Ireland’s VC community has benefited from continued financial support from its Government, but the time has come to prove itself in the private sector in the next round of VC fund raisings. The Enterprise Ireland scheme was originally set up to close the equity gap, funding fledgling companies to create a robust VC industry in Ireland. Many VCs believe this equity gap is now closed and are welcoming the prospect of increased funding from domestic and international institutions for the next stage in Ireland’s VC development and to set the scene for the nascent buyout market. The Irish-focused LP, however, is still hard to come by. Angela Sormani reports.
The limited partner (LP) issue is fundamental to what is going on in the VC industry in Ireland at the moment. The Irish Government has always been a dominant LP, particularly for many of the smaller funds, and there is increasing concern about the lack of domestic pension fund investment in Irish VC funds. This has to do with a number of issues: lack of a tradition of investing in private equity; pension funds preferring to invest in property rather than equity; lack of education on the part of the trustees about private equity investing; and the as yet unremarkable returns of Irish VC funds.
Niall Carroll of ACT, one of the longest-standing VC funds in Ireland, says: “The Irish institutions aren’t fully used to private equity yet. But this is changing. ACT has a solid international investor base, and this encourages Irish LPs to invest alongside them. Most Irish LPs don’t invest in venture capital funds outside Ireland, but they’re now beginning to look at venture capital as an asset class; this will lead them to develop an investment strategy, and decide what percentage of their funds they’re going to invest in private equity.”
Shay Garvey of Delta Partners, and outgoing chairman of the Irish Venture Capital Association (IVCA), adds: “Most Irish pension funds will invest in alternative assets, but don’t drill down to create a sub-asset allocation to venture. A long-term education is needed.”
The issue of where the next generation of LPs is going to come from is particularly timely as some of the largest Irish VC funds, which raised funds back in early 2000, should be due out to fund raise soon. Prominent players such as ACT Venture Capital, Delta and Trinity have all managed a balanced mix of institutional money in the past. Trinity, for example, for its E139m second fund, which is now three-quarters of the way invested, raised just under 10% of its fund from the Government. Its main investors are institutional investors and fund-of-funds. Irish investors in the fund account for between 50% and 60% of commitments.
In its third and largest venture fund, which raised E170m at the beginning of 2003, ACT Venture Capital also attracted a mix of investors. The fund was raised from institutional and fund-of-fund investors from Ireland and overseas. The Irish investors include AIB Group Irish Pension Scheme, Bank of Ireland Asset Management, Eircom Superannuation Fund, ESB Pension Fund, Friends First, the GMS Superannuation Fund, Hibernian Investment Managers and KBC Asset Management. International investors include JP Morgan Fleming and Merrill Lynch from the US, Partners Group from Switzerland, Access Capital Partners from France, Extorel and VCM from Germany, and the European Investment Fund in Luxembourg.
ACT, Delta and Trinity have all managed to attract a significant proportion of their funds from overseas, as well as attracting Irish LPs to their offering. The question on people’s minds now is whether the VC funds in the next round of fund raising, and those with a less-established track record, will be able to attract capital entirely from the private sector without relying on Government money. Enterprise Ireland has been supporting the VC industry for ten years now and at some point the Irish VCs will have to wean themselves off this money if the country is going to compete with the rest of the more mature European private equity markets.
The source of capital for VC funds is a determining factor in the development of a stable VC industry. In the US, pension funds are the largest supplier of capital to the VC industry, accounting for around two-thirds of funds raised. In Europe, the figure is somewhat lower, accounting for around 22% of funds raised between 1998 and 2003, according to the European Private Equity & Venture Capital Association (EVCA.) Ireland’s intake from the pension fund industry stands even lower, at 11%.
“Ireland raises far more capital from government sources than either Europe or the US,” says Diane Mulcahy, author of Angels and IPOs: Policies for Sustainable Equity Financing of Irish Small Businesses, who 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.
While government funds have contributed to the successful seeding of Ireland’s domestic venture capital industry, Mulcahy and many others are of the view that continued reliance on the Government as a significant source of capital could threaten the long-term growth and success of the Irish VC market.
Mulcahy outlines three main reasons. Firstly, government funds are dependent on political allocations and support that can erode quickly or disappear entirely in the face of, for example, a change in political party, short-term returns volatility, investment failures or a bear market.
Secondly, governments are not generally return-driven investors. This means government funding introduces the distraction of non-return objectives, such as economic development or regional investment. And thirdly, government funding does little to foster the long-term credibility of the Irish VC industry, carrying with it the stigma that Irish venture funds are not competitively able to attract and raise private capital.
