Ireland: expanding the investor base

With investment capital available to the Irish venture capital community close to being 100% committed, Irish VCs are on the fund raising trail again. The Irish Venture Capital Association predicts that VC investment would have to quadruple over the next five years to €4bn if Ireland is to satisfy the demands for capital in the marketplace. Angela Sormani takes a look at how the industry is going to raise those funds and whether the returns generated so far are attractive enough to pull in much-needed LPs.

There are two main issues surrounding VC investing in Ireland: attracting angel investors and realisations. Most high net worth individuals in Ireland have been investing in property so there has been much discussion centred on how to channel this funding to venture capital funds. This year, Ireland’s largest firms, such as ACT Venture Capital, Delta Partners and Trinity Venture Capital will be fund raising for their next vehicles. Whether these and other funds attract private investors, rather than more domestic government support, will be dependent on their ability to demonstrate a track record of achieving attractive exits and competitive returns.

Returns in Ireland haven’t been great, but it is still a young industry. According to PricewaterhouseCoopers (using Thomson Financial/European Venture Capital & Private Equity Association data) Irish VC returns overall in 2005 were as follows: three-year returns -11%; five-year returns -10% and 10-year returns -8%. Total divestments in Ireland in 2005 amounted to just €22.7m compared to €190.7m in 2004. Of this total, 37% of these divestments were write-offs and there were no IPOs with most venture-backed companies continuing to focus on sales to management (buy-back) as an exit route with 24% realising their investment this way.

While the Irish economy continues to be one of the strongest performing in Europe with a GDP growth of 7.9% in 2005 along with an unemployment rate of just 4.3% and an annual inflation rate of just 2.5%, Diane Mulcahy sees the so-far poor returns in Ireland as a major issue for the Irish VC industry to overcome. Mulcahy was a VC in the US for eight years before becoming a fellow at Trinity College Dublin. She has done extensive research on Irish venture funds and their relationship with the Government.

She predicts VC players in Ireland dividing into two camps: “The Irish VC industry is bifurcating. On the one hand are the many VC funds, supported by Enterprise Ireland under its Seed and Venture Capital Programmes, that are too small in size (under €50m) to be commercially viable, since the economics of the VC industry dictate that VC funds require size and scale to be successful. It is likely that these small funds aren’t able to generate competitive returns and won’t be able to raise capital from institutional investors going forward.” In fact, results from the first seed and VC programme do indicate a high failure rate. About 40% of the VC funds did not raise a second round of funding and ended up winding down, says Mulcahy.

On the other hand are the few large (over €100m) Irish VC funds likely to be generating competitive returns, as they have demonstrated an ability over time to raise significant capital from private institutional investors.

In spite of these far from impressive returns at the lower end of the fund size spectrum, fund raising last year was up on 2004. Irish private equity firms managed to raise €74.1m in 2005 compared to €47.4m the previous year, a rise of 56%, according to figures from EVCA. All of this was raised from domestic sources with 37% raised from private individuals, a major improvement on 2004 when none of the funds raised were from this investor grouping. Banks also increased their investments from €2.4m in 2004 to €11.6m in 2005 and now represent 17% of funds raised. None of the capital came from fund-of-funds and no funds were invested directly by government agencies in 2005. However, in terms of government spend, this does not represent a reduction in commitment as the funds committed in 2001 were for a multi-year period.

But these fund raising figures need to see a significant increase to satisfy the current demand for capital in Ireland. Denis Marnane of Enterprise Ireland, which has recently announced a €175m programme in Irish venture capital funds, predicts a need of between €1bn and €1.5bn to fund the Irish VC industry over the next five years and that’s just from Irish investors. The way Marnane sees it, for every euro raised from Irish investors, the same amount is needed from overseas investors.

He says: “We’re at the end of a VC cycle and the start of a new fund raising cycle. Enterprise Ireland’s €175m commitment to Irish venture capital is our third programme of supporting VC in Ireland. We see a need for between €1bn and €1.5bn of commitments to Irish VC over the next five years and we are hoping our €175m will help to leverage another €700m from other investors.”

