Firms learn that nothing ventured, nothing gained

1 May 2008

Tech start-ups are examining alternative routes to raising cash and are by-passing venture capital

When Piero Tintori (pictured) embarked on a recent funding round for his software company, he successfully raised the money without venture capital (VC) – by deliberate choice.

His company, TerminalFour, develops content management software and had been approached four times in the past six months by VC firms. In the end, he obtained €3m in expansion funds through a combination of retained profits and private equity.

Tintori had concerns about dealing with VC investors. “The last thing you want is where you’re trying to build your business and 20pc of your time is spent managing your VC,” he says.

“Ultimately, you want an organisation which can work with you to help you and not just be a silent partner. What you don’t want is somebody just looking at one particular angle of your business and who will make decisions you’re not comfortable with.”

Tintori’s opinion reflects a growing trend among Irish technology companies to avoid VC capital in favour of investment by alternative sources such as private individuals or Enterprise Ireland.

Cork-based Cubic Telecom attracts regular attention from VCs but if chief executive Pat Phelan is flattered, he doesn’t show it.

“I think the problem with VCs is that they tend to back horses 10 yards from the winning line,” he says. “The minute they’re going in, their job is to get their money back. They’re not interested in the company per se. I built Cubic Telecom with blood, sweat and tears, and a guy just putting in money wouldn’t have that kind of commitment.”

Ironically, this attitude prevails just as VC funding in Ireland is undergoing a mini-revival. According to the Irish Venture Capital Association, VC investment during 2007 was at its highest level since 2002 (see graphic).

A closer look at the figures shows a significant shift towards investments in biomedical and pharmaceutical firms, in addition to pure-play technology companies.

Tintori believes Irish VC firms lack the risk-taking approach of their US counterparts – he would prefer to see “the Silicon Valley model rather than the Dalkey model.

“Irish VCs are not, I believe, comparable to US ones which take a lot of risks and inspire innovation because they put money into early-stage companies and they have a good network. In Ireland, they’re much more conservative – maybe a little too much so. They’re almost looking for companies that have already made it and they’re not the ones who need the money most.”

Maurice Roche, a director with VC firm Delta Partners, accepts a natural reluctance among some companies to take on VC.

He disagrees with the view of Irish VC houses as being risk-averse. “We have invested in new companies that have either been start-ups or pre-revenue, just some guys from a university,” he says. “We did 25 investments in one of our previous funds and most of those had a product or an idea and had customer discussions but no orders.”

Some of the scepticism comes from a feeling that VCs favour re-investing in existing clients. Other observers believe recent acquisitions of Irish tech firms by larger multinationals were triggered by VC investors looking to get their money back, regardless of whether it was the most appropriate time to sell out.

Roche rejects the suggestion that VCs are thinking of an exit strategy from the moment they walk in the door. “We don’t have a specific timeframe where we have to get out by x, and it’s certainly not two or three years,” he says. “We wait to exit at the most optimal time for all shareholders.”

The mobile software company Xiam was bought for $32m by the US communications firm Qualcomm last month. Xiam CEO, Colm Healy, says the deal was a matter of good timing.

He praises Xiam’s VC investor Delta Partners for having “the experience and tenacity to stay with something it believed in, probably longer than some other VCs would have.”

The problem may be that many Irish technology start-ups exist at a level below VCs’ radar. It’s notable that serial technology entrepreneur Raomal Perera is funding his latest software venture, Empower with €1.5m in private equity through the Business Expansion Scheme.

Phelan says the sector would benefit from alternative sources of capital, such as wealthy, private individuals. “The Irish investor has four homes, a place in Spain, a Cayenne jeep and is too used to 40-50pc returns in property. I hope they would turn more entrepreneurial,” he says. “I’d like to see investors turning up and seeing the quality that’s there.”

Healy cautions against getting into bed with private investors that may have the cash but not the industry knowledge.

“Some angel investors are unfamiliar with building value in technology companies and become impatient with the progress of the company because they lack the knowledge and experience to understand what progress looks like for a technology company. We were loss-making for many years.”

Phelan believes many VCs aren’t aware of changes in software development trends which alter the nature of new technology ventures – that means smaller teams and faster product release cycles.

“Most start-ups with two guys coding need a couple of years’ wages and a couple of project people – you’re talking about a maximum of €250,000,” he says. “That’s where I’d love to see more VCs operate. Rather than putting €5m into one company, I’d like to see them put it into 50. That would be, in my opinion, a much better opportunity to get their money out.”

Roche disputes the idea that VCs are only prepared to invest million-euro-plus amounts. “It’s not the level of investment, it’s the opportunity that interests us,” he says.

One Delta client has been trading for close to seven years, having originally received the relatively small sum of €350,000. “I never had to write another cheque,” says Roche.

He urges those unsure of VC involvement to ask peers who have been through the experience. “Make some reference calls to other clients – ask what value-add other than money has the VC brought to the table. Ideally, they should have industry knowledge, partners or customers to introduce you to and they should be able to help hire senior management.”

For all their reservations, most in the tech sector are pragmatic enough to realise a good offer if it comes along. Money aside, the human factor can’t be discounted as a deal breaker. “It’s a personality issue also,” says Roche. “In our business, you have to get on with people.

Putting the right finance in place
When Dublin-based PutPlace sought pre-launch funding, it did so through the Business Expansion Scheme from a combination of angel investors and Enterprise Ireland, rather than VCs.

“The bottom line is, Irish VCs and VCs in general are averse to early-stage investment,” says PutPlace CEO, Joe Drumgoole.

“It costs the same amount of time and energy to invest €100,000 as it would to fund a medium-stage company for €10m. The economics don’t match up.”

Drumgoole knows the indigenous technology sector well, having created and run product development groups at Cape Clear Software and CR2. Experience hasn’t made him wary; he points out that PutPlace’s co-founder Brian Caulfield is a former venture capitalist.

“In the software sector, taking on board a VC is a bit of a dance with the devil because they are looking for an exit. They might invest in 10 companies, knowing only one will have a home run,” Drumgoole says.

“VCs add a huge amount of value at the same time – they can help build your management team, introduce you to new markets and have deep pockets.”

Based out of the Digital Hub, PutPlace’s service for organising, backing up and sharing people’s digital content – everything from music to files and photos – is currently in test mode.

A full launch is imminent and Drumgoole clearly has bigger plans. “I would be amazed if we don’t raise VC next year,” he says.

For now, an exit strategy is not on the agenda. “Our No 1 goal is to build a successful business, to break even and then to turn a profit. If we do that, all other outcomes will follow.”

By Gordon Smith