Mulcahy says: “The largest Irish VC funds are getting ready to go out into the fund raising market in the next 12 to 24 months and support from private sector LPs will be critical to their ability to survive over the next years. It will be interesting to see if they can raise the capital they seek, and if they can do so from private sector LPs in Ireland and abroad, rather than the Government.”
She adds: “What the industry has to ask itself is where the domestic pension funds are and why they aren’t investing. Part of the issue is that trustees don’t have a knowledge or culture of investing in private equity, so there could be an education issue.”
This is the main challenge facing the Irish venture capital industry: to develop a stable source of private sector institutional capital to fund and sustain the industry’s growth. The most viable source of untapped institutional capital currently available in Ireland is domestic pension funds.
Shay Garvey at the Equity Network Private Equity Conference in Dublin earlier this year emphasised the need for institutional funding and pointed out that the VC industry could fade away through the lack of institutional support, which would severely curtail the growth of Ireland’s indigenous high technology sector. He stressed that to survive a shared vision and a concerted effort is needed between the VC industry, the institutional investors (pension funds, insurance companies and banks) and Government.
Many of the existing funds in which Enterprise Ireland participated in its 1994 to 1999 Indigenous Industry Development Sub Programme are expected to be fully committed by the end of 2005 and many of these fund managers have already begun the process of seeking private sector commitments for new funds, which they hope to establish in 2005/2006. As part of this process a number of fund managers have approached Enterprise Ireland requesting it participate again in the proposed new funds. Enterprise Ireland has been involved with the VC industry for so many years and seeded so many small (under E20m) VC funds, which are probably not sustainable in the long term. “You can’t have a fund of E20m and expect to attract an institutional investor,” says Diane Mulcahy.
And so the Irish Government is currently undertaking its own evaluation of the VC industry, which PricewaterhouseCoopers is in the process of putting together, to decide what the next step is for Enterprise Ireland and its seed and early stage funding programme and whether it still has a role to play in the development of the seed and venture capital market in Ireland. The evaluation will be completed in July.
Mulcahy suggests one way the Irish Government could help the evolution of the Irish VC market is through its own pension fund assets, the National Pensions Reserve Fund (NPRF), a circa E10bn fund established in 2000 to fund social welfare and public service pensions from 2025 to 2055.
Sweden has followed a similar strategy, investing public sector pension fund capital in private equity funds, and pension funds now account for around 20% of venture capital funds raised in Sweden, compared to 0% in 1996, according to EVCA figures.
The NPRF does not currently invest in private equity as an asset class although its 2003 Review indicates it has started working on business plans for such investments and this should help raise the profile of private equity among pension fund managers.
The lack of domestic pension fund participation in Irish VC funds was also the subject of the 1993 Murray-Walsh Report, commissioned by Bertie Ahern, the then Minister of Finance, which reviewed Irish pension fund investment in venture capital. The report confirmed that Irish pension funds were investing very little in venture capital and following publication of the report, the Irish Government extracted a commitment from the Irish pension fund industry to invest £100m (around E126m) in domestic venture capital funds in 1999.
But there has been a gradual increase in international pension fund commitment in Irish VC funds, up from E2.5m in 2003 to E4.7m in 2004, accounting for 14.4% of funds raised, compared to 4.7% the previous year, according to EVCA figures. What percentage of this comes from Irish pension funds however is undisclosed.
According to the Irish Association of Pension Funds (IAPF), reasons for the lack of pension fund investments in private equity include the absence of decision-making at the strategic asset allocation level to invest in private equity; a dearth of trustee experience with knowledge of private equity investments; little tradition of investing in private equity and a cautious investment culture that resists the shorter-term volatility of private equity as an asset class.
Ways of tackling these barriers might include educating trustees about private equity as an investment class, disseminating aggregate performance results of VC funds and issuing a standard valuation policy to provide transparency to potential investors.
Mulcahy’s research reveals that increased investments by Irish pension funds would have a significant impact on the domestic VC industry. For example, if Irish pension funds invested 2.5% (half the rate of the US) of their US$50bn of assets into private equity, E1.25bn would be available to invest. Of that, assume a 15% allocation to venture capital and of that a 25% allocation to domestic venture capital (only half of the 50% normally allocated to domestic equity securities, according to the IAPF.) This would bring nearly E50m of capital to the Irish VC industry annually, a significant addition to the average of around E200m recently raised per year. And so even a very conservative asset allocation case would be compelling in terms of its impact on the Irish VC industry.
