IVCA director general Sarah-Jane Larkin warns that with Brexit and EU tax harmonisation looming, Ireland needs to get serious about backing its start-ups and SMEs.
The recent funding results from the Irish Venture Capital Association (IVCA) ought to have sounded triumphant when you consider that funding levels for Irish tech firms surpassed €1bn in just one year.
Reading between the lines, however, the results revealed that the figures were skewed by two massive €100m-plus deals and that, if anything, the Irish tech start-up community is heading directly for a seed funding time bomb as State-backed funds leveraged by venture capitalists (VCs) peter to a halt.
‘Corporation tax has generated fantastic economic returns but it will come under threat if there is European tax harmonisation’
– SARAH-JANE LARKIN
Not only that but, as well as an underlying softness in the market about to be revealed in Q2, funding from European VCs is also drying up.
I discuss this with Sarah-Jane Larkin, the newly appointed director general of the IVCA, who warns that there are a number of potholes in the road ahead for firms trying to scale up or get off the ground.
One of those potholes is a recent amendment to the Finance Act in November last that prevents friends and families from participating in Business Expansion Scheme-Employment Incentive and Investment Scheme (BES-EIIS) rounds, often the only source of seed funding for Irish start-ups.
Larkin, who holds an MBA from the Michael Smurfit Graduate Business School, lives in Cork with her young family. Prior to her recent IVCA appointment, she was commercial director at global pharma giant MSD. She has worked at director level in the healthcare and medical device sectors for more than a decade for organisations including J&J, Sisk Healthcare and the Irish Medical & Surgical Trade Association.
“Certainly the drop-off in seed funding in the first quarter of 2018 was really dramatic and really stood out,” Larkin said, referring to the recent results.
“Will that be a trend in Q2? That is something that we are really eager to see ourselves. As I mentioned, the seed funding has been cyclical; it comes in waves and we are heading towards the end of the wave.
“The figures … were a 50pc increase in 2017 and 2016. That’s the sign of people having money and wanting to spend it, and maybe now we are heading into a period where that money is gone and there is a gap, which is very challenging if you are a company that needs the money today.”
Crucially, what Larkin is referring to is a €65m seed fund created by the Irish Government three years ago that has been fully leveraged but has now run its course without any sign of a replacement.
Is there a strategic plan for backing Irish entrepreneurs?
She believes a new kind of approach to seed funding is needed to avoid future potholes and ensure start-ups aren’t affected when funds close.
‘We have to appreciate that the indigenous SMEs will be the lifeblood of our economy’
– SARAH-JANE LARKIN
“What we would like to see is a rolling seed fund. This situation shouldn’t be allowed to happen; there never should be a situation where there isn’t enough seed funding in the market at a given time and that is my suspicion at the moment.”
She said that the creation of the €30m Ireland Smart Tech Fund by the Dublin Business Innovation Centre (BIC) is a source of encouragement but the problem doesn’t just lie with Government supports. What is needed is institutional investment from banks and pension funds.
“The other thing apparent from our figures that will be more of a concern is the drop-off in deal sizes of up to €5m. These were 28pc in value and 16pc in volume in Q1. That is a concern for the overall landscape for entrepreneurs and scaling, and the health of the ecosystem, because the really big guys seem to get the funding anyway.”
By big guys, she is referring to $100m-plus rounds by Limerick’s AMCS and Dublin’s Intercom.
“I would definitely have a concern of that €1m to €5m level,” she said referring to efforts such as the EU creating a giant “fund of funds” that could be leveraged by institutional investors.
From my earliest experiences of dealing with the IVCA, it is clear that there is a constant struggle to get institutional firms such as pension funds and insurance companies to invest in VC funds and entrepreneurs and not just the stock markets.
Larkin said: “There is definitely a recognition that there is not enough money in Europe as there could be and, when you look at our Venture Pulse figures, one of the things that was striking was the amount coming from America rather than Europe.
“There is an issue overall in Europe in terms of funding and Ireland is an island behind an island at the very edge of Europe, so we are going to mirror some of those trends.
“We are very lucky that our VCs have some of those relationships across the world. The average amount syndicated internationally is 60pc of the funding that is coming in through Irish VCs but through the US and Europe and other jurisdictions.
“We have always been able to attract money, which is why you need really healthy VCs to do their due diligence and kick the tyres and be attractive to other funders … in Ireland, we really need now to look at the whole landscape, the threat to our economic model around Brexit, the likelihood of FDI continuing with US tax changes, and a trade war between EU and US.
