The economic expansion of the 1920's came to a sudden halt with the Wall Street Crash of 1929. For Ferdinand Porsche, Technical Director at Steyer this meant being laid off after less then one year with the Austrian company. Porsche had by this time built a large reputation as an automotive engineer to go along with his equally large ego. Unemployment should have been a temporary setback but Porsche insisted that any job offer need to be accompanied with a seat on the Board of Directors. Unable to find a company willing to meet his demands he decided to set up his own company. With the financial backing of Adolf Rosenberger, Porsche started his company with some former co-workers. Most prominent amongst his new employees was his Chief Designer Karl Rabe. The role of Karl Rabe in the design of the Auto Union has been often overlooked but should not underestimated. Rabe and Porsche formed a strong partnership in the early years. Because of the economic situation business was hard to come by and months would pass between commissions.

In 1932 Porsche anxious not to let his financial difficulty stunt his aspirations, decided to design a new racing engine without any confirmed customers! He established another company called Hochleistungs Motor GmbH (High Efficiency Engines Ltd.) In 1932 Auto Union was formed, comprising struggling auto manufacturers Audi, DKW, Horch and Wanderer. The Chairman of the Board of Directors, Baron Klaus von Oertzen felt that what was needed was a showpiece project that would bring fame to his new firm. Porsche had done some work for Wanderer and was commissioned to design a new racing car. Hans Stuck one of Germany's most successful racing drivers had met Adolf Hitler before he came to power so the three of them, Stuck, Baron Oertzen and Porsche went to meat the new Chancellor. Hitler, at the Berlin Motor Show had promised to boost the German car industry. This would involve a new "people's car" and also a government sponsored racing program. Initially 500,000 Reichmarks was pledged to Mercedes-Benz but Porsche was able to convince Hitler that two programs were better than one, and the 500,000 RM would be split by the two competing firms. Mercedes could not be pleased at the turn of events and on this note the great rivalry began. It would not be an exaggeration to state that some members of each German company was more interested in beating the other than the Italians.

The race car that Porsche designed was based on a mid-engined layout similar to the famous 1923 Benz Tropfenwagen. This unique car was built under the direction of Max Wagner who was now at Daimler-Benz and was raced by his current business partner, Adolf Rosenberger. The engine for this new car would be the V-16 engine that he had started designing earlier. It was designed to 6 liter specifications but would start at 4,360cc and 295 bhp. It had two cylinder blocks inclined at an angle of 45 degrees with a single overhead camshaft to operate the 32 valves.

The engine was designed to provide optimum torque at low engine speeds. The suspension would be all independent but unlike the Mercedes would use half-axles and torsion bars at the front while at the rear it used wishbones and a transverse leaf spring. The fuel tank was located in the center of the car directly behind the drive who would be placed well towards the front. The chassis tubes were initially used as water carriers from the radiator to the engine but often sprung small leaks. Additional work needed to be done on the cars behavior during cornering. Accelerating out of a corner would cause the inside rear wheel to spin furiously. This was much abated by the use of a ZF manufactured limited differential for the 1936 season. The body was subjected to strenuous testing in the wind tunnel of the German Institute for Aerodynamics.

Much has been written about the difficult handling characteristics of this car but its tremendous acceleration was undeniable. A driver could induce wheelspin at 150 mph! The initial list of drivers was headed by Hans Stuck. The engine for 1936 had grown to the full 6 liters and was now producing 520 bhp. In the hands Stuck, Varzi and especially new sensation Bernd Rosemeyer the Auto Union Type C dominated the racing world winning 6 of 12 races and Rosemeyer was crowned European Champion. Surprisingly their main competition was the Ferrari-Alfa Romeo team as Mercedes had a dreadful season. After the A.I.A.C.R. decided to delay the new 3-Liter formula for another year. Auto Union which ran on a much smaller budget than Mercedes modified their Type C to contest another year. Mercedes on the other hand replace their W25 with their new W125, a much improved car that prove the difference bringing Caracciola the European Championship for that year. Though Rosemeyer had won an equal four races, three of the four rounds counting for the championship went to the veteran.