Enterprise Ireland’s investment process has already begun. Marnane says: “Some funds have said to us, ‘we need your approval here so we can go out and target other investors and say we have had the Government back our fund’.” Which is what Jouni Hakala of the European Investment Fund (EIF) states is critical when the EIF is looking at investing in country-focused funds. “You need local support to be able to attract foreign investors to the region.” But he adds, as always, that ultimately performance is key. “What we look for when we invest in a fund is really the performance.”

Marnane’s view on angel funding is that it can work in certain situations, but start-ups should be cautious. He says: “Enterprise Ireland would welcome more business angel investment, particularly at the seed and early stage where these business angels can also give additional help and advice. However as companies grow and develop they need more capital and many business angels do not have the war chest to continue to support a company through the different investments cycles and can suffer financially, particularly if subsequent rounds are down rounds.”

Enterprise Ireland is inviting proposals from venture capital funds/promoters that can; demonstrate they can raise a minimum fund of €30m; have the expertise necessary to manage VC Funds that will invest in seed, start-up and developing companies; have a level of management skills to enable hands-on input into investee businesses; and have the capability to gain access to private sector and institutional capital. Enterprise Ireland may invest up to a maximum of 50% in any venture capital fund.

The Irish Government is also committing more funds to Science Foundation Ireland to increase the amount of early stage R&D undertaken in Ireland. By the end of 2005, the foundation had awarded funding commitments amounting to over €550m across 830 projects in Ireland. This commitment to R&D was further supported by the R&D tax credit introduced in the Finance Act 2004, which provides an additional tax credit of 20% of certain qualifying R&D expenditure that can be offset against corporation tax.

A further change announced in the Finance Act 2006 is the abolition of capital duty on new equity issued by companies in Ireland. This, coupled with the new holding company regime announced in 2004, is expected to attract further investment to Ireland in coming years. Ireland also provides an exemption from stamp duty on intellectual property rights such as patents, copyrights and trademarks.

The exit gap

The rate of IPOs among Irish companies is low (less than 5%), which is lower than the average in Europe and the US. Diane Mulcahy refers to this as the exit gap. “The exit gap is a problem in that IPOs, on average, generate the highest returns for investors. Ireland’s unusually low rate of IPOs suggests that Irish VCs and investors are missing out on the higher average returns that public offerings generate, which affects each fund’s, and the VC industry’s, overall rates of return. The most common successful Irish exits are trade sales, and the IPOs that do occur tend to be listings on foreign exchanges, such as the London Stock Exchange’s Alternative Investment Market (AIM.) The Irish Stock Exchange has been a poor source of capital raising for Ireland’s high tech venture-backed companies.”

The Irish Stock Exchange has had three different exchanges that cater to small and medium domestic companies, none of which have performed particularly well. They are the Developing Companies Market (DCM), the Irish Technology Exchange (ITEQ) and the IEX, launched in April 2005. The Irish Exchange also had a market called the Exploration Securities Market (ESM), companies previously listed there transferred to IEX upon its launch.

When IEX was launched in 2005, there were eight listings transferred over. During the remainder of 2005 and to date in 2006, six more companies listed. Just over a year since its launch, there are only 14 companies listed on the exchange, just one of which is a venture-backed company (see boxed item titled Irish Enterprise Exchange listed companies).

What is significant about IEX for venture-backed companies is firstly that although over 80% of venture-financed companies in Ireland are technology companies, there are actually no technology companies listed solely on IEX, suggesting this exchange does not appear to be an attractive or viable listing location for Ireland’s high growth technology companies. Secondly, even for companies that do list on the Irish exchange, it appears necessary/beneficial to list on another, foreign exchange as well, such as NASDAQ or AIM. Therefore, Irish small and medium companies, even those that choose to list on the domestic market, must also face and overcome the significant financial, administrative, and market obstacles of listing on a foreign exchange.

The only venture-backed company listed on IEX to date is AGI Therapeutics, which also has a listing on AIM. In February this year the Irish specialty pharmaceutical company held its dual float on AIM market and IEX, raising €42.5m. With a share price of €1.26 per share, it reached an opening day market capitalisation of approximately €85m.

ACT Venture Capital, Seroba BioVentures, Delta Partners and Merlin Biomed Group back AGI. All four got involved in the company’s one and only funding round, participating in a May 2004 fund raising, led by ACT, which saw AGI receive €3.5m. All the shareholders are subject to a 12-month lock-in period.

