Sovereign Wealth Fund

What is a sovereign wealth fund?

Sovereign wealth fund (German: Staatsfonds) refers to an investment company or special fund owned by a state that invests state assets for the long term. It is managed separately from the current budget and from the currency reserves that the central bank holds for its tasks. It is fed by commodity revenues, surpluses in foreign trade or in the state budget, and privatisation proceeds. A sovereign wealth fund can be thought of as a reserve that a state builds up for leaner years or for future generations and invests broadly on the capital market.

Sovereign wealth funds are among the large institutional investors, that is, among the organisations that invest large assets professionally. For companies they appear in three roles. They are investors in funds for private equity and venture capital, invest as co-investors alongside these funds and participate directly in late-stage financing rounds, IPOs and company acquisitions. The contractual basis is the same documents as for other investors, that is, the participation agreement and shareholders' agreement, supplemented by side letters on confidentiality, sanctions law and information obligations.

Types of sovereign wealth funds: source of funds and investment objectives

By purpose, sovereign wealth funds can be roughly distinguished as follows:

• Stabilisation funds offset fluctuating commodity revenues of the state budget and therefore invest predominantly in liquid assets.
• Savings or intergenerational funds build up assets for future generations and can choose very long investment horizons.
• Development and strategic funds are meant to put the domestic economy on a broader footing and invest specifically in industries and technologies that are to emerge in their own country.
• Reserve investment companies invest with a return focus the part of the currency reserves that the central bank does not need in the short term.

Commodity-based sovereign wealth funds exist, for example, in Norway and several Gulf states, and funds financed by trade surpluses and state shareholdings in Singapore and China. Many sovereign wealth funds have committed to the Santiago Principles, voluntary principles on governance, transparency and investment policy. The purpose also determines behaviour in transactions: a return-oriented savings fund acts in a financing round like a large financial investor, while a strategic fund combines return with industrial policy objectives.

Investment strategy of sovereign wealth funds in late-stage financing rounds

Sovereign wealth funds combine a long investment horizon with low liquidity needs and very large investment amounts. They therefore invest directly mainly where individual stakes are large enough: in late rounds from Series C onwards and in financings before an IPO. In the IPO itself, they act as an anchor investor who commits to a large part of the offering in advance. The minimum amounts are far above the volume of early rounds, often in the double-digit millions and above. Sovereign wealth funds reach the early market indirectly through their fund investments.

In the round they often behave with restraint. They often forgo a voting seat on the advisory board and instead demand observer status (observer seat) and extended information rights. Their decision paths are longer than those of funds because investment committees and, in some cases, state bodies must consent. Strategic funds often tie their participation to conditions outside the financial part, such as an establishment in their home country, build-up of staff on site or cooperation with domestic companies.

For the other parties, a sovereign wealth fund is also a question of the shareholder base. Co-investors, customers from regulated industries and later buyers examine where the capital comes from. Depending on its legal form, a state investor can invoke state immunity, above all against enforcement against state assets. The law firm therefore checks whether the contract needs an express waiver of immunity and an arbitration clause.

Investment screening for sovereign wealth funds in Germany

If a foreign investor acquires a stake in a German company, the Federal Ministry for Economic Affairs can review the acquisition under foreign trade law, that is, under the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz, AWG) and the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung, AWV). In most sectors, this concerns acquirers from states outside the EU and the European Free Trade Association, and in the defence sector every foreign acquirer. In sensitive areas such as armaments, critical infrastructure and selected key technologies, a notification obligation applies from defined voting-right shares, and until clearance the acquisition may not be completed. Which thresholds apply depends on the sector and the version of the AWV in force at the time.

In the case of sovereign wealth funds, the review may take into account whether the acquirer is directly or indirectly controlled by the government of a third country, that is, a state outside the EU. An indirect acquisition through intermediate companies in the EU may also be caught. In a financing round, clearance therefore becomes a condition to closing (closing condition), and the timetable is extended by weeks to months. In very large transactions, merger control and the European rules on third-country subsidies may also require a notification.

Practical example: sovereign wealth fund in a EUR 80 million growth round

A software company whose products control energy grids generates around EUR 40 million of recurring revenue. It plans a growth round of EUR 80 million at a pre-money valuation of EUR 320 million. A sovereign wealth fund from a third country offers to take EUR 50 million; the rest is shared by two existing investors and a growth fund.

