Germany slowly warms to private equity

Germany's private equity and venture capital industry has experienced significant growth over the past decade, with assets under management of Germany-based fund managers expanding from $18.6 billion in 2012 to $58.5 billion by the end of 2021, according to a recent report by Preqin.

Despite the increasing acceptance and interest in alternative asset classes, the private equity industry in Germany, Europe's largest economy, remains smaller and less developed compared to the United States, the United Kingdom, and the Nordic countries.

Kaspar Hartmann, a board member of the German private equity trade body Bundesverband Deutscher Kapitalbeteiligungsgesellschaften (BVK) and founding partner of Berlin-based lower mid-market PE firm KKA Partners, points out significant differences between the German approach to private equity and the Anglo-Saxon financial world.

Hartmann highlights that Germany has a relatively limited supply of general partners (GPs) despite significant demand for private capital investments in the country. On the other hand, limited partners (LPs) are attracted to Germany's stable economy, low debt-to-GDP ratio, and a large pool of interesting companies in need of capital. The desire to access the German market is high due to these factors.

Cultural differences between Germany's stakeholder economy and the shareholder economy prevalent in the Anglo-Saxon world also play a role. Institutional investors in Germany allocate relatively little to the private side compared to their Anglo-Saxon counterparts. This is reflected in the ratio of private equity assets under management (AuM) to GDP, which is only 4.4% in Germany, compared to 14.3% in the Nordic countries and 25.3% in the UK.

The limited number of German GPs has resulted in a scarcity of new funds being raised. In the lower mid-market segment in 2021, only four funds were raised in Germany, while the UK saw over 40 funds raised and the US had more than 400. Preqin reports that total private equity fundraising in Germany slightly decreased to $7.3 billion in 2021, following a year of $8.5 billion raised in 2020. As of October 2022, Germany's 155 active fund managers had $15.2 billion of dry powder, up from $14.5 billion at the end of 2021.

Venture capital strategies have attracted a significant increase in dry powder in Germany, with AuM reaching $25.6 billion compared to $18.8 billion for buyouts.

Hartmann highlights the differences in language and focus between German investors and their Anglo-Saxon counterparts. German investors prioritize products, customers, community, and employees, while Anglo-Saxons, particularly those from London, focus on EBITDA, multiples, enterprise value, and similar financial metrics.

Traditionally, Germany's family-run businesses, which form the Mittelstand economic powerhouse, have been less receptive to private equity investors. The stereotype of private equity as short-term investors solely interested in quick profits has led to them being labeled as "Heuschrecken" (locusts). However, attitudes towards private equity are gradually changing, according to Hartmann.

Mistrust of private equity is not limited to the mid-market. The largest private equity deal in Germany in recent years was the €17.2 billion carve-out of ThyssenKrupp's elevator business in 2020, which faced criticism within Germany's business community.

Germany's industrial and manufacturing sectors heavily rely on cheap Russian natural gas, but rising energy costs since the Ukraine conflict have posed challenges. However, a €200 billion government fund established to cap energy supplies for domestic and corporate use is expected to help offset the cost increases.

An economic slowdown in China, Germany's largest trading partner, could also impact German exports and pose additional challenges for the private equity market.

According to Deutsche Beteiligungs AG (DBAG), Germany's most active listed private equity firm, the number of management buyouts (MBOs) of mid-market firms decreased to 43 in 2022, down a third from 62 in 2021. The market volume fell from €6.6 billion to €4.1 billion. However, this decline does not undermine the long-term growth rate of the German buyout market, which has averaged around seven percent annually over the past decade, according to DBAG research.

Philipp Bunnenberg, head of alternative markets at the industry association Bundesverband Alternative Investments (BAI), expects German institutional investors to increase their exposure to alternative investments from the current 23.2% to 26.4% in the coming years. However, German investors in private equity still have a long way to go to match their international peers, particularly in the US.

The Preqin report concludes that given the low penetration of private equity investment in Germany relative to the size of the economy, there is still significant room for further growth.