The Dublin-based business is a specialty pharmaceutical company focused on the development and commercialisation of differentiated drug products for gastrointestinal diseases and disorders. It has six clinical stage product candidates, five of which are in phase II trials.

In spite of the poor IPO opportunities for venture-backed companies, the Irish Venture Capital Association is predicting a renewed optimism among VCs concerning exits. Research from the association reveals over half (56%) of Irish Venture Capital funds expect more of their client companies to IPO over the next two years. In addition a large majority of IVCA members (87%) are forecasting an increased level of exits from client companies through trade sales within the same period suggesting continuing interest from international firms seeking to acquire Irish companies. IVCA chairman Desmond Fahey said: “This is a significant development for the industry as investors in VC funds can now expect a profitable return of capital. VC funds are in a better position to liquidate investments because exit markets are improving all the time.”

Many Irish VC funds are almost fully invested, as evidenced by the survey results indicating only 25% of the respondents expect to invest in new projects in 2006 compared to 80% last year. And just over 60% expect to continue investing in existing companies, suggesting a concentration of limited resources on expansion and follow-on investments. “This confirms that the investment capital available to the Irish venture capital industry is close to being 100% committed. The industry must raise new capital in order to continue to support the development of the technology sector,” says Fahey.

The IVCA is also bullish on job prospects with 87% in the survey saying they expect client companies to increase headcount, with none forecasting a decrease. But the most serious challenge facing companies seeking VC backing, according to Fahey, is the lack of international sales expertise. The survey also showed senior management teams seeking venture capital were often incomplete. “However, this is something IVCA members expect and their funding is often used to attract experienced management into the investee companies,” explained Fahey. He added the survey also raised concerns that cost pressures in the Irish economy, especially salary expectations, are a threat to the success of VC backed-firms.

Where are all the angels?

The evidence is clear that in most vibrant entrepreneurial markets internationally, angel capital is the most significant, frequent and critical source of early-stage financing, so the dearth of such funding may be an obstacle for start-up companies in Ireland. Anthony Clarke, chairman of British Business Angels Association, believes opportunities for the growth of such funding is significant across the British Isles. He recently said: “In the US, business angel funding into small and medium-sized enterprises now stands at US$22.3bn during 2005, which is greater than their entire venture capital funding over the same period. There is now a real possibility that the same balance can be achieved here bringing with it all the benefits of ‘mentor capital’ that is an intrinsic part of the business angel investment model.”

The 2005 Ireland Global Entrepreneurship Monitor (GEM) report emphasises the importance of informal investment as a source of finance for new businesses. Writing in the report, William D Bygrave, who co-founded the GEM and is considered an international expert on informal/angel investing, highlights the fact that, in each of the countries that participated in GEM research in 2005, informal investment exceeded classic venture capital as the main source of capital for start-up companies. He also points out that even in the US, the world leader in venture capital, business angels fund 100 times as many high tech, seed stage companies as do venture capital firms.

According to the report, the average rate of informal investors across the EU and OECD participating countries is 3.08% of the adult population. This raises a concern for Ireland, as the early stage entrepreneurial activity there is higher than the average across these countries, yet the funds available from informal investors are less.

The policy recommendation section of the report suggests measures should be taken to improve access and availability of finance for early stage entrepreneurs, particularly for those who require larger amounts of start-up capital, by focusing on means of encouraging more informal/angel investment.

The main issue in Ireland, however, is that wealthy individuals invest disproportionately in property rather than in equity shares of young companies. This is partly due to the steady and excellent returns in the property market, and partly to the numerous government programmes, incentives, tax breaks and subsidies that encourage investment in property. Diane Mulcahy in her book Angels & IPOs: Policies for Sustainable Equity Financing of Irish Small Businesses counts at least 20 of such schemes, which she doesn’t think is exhaustive.

Mulcahy believes there needs to be a shift of investment focus in Ireland: “The Irish Government has focused exclusively on developing and investing in the VC industry, with little attention to improving the supply of the critical early stage financing that angels provide. This approach puts the cart before the horse, since, internationally, angel financing is by far the most common source of early stage financing and is critical for helping companies finance the growth needed to credibly approach VCs.”

There have been attempts in the past at attracting Irish angel investors by setting up networks but, as many trying to access such capital have found, there is also a certain reluctance among high net worth individuals to be databased anywhere.

