End of investment terms pose challenge to Irish tech firms

4 Mar 2014

The scenario appears bright for Ireland’s indigenous tech sector. At the Mobile World Congress conference and exhibition in Barcelona, Spain, this past week, Irish tech firms 3V and Asavie secured multi-million euro deals with mobile operators Orange and Telenor, respectively.

Over in Silicon Valley, California, Irish brothers John and Patrick Collison saw a recent funding round value their start-up Stripe at more than US$1bn.

Yet there is a shadow on the horizon. Ireland is facing a tech-funding time bomb.

Irish businesses raised €285m from investors in 2013, up 6pc from €269m raised the previous year, according to the annual Irish Venture Capital Association (IVCA) VenturePulse survey. Knowledge-based companies covering software, medical devices, pharma and biotech raised more than 95pc of the funds in 2013.

Irish venture-capital (VC) firms are now entering the end of the investment term within their existing funds, and funds supported by the banking sector and Enterprise Ireland (EI)’s Seed & Venture Capital Programme of 2006-2012 are close to being fully invested.

Challenges ahead

Mark Horgan

Mark Horgan, partner in Atlantic Bridge and chairman, IVCA

Rob Leslie of Waterford Institute of Technology-based company Sedicii, a maker of security software, said many start-ups are either too starry-eyed to see this or just aren’t aware of the issue.

“I fear there is going to be a big problem when many of these companies try to access funding to grow and scale because of two things,” Leslie said.

“The risk appetite of Irish investors is pretty conservative and secondly, the pool of available funds for investment is not big enough to support the number of start-ups seeking to access it. This will undoubtedly mean a lot of companies running out of cash even though they may have the bones of a very good business.”

Mark Horgan, partner in Atlantic Bridge and chairman, IVCA, said many Irish VC firms are close to the end of their investment periods and are raising new funds.

“They will have maintained reserves of capital to support their existing portfolio companies but will need to be successful in raising new funds to invest in new opportunities,” said Horgan.

Venture capital supporters

VCs are being supported by EI and hopefully by the National Treasury Management Agency through the Ireland Strategic Investment Fund, although this is yet to be confirmed, he added.

“Following a competitive tendering process, EI awarded Irish VCs €100m in late 2013 on the basis that VCs will raise four to five times matching funds. If successful, this will lead to the next wave of Irish VC investment in innovative SMEs,” Horgan said.

So there is hope. There is also danger, said Peter Sandys, managing partner at Seroba Kernel Life Sciences. A major fall-off in new projects will occur without fresh domestic capital. Only exceptional cases will attract international money and even these will struggle without a domestic VC as a validator, he said.

“Start-up activity will fall off and there will be no expansion capital for existing companies who do not already have VC investors.”

About €600m had been available for Irish VC firms to invest in Irish technology companies between 2007 to 2010, said Maurice Roche, general partner, Delta Partners.

Most of this capital has been invested and needs to be replenished for the next cohort of start-ups and early stage companies, and also to scale the companies that have received investment during this period, said Roche.

“This is a huge challenge for the domestic VCs. There are far fewer private pools of capital in Ireland investing in VCs. Without this level of capital, the technology ecosystem which has developed significantly over the last 10 years cannot continue to grow or even be maintained.”

The tech sector has been the one sector that has prospered in the last five years, despite the macro economic issues Ireland has faced, Roche added.

Enter pension funds

So where do the VCs look to replenish their funds? One target is pension funds, which have €90bn of assets yet prefer to invest in public markets.

“Right now, VC as an asset class, offers very good return on investment,” said Horgan. “There are a number of reasons for this – scarcity of scale-up capital in Europe means attractive pre-investment valuations for investors, IPOs are back, Tier 1 corporates have cash and are acquiring tech companies at high valuations, and many VCs are domain experts in the sectors they are investing in.”

Just look at the US$19bn acquisition of WhatsApp by Facebook and the return Sequoia made on its US$60m investment – it’s estimated to be between US$3bn and US$7bn, said Horgan. Another recent example Google’s acquisition of Nest for US$3.2bn, where investors earned a 20-times return on their investment.

Many of the world’s most successful pension funds are investing in alternative asset classes, which include private equity and VC funds, Horgan said. By investing, say, 2% of a pension fund in alternatives, such as VC, they are not risking the fund but are putting themselves in a position to make material returns relative to the size of the fund.

“Defined contribution (DC) schemes are also a large element of the €90bn,” said Sandys. “The managers of DC schemes demand that the investments have liquidity – the ability to sell in a liquid market on a regular basis. This is inherently impossible in the VC world, where you are dealing with liquid private company investments.

“The end result is there are only a handful of pension schemes that could consider VC. Several of these have made or will make commitments to VC funds, many won’t owing to the foregoing reasons and/or VC just not fitting their investment strategies.”

Seed funds

Another acute area of difficulty could be the seed-funding area, where after significant investment activity existing funds are almost fully deployed.

“As fund manager for €53m AIB Seed Capital Fund, Dublin BIC has seen continuing strong demand for seed-capital investment from start-ups,” said Alex Hobbs of Dublin BIC.

Dublin BIC has made more than 130 investments in 70 companies over the last six years, Hobbs said. Its first-round investments cycle will conclude at the end of 2014.

“Continuing seed investment support for entrepreneurs is crucial to kick start new SMEs and nurture them to grow to the next stage for VC and Series A rounds,” said Hobbs.

When the Irish Government announced the Seed & VC Scheme of €175m in budget 2013, €100m was allocated to Irish VCs late in 2013, said Horgan.

“The remaining €75m should now be allocated to seed funds. The banks, in fairness to them, were very supportive of the seed funds and must be very happy with the results to date. On that basis they also should consider supporting the next wave of seed funding,” he added.

Angel investment by private individuals has risen in Ireland over the past five years. In 2012, €90m of angel funds were available for investment, via the formal business angel networks throughout Ireland, according to the Halo Business Angel Network (HBAN).

‘I would not use the word crisis’

Michael Culligan

Michael Culligan, national director of HBAN

Michael Culligan, national director of HBAN, said the funding journey, from seed to Series A, B and C rounds, requires healthy funding levels. He is confident local funds will receive the support they need.

“I would not use the word crisis, however, it is vitally important that a new round of venture-capital funds is put in place with support from both public and private funding sources.”

Ireland has made significant progress in the range of entrepreneurial funding sources available in recent years, Culligan said. There is increasing co-operation between domestic Irish VCs and international VCs.

“Very often the Irish VC is naturally the initial institutional investor and thereafter leverages in an international VC. This model works well and can help companies to bridge both funding and market access gaps as they seek to scale globally.”

In Ireland, the National Pensions Reserve Fund has invested in VC funds via Innovation Fund Ireland recently, and there is room to build on the progress, Culligan added.

Irish tech firms need to think internationally from the outset with regard to funding, said Leslie. Sedicii has just completed three months in London on the Oxygen Accelerator Programme, culminating in a showcase demo day when it presented to more than 150 investors, ranging from high net-worth individuals to early stage VCs.

Ireland is a small market and tech start-ups should spread their wings and be willing to travel, Leslie said.

In addition to the UK being a bigger market, London is hot right now and it has fantastic tax supports for start-ups, such as the Seed Enterprise Investment Scheme, Leslie added.

“UK-based investors can invest in Irish companies and still take advantage of UK tax breaks provided some conditions (that are fairly easy to comply with) are met.”

A version of this article appeared in The Sunday Times on 2 March

Investments image via Shutterstock

John Kennedy is a journalist who served as editor of Silicon Republic for 17 years