future research in this area. The framework should connect the dots between the most important research findings and applicable economic theories and, if necessary, expand them.

4.2 Data Collection

The following section presents the main outline of the data collection, as well as the general design of the conducted interviews which were used for qualitative data generation.

4.2.1 Sample

CRESWELL (2013) described “the idea behind qualitative research is to purposefully select participants or sites that will best help the researcher understand the problem and research questions”88. In order to obtain relevant information of the investment behavior of German foundations and private investors, the method of expert sampling also known as judgement sampling has been implemented. Expert sampling represents a nonprobability sampling technique and is not intended to be statistically extrapolated from the sample to the general population.89 Thus the basis for drawing generalizations from nonprobability studies is based on the concept of “theoretical saturation” and “analytical generalization”.90 The sample consists of professionals of two German foundations and three private investors in the form of SFOs. Additionally, two representatives of an analysis and consulting company for effective social investments was interviewed. The interviewees were identified as experts according to the following criteria:

- More than ten years of investment experience or proven relevant market knowledge- Management function within the organization or being responsible for the investment segment- Based and active in Germany Based on own internet research and an already existing data base from the cooperation partner Peppermint Venture Partners (PVP) potential experts were identified in a first screening step. After a second screening with a due diligence to determine whether the identified experts met the defined criteria, the potential interview candidates were contacted via e-mail with a standardized inquiry that included a short description of the content and process of the overall research project in order to encourage participation (see appendix A). Altogether 19 German foundations, 12 SFOs and three analysis and consulting companies were approached to which eight foundations, four SFOs and two analysis and consulting companies responded. Two foundations, three SFOs and two consulting companies have agreed to participate in a semi-structured interview, so that the overall conversation rate was 20.58 percent. Overall approximately 5.72 hours of interview material were recorded and transcribed. The interviews were conducted in German, which was the native language of all interviewees, to avoid language associated misconceptions.

The answers provided by the investors and consultants will constitute the rationale for the data and result in a framework which seeks to answer the research questions. Furthermore, on the basis of the framework, research propositions will be derived to be the signposts for further investigations. A detailed overview of the interview participants can be seen in the list of interview sources. Over the course of the study, respondents are coded and identified as shown in table 3.

Table 3: Interview sample91

Abbildung in dieser Leseprobe nicht enthalten

The appropriate sample size is an often-discussed topic in the literature. Most scholars argue that the concept of saturation should dictate the sample size. In qualitative literature saturation is defined as the point at which the data collection process no longer provides new or relevant data.92 According to MORGAN et al. (2002) the point is already reached within the first five to six in-depth interviews and approximately 80 to 92 percent of concepts were identified within the first ten interviews.93 By using the study as point of reference, it can be concluded that a sample size of seven is sufficient.

4.2.2 Semi-structured Interviews

The method chosen to obtain the relevant in-depth research data is semi-structured interviews. Due to their explorative character, semi-structured interviews are an appropriate way to generate less biased, rich insights to understand the participant’s viewpoint rather than generalize it.94 This ultimately contributes to a framework that aims to answer the research questions posed. Contrarily to quantitative interviewing non-leading, open-ended questions are asked to enable and stimulate a detailed free response. Prior to the interviews, a guideline (see Appendix B) was set up in line with the recommendations made by

Abbildung in dieser Leseprobe nicht enthalten

Figure 7: Question formulation process for an interview guide95

PATTON (2002).96 The questions for the interview guideline were formulated in accordance with the guide provided by BRYMAN (2012) as seen in figure 7 and were assigned under several interview topics.97 Even though the guideline conveys the impression of a rigid corset, it merely serves as orientation. This means that the course of the interviews was open for new topics proposed by the interviewee as suggested by FLICK (2009) and MEUSER/NAGEL (1991).98 ;99 A test interview was conducted both to revise the interview questions and to estimate the duration of each interview. Furthermore, it helps to assess whether the guide is capable of generating relevant findings or whether a revision of the questions is necessary. The semi-structured interviews were conducted on the telephone and were recorded and transcribed (see appendix C) with the consent of the respondents.


1 See Deloitte (2018)

2 See Fischer (2003), p. 30.

3 See BVK (2018)

4 See Fried/Hisrich (1994)

5 See Mason/Harrison (2004)

6 See Gupta/Sapienza (1992)

7 See Barnes/Menzies (2005), p. 209.

8 See Fried/Hisrich (1989)

9 Own source

10 BaFin (2014), Leaflet on the obligation of family offices to obtain permission

11 Stöckemann (2016), LABOonline interview, 12-09-16

12 See Kaserer/Achleitner/Schiereck/von Einem (2007), p. 13.

13 Taken from Geigenberger (1999), p. 4.

14 See Becker/Villinger (2017), p. 192.

15 See UNESCO Science Report (2015)

16 See Ernst & Young – Momentum nutzen - Politische Signale setzen für Eigenkapital und Innovation (2015), p. 25.

17 See Whitepaper Digital Health – Project A Ventures (2018), p. 9.

18 See Ernst & Young – Sprung nach vorne Biotechnologie Report (2018), p. 9.

19 See BVK Statistics 2000 - 2017

20 See EVCA Annual Report

21 See Becker/Villinger (2017), p. 194.

22 See GoingPublic Life Sciences - 2016 - ein sehr gutes Jahr für die deutsche Life Science Industrie (2017)

23 Manigart/Struyf (1997), p. 125.

24 See Moore (1994), pp. 114f.

25 Taken from Gruber (2009), p. 29.

26 EXIST is a funding program of the Federal Ministry of Economics and Energy. It aims to improve the start-up climate at universities and non-university research institutions and to increase the number of technology-oriented and knowledge-based start-ups. Students, graduates and scientists are provided with financial resources and start-up-related know-how via EXIST in order to develop scientific results to market readiness, to prepare the company foundation and to carry out the market entry.