“It is a good time to take a look back at all the supports we have in place and make sure we are eliminating any gaps.”
Brexit war drums beat on
Critically, Larkin warns about the £20bn fund of funds being created by the UK government to support British start-ups once Brexit takes hold.
This brings us to our next point: why does it seem the Irish establishment fails to back start-ups in the same way as it provides generous supports for multinationals?
This covers a plethora of issues from capital gains tax to stock options and even pensions. All of them are related. Even though the SME sector supports the majority of the economy, its employers and employees appear to be continuously penalised and on the back foot financially.
Even when it comes to exits and awarding stock options, the UK just seems to have a much better set-up than Ireland when you consider capital gains tax (CGT) and the superior EIS-SEIS (Seed Enterprise Investment Scheme).
Larkin said that more work needs to be done with the KEEP scheme announced in last year’s Budget as well as the previous changes to CGT.
What is needed, she believes, is for officials from the Department of Finance and the Revenue Commissioners to just listen to entrepreneurs and understand them.
“Sometimes, we look to the UK or US but if you look at Denmark or Sweden, everything there works well across the entire ecosystem, from policy supports through to stock exchange, where small companies can list and generate an exit for investors. One of the things I found odd is that we are answering questions around specific policy supports in isolation. We are answering a consultation on the EIIS and the share options scheme, which doesn’t touch on capital gains tax.
“That would be the one big difference I would like to see addressed. Even just six months into this role, I would see a need to step back and have a look at the overall ecosystem, listen to entrepreneurs who have gone through it.
“Look at the market and stand back and ask: ‘How can we have a world-class ecosystem?’”
Nothing happens in isolation and Larkin believes that everything from pensions and tax reliefs, to the dearth of investment in entrepreneurs and the small number of private sector workers with actual pensions, are all part of the same problem. Everything requires a fresh look and a new strategy.
She points to efforts by the UK government to encourage institutional investors to back British entrepreneurs.
“The difference between the UK and Ireland on this is that in Ireland, this is an IVCA idea that we are trying to promote. In the UK, this was a government-sponsored initiative and the government said, let’s do a consultation on this, let’s go out and get the views of everybody who might be a stakeholder in this. And, after a year, they now have developed a fund of funds that allows for the institutional investors and the kind of patient capital that SMEs need.
“You could unlock substantial value if only a small portion of their coffers went into an asset class that is venture capital. But if you look at the amount of pension funds being managed in Ireland, just 1pc or 2pc of that funding innovative SMEs could totally revolutionise the funding landscape.”
Ireland needs to think holistically about entrepreneurship
Larkin is motivated to focus on solutions rather than lament problems and is hopeful that an overall review of the entrepreneurial ecosystem is embraced by policymakers and institutional investors as Brexit looms.
In her new role, she is studying various funding routes from angel investment to crowdfunding and initial coin offerings (ICOs).
“We would be broadly in support of anything that helps an entrepreneur get their product into the market and get feedback.”
That said, the loss of the involvement of friends and families in BES rounds will hurt start-ups.
“They can still invest but won’t have the same tax breaks because European Block Exemption Regulation says you cannot have an association with a company to benefit from a tax break from an investment.
“One of the requests that we have made is that, if that is the case, that under the EIIS scheme family and friends can’t get tax incentives, that needs to be looked at and some other replacement is needed.”
Looking to the future, she is keen to get involved in encouraging more investment in women-led tech companies as well as increasing the number of women in the ranks of VC firms in Ireland.
“One of the anecdotal things I have discovered is that men and women approach venture capitalists very differently. Women will have informal meetings and coffee with potential investors at networking events but will wait for a formal setting or invitation to do their pitch, while male founders will use any opportunity to get closer to investment. What we need to do is make sure women founders do the same and are ‘investor-ready’ all the time, not building up to it.”
Ultimately, Larkin believes a fresh approach to Ireland’s entrepreneurial ecosystem is needed with policies that support them, removing roadblocks. One suggestion she has in mind is a Minister of State for start-ups.
“We have to take a step back and look at our economic model. Corporation tax has generated fantastic economic returns but it will come under threat if there is European tax harmonisation.
“We have to appreciate that the indigenous SMEs will be the lifeblood of our economy and hopefully, we will have major success stories – maybe the next Google will come out of Ireland. Right now, we need to smooth the path for them.”