• Size of the stake: EUR 50 million / EUR 400 million post-money valuation = 12.5% of the shares.
• Investment screening: Because the software is used in critical infrastructure, the law firm examines a notification obligation early. The round is split into two closings: the other investors pay in immediately, the sovereign wealth fund after clearance.
• Ancillary conditions: The desired location in the fund's home market enters the financial model with costs and staff. The commitment is tied to market milestones and formulated without a contractual penalty.
• Access to information: Instead of an advisory board seat, the fund receives observer status. Technically sensitive information is excluded to the extent that conditions of the clearance require this.
• Later sale: The shareholders' agreement obliges all shareholders to cooperate in a sale resolved by a majority and to support the approval procedures required for it.

As a result, EUR 30 million is available to the company immediately, and the EUR 50 million of the sovereign wealth fund only after clearance. Liquidity planning must therefore also cope with the case that clearance is delayed by months or granted with conditions.

Distinctions: sovereign wealth fund, family office, private equity and CVC

• Family office: manages the private assets of an entrepreneurial family. It is likewise long-term in orientation but pursues no state objectives.
• Private equity fund: invests third-party capital with a fixed term and must sell its holdings again. Sovereign wealth funds are often themselves investors in such funds and have no fixed term.
• Corporate venture capital: investments by a company with a strategic interest in its own business. The strategic proximity resembles that of a strategic fund, but the sponsor is private.
• State development bank: supports the domestic economy through loans, guarantees and equity programmes, primarily according to its statutory promotional mandate.

Common mistakes

• Approaching too early. Sovereign wealth funds invest directly only in rounds whose volume matches their minimum amounts. Contacts in early phases tie up time without leading to an investment.
• Ancillary conditions not valued. Location commitments, staff build-up and cooperation obligations cost money and management capacity. They belong in the financial model with figures and in the comparison with other offers.
• Investment screening considered too late. If a notification obligation is recognised only after signing, closing is delayed, and the prohibition on completion can block the cash inflow.
• Consequences for the shareholder base underestimated. A state shareholder can influence the choice of later buyers, customers from regulated industries and co-investors.
• Decision paths planned wrongly. Investment committees and state bodies lengthen the round. A timetable that assumes the speed of a fund endangers the cash runway.

Frequently asked questions

Do sovereign wealth funds invest in early-stage companies?

Directly only rarely, because early rounds are too small for their minimum amounts. Indirectly, however, sovereign wealth funds are often involved, namely as investors in venture capital funds.

Do sovereign wealth funds demand a seat on the advisory board?

Often not. Observer status and extended information rights are common. Strategic funds with larger stakes sometimes demand more influence, which in turn can affect the investment screening.

Does the participation of a foreign sovereign wealth fund have to be approved in Germany?

Not in every case. A notification obligation with a prohibition on completion exists only in certain sectors and from certain voting-right shares. Outside these areas, the ministry can review an acquisition of its own motion within statutory time limits; legal certainty is then provided by a certificate of non-objection applied for. Whether an obligation exists is clarified by the law firm before signing.

Does Germany have a sovereign wealth fund?

Not in the classic sense of a fund that invests commodity or budget surpluses. The closest is the fund for financing nuclear waste disposal, a foundation under public law that invests the payments of the power plant operators for the long term on the capital market. The federal government reaches growth companies mainly indirectly, for example through KfW (Germany's state development bank), which participates in venture capital funds.

How long does a financing round with a sovereign wealth fund take?

Usually longer than with a fund investor. In addition to internal committee processes, approval procedures may also apply. A separate closing for the sovereign wealth fund prevents the cash inflow from the other investors from being delayed.

The Roemer Capital view

State investors come into consideration in our mandates only for large growth rounds. This means Series C rounds and those approaching a size of EUR 100 million. Whether such an investor fits, we assess not by the amount alone but by how it changes the shareholder base for later rounds and buyers.

If a participation emerges, we build the possible investment screening into the timetable from the start and include ancillary conditions such as location commitments in the financial model. The question of the notification obligation is assessed by the company's law firm. We structure the round economically so that the other investors do not have to wait for the clearance.