Ireland’s start-ups are sitting on a seed funding time bomb

11 May 2018

Image: Fer Gregory/Shutterstock

With seed capital plummeting and the funding market softening, the failure by policymakers to create tax reliefs equal to the UK’s EIS-SEIS is shameful, writes John Kennedy.

Irish-based start-ups are heading for a seed funding wall. And, if they hit that wall, all the good work in building entrepreneurial momentum in Ireland over the past decade risks being dissolved.

We have to ask ourselves, do we want a tech economy that only supports multinationals?

It became clear to me this week that things are changing on the funding front – and not for the better. The headline figure from the Irish Venture Capital Association’s (IVCA) Q1 analysis of investment in Irish tech suggested that the €1bn barrier for the past year had been surpassed. It looked rosy, but it’s not. Far from it.

IVCA chair Peter Sandys had the honesty to point out that the €332m raised during the quarter was a misnomer and that a large number of deals – including two circa €100m raises by Intercom and AMCS – actually mask what, in reality, is a major fall-off in funding.

The figure could actually be a lot worse when you consider Intercom isn’t technically an Irish company. It has Irish founders but was founded in the US and is, to all intents and purposes, a US company that happens to have a substantial workforce and development base in Dublin.

“The second quarter will give us a better picture as to whether we’re witnessing an underlying softness in 2018,” Sandys said.

His colleague, Sarah-Jane Larkin, director general of the IVCA, said a lack of capital in Europe is exacerbating the problem.

The truly frightening aspect of this is that seed investment – initial funding that start-ups need to get off the ground – accounted for just 1pc of the total €332m in Q1 and is actually down 50pc on the same period in 2017. Additionally, there has been a decline in deals below €5m, of 16pc in number and 28pc in value.

Q2 is likely to reveal that the start-up scene in Ireland, hampered by a lack of funding at seed level, will have hit that brick wall.

But wait, isn’t there a nice big tech boom going on?

tech ireland, bank of Ireland, scaling successfully event

From left: Katharine Byrne, corporate finance partner at BDO Ireland; Adrian Mullet, head of technology sector at Bank of Ireland; Sandra Notardonato, research VP with Gartner; Jack Donaghy, CEO, Roomex; Philip Maguire, CEO, IT Alliance; and Paul Sweetman, director of Technology Ireland. Image: Julien Behal

I reported in March how the indigenous Irish tech industry was forecast by Bank of Ireland to grow more than 20pc this year.

Those figures were repeated this week at a TechIreland-Bank of Ireland event on successful scaling by the bank’s head of technology, Adrian Mullett. He said that the robust forecast was also influenced by a 150pc increase in the level of debt funding to technology firms in software, telecoms and IT services compared with 2016.

On the surface, this all looks good. However, this really concerns established tech firms, many of which are evolving from traditional software sales to a SaaS model, with the core mantra now being ‘customer success’.

Many of these companies have been through the mill of surviving and scaling in a small economy with insufficient tax breaks and a dearth of seed funding. They are a hardy bunch. But, it is clear that at the other end of the spectrum, among not-so-established tech start-ups, this dearth of funding is going to be a killer.

So, what’s the solution? Companies need to get off the ground somehow.

Year after year, in budget after budget, the Irish Government has failed to address the anomalies around capital gains tax (CGT) and employee share ownership.

Irish start-ups need a simpler tax code

Many entrepreneurs in Ireland get their initial seed funding not from angel investors or venture capitalists but, in most cases, in ‘friends and family’ rounds using the mechanism called BES-EIIS (Business Expansion Scheme-Employment Incentive and Investment Scheme). The problem is, these mechanisms, which allow investors to write off part of their tax bills, don’t do enough or go far enough.

In Ireland, the total amount invested under BES has fallen by 70pc since 2011. In the UK, a more competitive scheme called EIS-SEIS (Seed Enterprise Investment Scheme) has grown in participation by 55pc and there is evidence that Republic of Ireland start-ups are locating offices in Northern Ireland to avail of the more realistic UK scheme.

While Budget 2018 avoided CGT, it attempted to address employee share ownership through the KEEP initiative, a move that was cautiously welcomed at the time by veteran entrepreneur Brian Caulfield.

At the time, Caulfield pointed out that under the current scheme, however, if a company is acquired, share owners would be automatically hit with a high tax bill.

“It seems they [the Government] just don’t get start-ups, and the start-up community is badly organised and fragmented and does not have a powerful lobby in the same way that the farmers or the tourism sector does.

“Failure to resolve CGT is yet another missed opportunity. To some extent, there is a sense of, ‘Well, sure aren’t they doing grand’, which is informed by the perception of the rude health of the tech economy they read about in the newspapers.

“But, as we all know, young start-ups and small tech companies are struggling to keep the show on the road.”

At the TechIreland-Bank of Ireland event, I asked Katharine Byrne, corporate finance partner at BDO Ireland, what she thinks of Ireland’s continual failure to come up with a similar scheme to the UK’s.

“We are really frustrated with the system having had a fund for 25 years, originally the BES and then the EIIS … when it was originally established, it was fit for purpose and now it is not,” she said.

“Unfortunately, with the system we have now – EU State aid rules have forced a change in the rules – those rules don’t appear to be entirely clear to the Revenue, and there is a significant delay as a result.

“But, if you step back from it and say, in principle, here is an opportunity for investors to get tax back on their investment up to 41pc, it is still very attractive. So, there’s an opportunity to raise significantly more funds within this and private placement.

“But, to me, failure to make changes slightly to adapt more along the lines with the UK is more frustrating when you look at other tax reliefs that are in the country. When you look across the water, they have a very well-established system. Entrepreneurs’ relief of €1m on capital gains tax is not enough and needs to be increased significantly.”

Less red tape, please

I put the same question to Philip Maguire of outsourced tech player IT Alliance who said that the big problem for tech start-ups in Ireland is red tape.

“I would like to see a focus on the whole R&D space. Enterprise Ireland provides a lot of great support.

“But I don’t know how many times we need things audited by how many different agencies, and then you add the tax-back idea on top of that and, lo and behold, there is a whole new set of people that arrive to do an audit and a different set of rules.

“Just give us one set of rules, please. And, if Revenue wants to get that up and running from the get-go and everything is clear, that would be great.

“But simplify the whole thing. The ideas are there, but it is just way too complex. And that’s coming from a company that is well established and a lot more mature.

“I don’t know how start-ups can get involved.”

Put simply, the policymakers in the Department of Finance and their colleagues at Revenue need to act quickly and put in place a similar system to the UK that enables entrepreneurs to get backed and investors to get a return.

As seed funding dies off, so too will Irish start-ups.

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