It’s crunch time for early-stage venture funding in Ireland

9 Nov 2015

Ireland needs more clarity on seed funding and needs greater numbers of business angel investors. Photo via Shutterstock

Seed funding is running out and angel investment is still quite low. In the broader context of a venture capital funding crunch, how will Ireland weather the storm, asks John Kennedy.

Talk to any start-up in Ireland today and they’ll quite honestly tell you that, despite their grumbling, Ireland has one of the most supportive environments for a start-up anywhere in the western world. Yes, there’s a lot of doors to be knocked on, red tape, exacting requirements by Enterprise Ireland and more, but it is better than most. It’s probably better than it has ever been.

Of course, this is belied by the damp squib of a Budget for 2016, which failed to address urgent issues like capital gains tax, share options and tax allowances for company owners and the general consensus that the UK is further along in terms of encouraging start-ups to begin in the first place. It is still a shock to quite a few in the entrepreneurial community that, despite all the budget submissions and the Start-up Gathering of 400 events across the land, barely a nod nor an attempt was made to acquiesce to urgent demands.

‘There continues to be an encouraging international investor appetite for Irish tech firms, although these investors usually require the reassurance of local venture capital involvement’

None of these demands were new. They weren’t even novel. But they were made with an energy and zeal I had never seen before. In a Budget aimed at securing a populist vote, anger and outrage among entrepreneurs was lost. It’s as if it was decided we can sacrifice this one little camp to appease the many and, sure, maybe we can address this other shower the next time.

But time is an issue

On the surface things look good, as venture capital investment in the first nine months of 2015 reached €415m, this is up by a third on the €401m invested last year. The IVCA VenturePulse survey shows that Irish companies raised €108.2m from investors in Q3 2015.

However, there is cause for concern. Total seed funding raised during the third quarter was a mere €6m, just 6pc of the total funds raised.

In the context that the brilliant seed funds managed by Bank of Ireland and AIB are reaching the end of their current life, addressing this seed funding anomaly is urgent. Otherwise, it will be harder for local start-ups to attract international investment.

“There continues to be an encouraging international investor appetite for Irish tech firms, although these investors usually require the reassurance of local venture capital involvement,” said Regina Breheny, director general of the IVCA.

Precisely. Unless we have a strong local seed funding environment then it will be harder to maintain the levels of investment in high-growth Irish firms.

For this reason, plans need to be laid for what happens when the Bank of Ireland and AIB seed capital funds reach the end of their lives.

We need more angels

IVCA chairman Brian Caulfield, who is a seasoned and respected tech entrepreneur in his own right, isn’t one to mince his words. At the IVCA’s recent annual dinner, he rightly pointed out that while the Government has been supportive of the industry through Enterprise Ireland and the Ireland Strategic Investment Fund, it remains difficult to attract matching private institutional capital to what is a high-risk and illiquid asset class.

Locally, this means encouraging the pension funds to place investment in venture capital funds rather than focus mainly on stock markets. When it comes to seed funding and generating the businesses and industries of the future in Ireland, the pension funds need to listen

Caulfield has pointed out that Ireland’s start-up scene was in danger of being stifled due to lack of tax incentives for angels and early-stage backers combined with discriminatory personal and capital gains taxes for entrepreneurs.

“Conventional venture capital was never intended to efficiently make investments of €20,000 to €100,000,” Caulfield told the venture capital industry. “We need to create a vibrant angel capital environment and to look at other innovative funding approaches for these seed-stage companies. We need look no further than the UK to see the transformative and job-creating impact that such approaches can have.”

But where are the angels?

Angel investors – or business angels as they are sometimes known – are generally people who have been successful in business, have cash to invest but also wish to be involved in an advisory or mentorship capacity. They want to help. Most of their activity tends to be discreet, behind the scenes and usually depends on personal connections.

Attempts have been made to formalise their existence through groups like the Halo Business Angel Network, which organises willing business angels into syndicates where as a group they can invest in specialised areas like ICT and medtech.

Since 2008, investment by HBAN members has reached the milestone of €50m invested, which in the overall venture capital picture is just a drop in the ocean. But it is a nevertheless vital drop in the funding pool because thriving Irish tech companies like Storyful (acquired by News International), AventaMed, DecaWave, MicksGarage, EMBO, Scurri and X-Bolt Orthapaedics owe their endurance and success to angel investors taking a chance on them.

The simple truth, as Caulfield pointed out, is we need more of these angels to participate in order the get the ball rolling. It’s a symbiotic thing because, as pointed out earlier, these companies need to get the local investment early on to get to a stage where they can attract the international investors later on.

The international landscape is shifting

On the face of it, tech is thriving and the venture capital activity is frenetic, epitomised by the massive amounts of investment going into so-called unicorns like Uber, Airbnb and even Stripe, which was founded by Irish brothers Patrick and John Collison and is currently valued at $5bn.

These businesses differ from their dot-com counterparts of 15 years ago because they are actually fixing real-world problems, transforming existing industries, and right-sizing them for the digital age. They have real revenues and it is only a matter of time before they go for the inevitable IPO.

In the meantime, they are absorbing greater amounts of available capital, which again puts pressure on other companies in the ecosystem to compete for investment. This will become particularly acute at the seed and angel stage because waiting and seeing ebbs on everyone, even the smallest investor.

Just like on the face of it in Ireland, the investment picture looks strong across Europe. But beneath the surface there are worrying signs.

In Europe, strong valuations have helped the total amount of investments made by the third quarter of 2015 soar to €9.5bn. However, according to the Pitchbook European PE Breakdown for the fourth quarter, quarterly deal count has fallen 36pc from its 2014 peak when there was a swell of activity that hit 1,534 deals.

Between the UK and Ireland, the number of deals fell to 377 in the third quarter of 2015 from 551 this time last year.

The €9.5bn sum has been skewed heavily by Spotify’s massive US$526m funding as well as continuous late-stage investment in Delivery Hero.

“It stands to reason that if there is an imbalance of late-stage investment flooding a select group of hyped start-ups in the US, Europe would see a similar overweighting,” Pitchbook said.

“The issue with the spread of VC funding is that many fear there is a lack of necessary capital infusions at earlier stages. That may not necessarily be the case, as breaking down venture activity by stage reveals there is still plenty of money flowing at the early stage, and a reasonable chunk of euros devoted to angel/seed activity.

“But the decline in round counts across the board suggests spread issues on a smaller scale at even the early stage, with cautious investors plying only the best-prepared start-ups with wads of cash in order to keep up with current round and valuation inflation, to the detriment of smaller companies that warrant investment but miss out by a small margin of risk.”

With activity weighted towards the more established companies, at a time of greater-than-ever awareness of start-ups and starting up, locally in Ireland we need clear signals as to what’s going to happen after vital existing seed funds reach the end of their current existence.

As well as growing the ranks of business angels, clarity on tax issues would also encourage successful executives from start-ups to invest more readily in the local scene. In essence, creating angels by default.

Just because the numbers look good today, the cracks are beginning to show. We need to worry about tomorrow.

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Seed funding image via Shutterstock

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