VC sentiment in Germany cooled considerably at year end

• Valuation adjustments weighed on market sentiment at the end of the year
• Investment climate is deteriorating as muted expectations weigh on investor appetite
• Sentiment around entry prices for new investments rose to ten-year high

Sentiment in the German venture capital market cooled off considerably towards the end of the year. The business climate indicator of the early-stage segment nosedived 25.6 points to -42.9 balance points. With the exception of the unprecedented coronavirus shock in the first quarter of 2020, the only recent time sentiment was worse was 20 years ago. In the final quarter of 2022 the indicator for the current business situation plunged by -28.9 points to -41.2 balance points, while the indicator for business expectations fell by -22.2 points to -44.7 balance points.

One of the likely main reasons for the drop in sentiment is that the values of companies have been on the decline since the start of last year, prompting valuation adjustments in financial statements. Furthermore, the VC deals concluded in the fourth quarter showed particular restraint on the part of US investors. They are the well-capitalised syndication partners missing for German investors, which limits investment opportunities. The low company valuations drove the sentiment indicator for entry prices for new investments to a 10-year high in the final quarter.

Sharply lower expectations drove the investment climate into the red in the final quarter, potentially weighing on investment activity in the following quarters. Amid declining investment appetite, actual deal volume collapsed by 40% on the third quarter – not least as a result of the restraint exercised by US investors. This quarterly trend is emblematic of the year 2022 as a whole, in which deal volume also remained a good 40% below the previous year’s level. However, after the exceptional year 2021 it remains the second strongest VC year in the recent history of the German VC market.

“VC sentiment dropped yet again in the fourth quarter of 2022”, said Fritzi Köhler-Geib, Chief Economist of KfW. “As companies prepared their annual accounts, the valuation adjustments that became necessary because of the way the year panned out appear to have come into focus again and weighed on sentiment. The reluctance of US investors also weighed negatively. This underscores the need to do even more in the scale-up stage in order to reduce dependence on US investors in that area. The good medium-term outlook for VC investment activity brightens the start of the year 2023. The amounts of investment capital which young funds in particular can still receive from their investors have risen further despite the adverse macroeconomic environment. Fortunately, the INVEST grant, an important investment incentive for Business Angels, had a fast relaunch.”

Ulrike Hinrichs, Managing Director of the German Private Equity and Venture Capital Association (BVK), commented: “Towards the end of the year, a perfect storm developed from the most varied factors and pushed venture capital sentiment further downwards. Combined with the further worsening economic outlook, this is weighing on venture capitalists’ investment appetite. The retreat of international investors, especially from the US, is also making large financing rounds a challenge. This underscores yet again that a well-capitalised domestic scene with a strong German investor base is needed to make the German market more robust and more resilient in times of crisis. We need to join forces with market stakeholders and policymakers to achieve this, and even when the fundraising situation is rated extremely critically. The fact that the funds still have considerable capital available for investments is cause for optimism. After all, a number of new venture capital funds were set up successfully in 2022 despite the difficult environment.”

KfW produces the German Venture Capital Barometer in cooperation with the German Private Equity and Venture Capital Association (BVK) and the Deutsche Börse Venture Network exclusively for the Handelsblatt business daily. Detailed analyses with data tables and graphs illustrating the development of the business climate in the venture capital and later-stage segments can be retrieved at
www.kfw.de/gpeb