Finding the money trees


24 Jun 2004

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Barely with his feet under the table as chairman of the Irish Venture Capital Association, Delta Partners’ Shay Garvey couldn’t have taken on the role at a more interesting time. When Garvey and his colleagues set up their own venture capital (VC) firm in 1994, there was no VC industry in Ireland. Since then, the Irish VC industry sector has emerged as one of the most frenetic and best-funded markets remaining in Europe after the tech meltdown of recent years.

Grasping a few pages filled with figures and annotated with scribbles, Garvey grins ruefully as he reminds me: “It’s going to be tough next year, bloody tough. The golden nugget of hope is that locally investors are continuing to opt in, which is not the situation across the rest of Europe right now.”

In the world of high finance, VC is a new concept to investors such as pension funds, individuals, government agencies and corporate investors. Despite claiming a better return on investment (ROI) than stock markets, VC accounts for less than 1pc of the pension industries’ investment allocation. He doesn’t deny that the VC sector has been criticised for being slow to invest, but emphasises that it cannot invest unless it can guarantee a return for its investor base and the evidence of return is harder to guarantee. “The truth is that from scratch, when there was no VC industry in Ireland, more than €1bn has been raised by the various funds. However, in terms of ROI, only €58m has actually been yielded from various exit mechanisms. The VC industry will have to work a lot harder to yield returns,” Garvey warns.

Sifting through the various figures Garvey says that in 2003 the VC industry invested €255m in 187 companies, compared with €105m invested in 2002. Some 96pc of that investment went into technology companies. However, on closer inspection it becomes obvious that more than 70pc of that €255m investment — around €175m — went into the buyouts of seven existing technology companies, including Alphyra, Riverdeep and Conduit. The remaining 180 companies had to make do with sharing €79m in funds.

“If you want to look at this separately in pure VC terms as opposed to buyout investments, that €79m is 25pc below a €105m figure in 2002.”

But he reckons there’s a chink of sunlight: “In terms of pure start-up investment, venture capitalists invested €33m in seed capital for 106 start-ups in 2003, compared with €17m in 62 start-ups in 2002. However, worryingly, in terms of investment in the expansion of existing companies, only €46m was invested in 2003, compared with the 2002 level of €76m. The good news is that there’s a lot of capital and goodwill towards start-ups, but for existing companies, unless they are making solid revenues and can demonstrate traction in the marketplace they are not going to attract money to fund expansion.”

Garvey’s assertions are borne out by the emergence in the past year of new VC players such as 4th Level Ventures that are focused purely on early-stage investments in ICT and life-sciences companies that are born out of technology-transfer projects in Irish colleges and universities.

Former Siemens Nixdorf Ireland boss Ray Naughton and University College Dublin’s (UCD) Dennis Jennings, in collaboration with Dolmen Securities, founded 4th Level. The new VC company started with a fund of €20m but is in the process of increasing this to €40m in the months ahead. Pat Duggan of Dolmen Securities explains: “At 4th Level we try to get in at the early stage. We have offices next door to Trinity College Dublin and our goal is to have offices at UCD, University College Cork and University of Limerick — as close as possible to the technology transfer facilities of these institutions. Our fund is split in two — the 4th Level Seed Fund is active in investing with Enterprise Ireland (EI) in promising campus companies while the 4th Level Fund looks at follow-on investment in later-stage companies.”

Expanding on the tough criteria involved in selecting an investment, Duggan explains: “We’ve got to believe in the company, the management and the business plan. Primarily, do they have the people to deliver? Is the product fundamentally disruptive to its target market? The end game: is the product better than what’s already out there? There is room for improvement with every company we encounter. We have input and they have input to get to the goal. One company we invested in recently, Celtic Catalysts, was very early stage and we worked hard with it to commercialise its focus. It was lab-based and we brought it to the point where it is getting out to sell.”

Ultimately what venture capitalists have their hearts set on is the exit route. And while the world waits on impending initial public offerings (IPOs) by Google.ie and Sales- force.com to inspire investors in technology once again, Duggan does not discount the potential of future Irish IPOs. “We view London’s Alternative Investments Market (AIM) as a really good goal to focus on,” he says, citing the recent floatation by Kerry online hotel booking firm CNG, which raised €33m on its first day on the market in May.

Katherine Raleigh, director of the Irish Software Industry, acknowledges: “There is a gap between seed level and subsequent phases of funding. The venture capitalists are certainly engaging younger companies, which is very encouraging, but companies looking to their first- and second-round investments are harder pressed than ever before.

“The markets are improving and we would hope that the venture capitalists will stop being nervous and start investing the ‘venture’ part of their capital. They need to start prospecting again and to stop acting like a bank.

“In fairness, however, I’m not surprised at their conservative stance. Many investments have not worked out. Venture capitalists are absolutely right to scrutinise every organisation and company they invest in. Young technology companies need to start looking at their own management capabilities and in particular good sales and marketing practices if they are going to encourage investment. A good technology product will not set the world on fire unless there is good marketing and sales behind it,” Raleigh warns.

In examining the truth behind early-stage investment in Ireland, it is clear very few seed investments actually take place without EI’s involvement. Denis Marnane, manager of equity and VCat EI, explains that the state agency never takes more than 10pc equity stake in a company and acknowledges that most of the terms of the investment are driven by private sector investors — such as venture capitalists — who are also involved in a round.

“The world has moved on from the heady days of 2000. A phenomenal amount of money went into companies that was lost and burned with the market. However, I’m still seeing investments being made. Yes, venture capitalists are doing tougher due diligence, checking out customers and product demand. In the past, it used to be about putting money into a company to keep it going or bringing a product to a stage where somebody actually wants it. That’s no longer the case. Now it is about having a product that people ‘need to have’ rather than a ‘nice to have’.

“What people fail to realise about venture capitalists is that they had a tough job managing their existing investments and had to delve back into their existing portfolios to make those companies work. Now the bar is set higher and to gain investment strict criteria have to be met,” Marnane says.

Paul O’Connor, partner at PricewaterhouseCoopers, qualifies this by indicating that investors are no longer investing big chunks of cash in a potential company, but rather focusing on segments of money. “The average deal size seems to have come down to under half a million compared with €5m three or four years ago. Investors are taking a more cautious approach. They want to see actual progress in terms of sales targets and not just the implementation of strategic plans.

“Rather than give them sufficient funds to keep them going for 19 months, give them enough for six months and if at the end of that period their product is selling in the numbers they said it would, give them the next agreed tranche. It’s the prudent way and it works.

“The truth about funding companies in Ireland today is that there is a large amount of money being invested in funds and being invested by those funds, but these figures are being distorted by large buyouts such as those of Alphyra and Riverdeep. The actual amount of funding is down on the year and will be so next year as well. The transmission of funding into companies is also at a much slower, more prudent pace,” O’Connor says.

Garvey of Delta concludes: “More start-ups than ever are being funded, venture capitalists have up to €250m in available cash to invest and the rate of investment for 2004 appears to be already exceeding that of 2003. However, the stark truth is that over €1bn has been raised in the past 10 years. Some 25pc of that has already been written off and only 39 companies have generated a return of €58m. In the coming years the VC sector will have to get its act together and show real returns.”

By John Kennedy