Performance is the main factor deterring domestic institutional investors from committing to Irish VC funds. The Irish VC industry does not release aggregate returns information, so it is difficult to determine relative returns performance. Mulcahy says: “The whole industry is pretty secretive in Ireland in terms of disclosing aggregate return results from the past 10 years, even more so than the rest of Europe. Certainly the lack of IPO exits has had a negative effect on returns over the past decade and with the rate of IPOs so low in Ireland, it is hard to imagine how they could match the average returns in Europe or the US.”
As the public sector is such a prominent investor in these funds, there is an argument for some sort of transparency in these returns. One of the main reasons for a lack of this data is that most of the VC funds are so small, that the large funds (of which there are only a handful) would dominate the figures, giving skewed results.
Shay Garvey says: “The Association doesn’t get involved in returns data, it’s only ever collected by the consultants. We have never said that it’s part of our remit, especially in Ireland, where there are so few players. There are 22 paid-up members of the Association, but there are only really 15 active VCs. The VC partnerships set up in 1994 such as AIB, ICC and Delta, which all received pension fund allocations, are now maturing. I would know anecdotally that all those funds have done well and have done as well as any fund in Europe of that vintage.”
One of the reasons the stellar returns are not there in the Irish market is because it is still a young market, which is predominantly tech-focused. During the bubble too many companies got funded and there were too many VCs. When it burst, the demand collapsed and the customer base shriveled. John Tracey of Trinity Ventures says: “There haven’t been that many exits over the last two to three years, but that’s starting to change. This is because between 85% and 90% of Ireland is technology deals.”
Niall Carroll at ACT adds: “Ireland has been a VC tech hotspot since 1996. But if you consider the bubble and the bust, many of the deals done in 1999/2000 are probably underwater so any returns on a portfolio built up in that period will not be great. It was a matter of assessing what degree of trouble these companies were in and whether they were worth saving by providing them with more and more capital during the tech downturn.”
That said, the fact that US VCs have been seeking out tech investment opportunities in the Irish market certainly points to its potential to generate returns.
Another issue holding back the market in terms of exit opportunities is the poor performance of the Irish Stock Exchange and a lack of planning and preparation for public offerings within Irish small businesses. London’s Alternative Investment Market (AIM) has proved a popular exit route and Ireland is highly represented on the exchange, with fewer than 20 company listings.
Trinity Ventures’ John Tracey says: “One of the main problems in Europe as a whole is a lack of a public market. There is nothing that would rival NASDAQ although AIM is an interesting route. The Irish Stock Exchange is launching its own AIM-type exchange, EX. But the main advantage AIM has is liquidity. There is a slight indigestion on AIM as quite a few companies have gone public, but it is a very viable route for young companies.”
There are certainly enough investment opportunities to go round. The keyword in Ireland, as always, is technology. In the US you have Silicon Valley. In Ireland, the greater Dublin area is one of the main technology centres in Europe. According to the Organisation for Economic Co-operation and Development (OECD) Ireland has the second highest rate of entrepreneurship in Europe. And for this reason there is a high level of international investment in Irish technology companies. But at the same time international VCs want a credible local partner on the ground and will normally only come into a VC funding round once a domestic investor is already in place.
John Tracey says: “In most cases where a US investor has invested there is already an existing Irish VC. I do believe you need a credible Irish investor in there first. For us, it’s very important that international VCs choose to invest here when they could choose to invest anywhere in the world. And if they’re not investing here we should ask ourselves why not?”
He cites the importance of links with the US. “The US is very important as the likelihood is your strongest competitor is going to be in the US and you really need to validate your product there and so the earlier you look there, the better.” Of Trinity’s 16 portfolio companies, a third of revenues are in the US. And yet all the companies are Irish. This investment model is a similar model to the Israeli style of VC investing, which exports its strong technology base to take advantage of the sales and marketing opportunities Stateside.
John Tracey says: “All of our companies sell overseas, some of our companies here have zero sales in Ireland. The increasing level of international investor interest in Irish companies reaffirms the opportunity there is here.”
Niall Carroll adds: “Because of the small size of the Irish economy, and despite the existence of many US multinationals here, hardly any technology companies sell anything in Ireland. The technology is here, but most is marketed to the US. As a country that exports almost everything that we produce, Ireland has a similar mindset to the Israeli model of investment, but, of course, has a deeper manufacturing infrastructure.”
John Olden, head of the venture capital and private equity practice at A&L Goodbody, which over the years has advised many of the members of the IVCA, says: “There is a cultural ease of dealing with the US. It is easy to pick up the phone to someone in the US. The very specific sectoral focus of US Route 128 and Valley-located funds, particularly in the area of ICT and life sciences, is important as those are the areas of most Irish start-up activity. Additionally many senior managers have worked for the Irish operations of US corporates and are sophisticated in working their US networks when they establish or join a start-up.”