Morgan Pierce was the founder of Horsepower Funding, an angel/entrepreneur matchmaking service in Ireland, which she set up in early 2000. She shut down the service because she could not obtain any support to get it through its early stages. She says: “I don’t have the matchmaking service anymore because there weren’t any investors who were willing to take part! There are definitely angels in Ireland who invest, but I came to the conclusion at the time that it is such a small market that it is easy for those who need funding to get to the people they need to get to.”

Also, after 2001 there were few investors in Ireland who actually wanted to invest in technology, and even now the technology market for these investors hasn’t rebounded yet. Pierce says: “For the most part in Ireland what you have are very, very sophisticated property investors. So why invest in a risky technology investment when you can make a good long-term return on a property investment. They are just not willing to take the risk. In contrast to where you can put your money in property and get a pretty sure bet, [venture capital] is just too high a risk for those private investors.”

What this is doing, she says, is forcing start-up companies to do more hard work. “These companies have to generate significant revenue before anyone will even consider looking at them and at that point the VC funds will consider them for funding anyway.”

She adds: “I thought the network was a great concept. It was something I came up with in 2000, but it wasn’t the right time. However, I still can’t see that many private Irish investors funding early stage stuff. I just think they’ll go to another country and buy more property because they can get the returns they want that way.”

New Northern Ireland-based business angel network, halo, seems to be breaking the mould in the region, however. Set up two years ago as an initiative operated by Investment Belfast, with support from InterTradeIreland, Invest Northern Ireland and the Northern Ireland Business Bankers’ Association, the network aims to facilitate the provision of support and financial assistance to entrepreneurs keen to grow their businesses, but lack the expertise, experience and funding required to achieve this successfully. The initiative acts as a matchmaking service between the investor and the entrepreneur based on a confidential selection process. halo also has a steering committee, which includes business angels and VC representation, providing strategic direction and an awareness of what is going on in the industry.

Director Desmond Oliver is pleased with the halo network’s progress so far. “After two years we have recruited our fortieth angel and they have pledged over £10m for suitable businesses to invest in. We are just awaiting the announcement of our fourth investment.”

A similar halo project has now been established in Dublin. Although served by two different jurisdictions and financial services regulations, the two projects will be working closely to promote business angel finance on the island. Desmond says: “It’s in the country’s interest if we can grow the business angel awareness and investment. The main thing is that we have proposals in the pipeline that will be suitable business opportunities for angels to invest in.”

Another medium helping to fly the angel flag is the Internet phenomenon of blogging and the idea that email can also help create an informal, virtual network of angels and entrepreneurs. James Corbett writes the Eirepreneur blog in Ireland ( and recently did a posting on angel investing in Ireland.

One of the bloggers on the site suggested a problem with angel investors in Ireland that the US doesn’t have is that many of the high tech industries young Irish entrepreneurs are in don’t have a long enough history to attract wealthy investors with an interest, professional or otherwise, to understand and invest in them. Angel investment in the US works because the US has had those kinds of industries long enough to entice the necessary industry veterans to produce angel investment. The question then becomes, if Ireland can’t produce a sufficient quantity of angel investment in Irish businesses by Irish people, what can the industry do about attracting foreign angel investment, something which is obviously a major issue considering all funds raised for Irish VC funds in 2005 came from domestic sources.

Stuart Coulson, a successful entrepreneur and business angel, says: “The situation in Ireland is a problem of both scale and youth. There’s never going to be many business angels in Ireland because it’s a small population and a young generation of business angels and so those who are involved in the industry are still tied up in their first projects.”

He adds: “You also have the wealthy grey-haired individuals from the large corporates. There are a huge number of individuals who could be business angels, but who may be of an age where they are still tied into multinational careers. Most of the potential candidates in Ireland are working for the multinationals and are making an awful lot of money and don’t want to risk it on their own.” In Coulson’s opinion it will be when those guys reach retirement that we’ll start to see the angel money coming in.

But there is hope for angel investment in Ireland with entrepreneurs such as Coulson who do have the VC mindset: “From my own perspective, I actually enjoy it. I enjoyed my own start-up experiences and success and I enjoy the capability of going through the excitement of that with angel investing, but not having to live with it 24 hours a day as if it were your own project.”