27 The Helmholtz Validation Fund, which is financed by funds from the Helmholtz President’s Initiative and Networking Fund, aims to bridge gaps between scientific findings and their commercial applications, and between public research and private investment. In creating the Validation Fund, the Helmholtz Association wants to minimize gaps in financing and ease the transition from idea to application.

28 See Ozmel/Robinson/Stuart (2012), pp. 655f.

29 Source for the following information: (2018)

30 See crunchbase (2018)

31 Source for the following information: (2018)

32 Source for the following information: (2018)

33 Source for the following information: (2018)

34 Source for the following information: (2018)

35 Source for the following information: (2018)

36 See crunchbase (2018)

37 Source for the following information: (2018)

38 See Brandkamp/Zillikens (2017), p. 191.

39 Source for the following information: (2018)

40 See Jarchow (2013)

41 See (2017) Marktreport 2016, p.11.

42 See BaFin (2015), Small Investors Protection Act, Article 2 No. 4 of § 2a VermAnlG

43 With GO-Bio the BMBF supports research teams in the life sciences that are willing to found a company. GO-Bio funding is divided into two phases, each lasting a maximum of three years. The BMBF provides between EUR 15 and 30 million for each funding round. The amount of funding per project depends on the content of the project.

44 The Federal Ministry of Education and Research (BMBF) is pursuing the BioChance funding measure with the aim of strengthening the innovation potential of small and medium-sized enterprises (SMEs) in the field of cutting-edge research. Important funding criteria are excellence, degree of innovation and the importance of the contribution to solving current socially relevant issues.

45 Source for the following information:

46 Source for the following information:

47 See Stam/Spigel (2016)

48 O’Connor/Stam/Sussan/Audretsch (2018), p. 5.

49 See Audretsch/Keilbach (2007), p. 1242.

50 See Feldman (2014), pp. 9f.

51 See Stam/Spigel (2016), p. 5.

52 See Feld (2012), p. 186-187.

53 See Stam/Spigel (2016), p. 6.

54 Based on Stam/Spigel (2016)

55 Stam/Spigel (2016), p. 9.

56 See Acs/Armington (2004), pp. 244f.

57 See Audretsch/Lehmann (2005), pp. 1191f.

58 See Zhang/Li (2010), pp. 88f.

59 Barnes/Menzies (2005), p. 209.

60 Taken from Barnes/Menzies (2005)

61 See Gompers/Lerner (1999), p. 1.

62 See Amit/Brander/Zott (1998), pp. 442-44.

63 See Barnes/Menzies (2005), p. 209.

64 See Fried/Hisrich (1994)

65 See Gompers/Lerner (1999), p. 34.

66 Taken from Barnes/Menzies (2005)

67 Barnes/Menzies (2005), p. 223.

68 See Barnes/Menzies (2005)

69 See Kollmann/Kuckertz/Middelberg (2014)

70 Taken from Barnes/Menzies (2005)

71 See Barnes/Menzies (2005), p. 210.

72 See Gompers/Lerner (2001), p. 145.

73 See Gompers/Lerner (2001), p. 21.

74 See Ehrlich et al. (1994)

75 See Achleitner (2001), pp. 513f.

76 See Kaserer/Diller (2007), p. 40.

77 See Macmillian/Kulow/Khoylian (1989)

78 See Bessler/Kurth (2003), p. 2.

79 See Pratt/Zeckhauser (1985)

80 See Küpper (2008), p. 83.

81 Taken from Lecture: Private Equity – Prof. Dr. Reiner Braun, Technische Universität München, Chairs of Entrepreneurial Finance

82 See Mehta (2004), pp. 7.

83 Sahlman (1990), p. 474.

84 See Gompers/Lerner (1999)

85 See Gompers/Kovner/Lerner (2009), p. 819.

86 See Sandberg/Hofer (1987), p.6.

87 Palinkas (2014), p. 3.

88 Creswell (2013), p. 189.

89 See Strauss/Corbin (1990)

90 See Yin (2014)

91 Own source

92 See Guest/MacQueen (2008)

93 See Morgan/Fischhoff/Bostrom/Atman (2002)

94 See Mitchell/Jolley (2007)

95 Taken Bryman (2012), p. 319.

96 See Patton (2002)

97 Bryman (2012)

98 See Flick (2009)

99 See Meuser/Nagel (1991)

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Investment behavior of German Single Family Offices and Foundations towards Venture Capital with a focus on the life sciences sector
A qualitative analysis
Technical University of Munich
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ISBN (eBook)
ISBN (Book)
Venture Capital, Family Office, Stiftungen, life science, Start-Up, Finance
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Hao Nam Nguyen (Author), 2018, Investment behavior of German Single Family Offices and Foundations towards Venture Capital with a focus on the life sciences sector, Munich, GRIN Verlag,


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