Healthcare: the new technology?
While technology will always be Ireland’s forte, Irish VCs are showing an increasing interest in healthcare investments with established players such as ACT and Trinity both incorporating such investments into their portfolios. Enterprise Ireland is encouraging this trend and expects to see the number of life science start-ups in Ireland double in the next couple of years to over 100. To date, it has invested around E20m in seed funding in over 60 life science projects.
John Tracey of Trinity Ventures, however, doesn’t see the trend reaching the heights it has in neighbouring countries down to the simple fact that Ireland doesn’t have the same pharmaceutical skill base present in the UK or Germany, for example.
The three main areas in healthcare, which Irish VCs see as lucrative investment opportunities, are drug development; medical devices; and IT and services for the medical sector, all of which are easily exportable areas.
Seroba BioVentures is the manager of The Irish BioSciences Venture Capital Fund (IBVCF), Ireland’s only venture capital fund exclusively dedicated to the life science and medical technologies sectors. Seroba launched the E25m IBVCF in February 2002 that invests in start-up and early stage life science and medical technology companies spinning out of Irish research Institutes, universities, research hospitals and existing companies. Its most recent investment is Opsona, a development stage immunology company, focused on novel therapeutic and preventative approaches to autoimmune and inflammatory diseases. Founded in March 2004, Opsona is a spin-out from Trinity College Dublin. Earlier this year, the company completed a financing of E6.25m earlier this year co-led by Inventages Venture Capital (Bahamas) and Seroba BioVentures (Ireland) with co-investors Genentech, Inc. (US) and Enterprise Ireland.
Shay Garvey is optimistic about the healthcare sector in Ireland. While Delta Partners has always had around a quarter of its investments in healthcare, he says the team is beginning to see more interesting healthcare deals than in the past.
Deal flow in Ireland is abundant and it is evident the players are also optimistic about its quality. The main challenge now is educating the domestic pension funds to invest in Irish venture capital and slowly weaning the VC funds away from government support. As Shay Garvey says: “The role of the Government is to pump-prime the industry, it is not to be a major investor. The pension funds have to be the long-term funders of this industry. But the industry is still young so there is still a role for the Government until the pension funds consider it an asset class.”
4th Level Venture University Seed Fund Limited Partnership
ACT Venture Capital Limited
Alliance Investment Capital
Anglo Irish Capital Partners Limited
BOI Venture Capital Limited
Campus Companies Venture Capital Fund
Delta Partners Limited
Dublin Business Innovation Centre
Enterprise Equity Venture Capital Group
Enterprise 2000 Fund
EVP Early Stage Technology Fund
Glanbia Enterprise Fund
Growcorp Group Limited
Hibernia Capital Partners Limited
ICC Venture Capital
Kernel Capital Partners Private Equity Fund
NCB Ventures Limited
Trinity Venture Capital
Western Investment Fund
Enterprise Ireland: a dedicated investor
In 2004 Enterprise Ireland supported the establishment of 65 high growth export-focused start-up businesses with a total investment of E80m. The number of positions for employment within these businesses is expected to reach 1,900 within three years, the majority of which are high skilled positions.
A recent analysis by Enterprise Ireland of start-up companies from 1989 to 2004 shows that of the 470 companies started, some 357 (four-fifths) are still trading. These companies generated sales of almost E1bn in 2003. The analysis also showed that almost 70 of the companies achieved sales of more than E5m in 2003.
A key objective for Enterprise Ireland is to accelerate and increase the number of start-ups that achieve this critical sales level. In order to do this new start-up companies will need to be ready to compete in international markets at an early stage of development. And to do this, companies need to establish an overseas market presence as early as possible.
Enterprise Ireland recently announced its strategy for 2005 to 2007 entitled Transforming Irish Industry. The strategy is focused on accelerating the development and internationalisation of Irish-owned business. Enterprise Ireland has also launched a new E20m Productivity Improvement Fund for Irish industry.
The Minister for Enterprise, Trade & Employment, Micheál Martin, said: “Enterprise Ireland’s new strategy clearly represents a major change in approach. It will, I believe, make a substantial contribution to the further internationalisation of Irish companies in an increasingly knowledge-driven global economy. Transforming Irish industry is a significant challenge in the context of globalisation and increased competition. The reality is that Ireland is at a turning point in its economic development where the low cost model is no longer an option.”