Irish venture: are VCs’ eyes a’smilin’

The Irish Venture Capital Association reported that 2003 was a good year for investment, and GPs in the market think things can only get better. Tom Allchorne finds out whether this optimism is well-founded.

Ireland has traditionally been a venture market where technology rules, and the figures released by the Irish Venture Capital Association in June 2004 show this has continued. Of investment in 2003, 96% went into tech firms, the highest proportion in Europe. Overall, €255m was invested by Irish VCs in 187 companies, compared to €105m in 156 companies the previous year. Total investment, domestic and foreign amounted to €535m, compared to €129m in 2002.

Taking into account the seven buyouts of last year, the total invested by Irish VCs would still reach around €79m, a 25% decrease on 2002’s figure of €105m. Despite this, and perhaps it is due to their natural optimism, Irish VCs are more up-beat about the future than their European counterparts. Words like “vibrant”, “healthy” and “buoyant” are bandied around regularly.

The story so far

The growth of the Irish economy, the so-called Celtic Tiger, is one of the success stories of the EU, and this has largely been down to the favourable business environment put in place by successive Irish governments and generous EU financial support. The most obvious example of the former is corporate tax, which currently stands at 12.5%, still at the lower end of the scale relative to other EU countries, and before 2003 it was just 10%. Ireland has also made a big play to attract foreign investment, particularly from the US and especially technology, and it is this which has laid the groundwork for the venture capital market we see today.

“Ireland is a relatively vibrant market,” says John O’Sullivan, investment director at ACT Venture Capital. “We have seen quite a bit of deal flow and in technology deals it punches above its weight in regards to population size.” Ireland has a young population, and there are now a lot of people in the country who are well educated and have worked in foreign multinationals, either as a result of foreign investment or have worked abroad.

Ireland has a network of people on two fronts which has promoted the take-off of venture capital. Firstly, there are those people with the technical expertise, and secondly, there are those with managerial experience. “In the past these people used to leave Ireland and go to the UK or US,” says James McNaught-Davis, general partner at Advent Venture Partners. “Now they are coming back. This means there is a good supply of software developers and architects, as well as a reasonable supply of business managers with experience.” One such person is Raomal Perera. Perera was co-founder of Isocor and as the head of the engineering team developed one the world’s leading Internet mail servers. This floated on Nasdaq in 1996 and three years later it was bought by US firm Critical Path for over $450m. In 1999 he set up Network365, the Irish mobile payments developer. Its products included online shopping malls, information and ticketing services. The people behind Network365, which merged with iPIN in 2003 to become Valista, were all ex-Isocor managers, and this matters. “The importance of experienced and successful entrepreneurial IT management teams cannot be over-emphasised,” said McNaught-Davis. “There are quite a lot now in Ireland and the UK, whereas ten years ago they were much harder to find.”

Unscathed or unsure?

Taking the favourable business environment, foreign investment and technical and managerial skills into consideration, Ireland can be said to have a very positive climate for venture to grow. Added to this has been its relative resilience to the economic downturn since the days, some argue.

“While there was a decrease in deal flow, activity in Ireland never reached the dizzy heights we saw in other countries, especially in the US,” says O’Sullivan. “This was for a number of reasons. One, Europe was behind the US in tech anyway. Two, Ireland did not produce projects requiring vast amounts of capital for start-up, simply because the local market was too small. Three, the companies in Ireland were not as capital-intensive. Since the downturn, VCs in Ireland have been more conscious of the burn-rate of companies.”

Denis Murnane, manager of venture and private equity at Enterprise Ireland, agrees: “Irish VCs were not as exposed as the US VCs to the dot bomb. There were a couple of dot.coms but most of the companies in Ireland were technology companies. That said, these companies did suffer because the big companies were not purchasing.”

Despite this perceived economic robustness, Ireland has suffered like any other country when it comes to both fund raising and making good investments.

Frank Kenny, founder of Delta Partners, says: “The general view is that we are coming back from a terrible recession. For two and a half years we did very few deals. It has been a bloodbath for the 2000/2001 funds.” Delta’s own €90m 2000 vintage fund is two-thirds invested.

Quality deals

A lot of money is flying about which is not necessarily matched by quality of deals. According to the IVCA’s Annual Review, the valuation of the aggregate investments made by Irish VCs in the past decade now stands close to €1bn. “Are there enough quality deals to justify that sort of money?” asks Neil O’Leary, chairman and chief executive of Ion Equity. “Ireland is probably overprovided at the early stage, and a lot of Irish funds, like ACT and Delta, are looking keenly outside Ireland towards the UK.”

Trinity Venture Capital, which closed its second fund in November 2002 at €139m, is a first round investor. Chief executive John Tracey disagrees with O’Leary’s statement: “I don’t think there is. There are only three funds here larger than the €30/€40m mark: Delta, ACT and us. There is good, healthy competition but I don’t think three is too many.”

McNaught-Davis, whose firm Advent Ventures is a UK-based investor in Ireland, says: “The only thing worrying about the Irish software market is that there is too much money chasing too few deals, and this increases the risk that people will over-pay.”

Fund raising

The obvious affect of too much competition is that prices are distorted which then goes on to affect IRRs, a situation which hasn’t been helped by the economic slowdown. “There have been a lot of poor returns because of the recession, some deals as low as 2%,” says O’Leary. “Firms put money into companies but had to keep topping them up because of the recession and this diluted their returns, and this has hurt early stage investment.”

This has had an obvious effect on fund raising. Last year was a poor year for raising capital, as the EVCA figures show. Just under €60m was raised in Ireland compared to €201m in 2002 and €210m in 2001.

Ronan Reid, managing director of 4th Level Ventures, which manages a seed fund and an early stage fund, says: “Fund raising is difficult because VC funding is still an emerging class with fund managers. It is not a mainstream market but it is improving.”

There is a definite sense of optimism in the Irish VC community that things are going to get better. O’Leary says: “The new funds might get lucky because of the timing, although I can’t see much fund raising this year.” This isn’t particularly surprising and is pretty much the story all over Europe. Like elsewhere, there are a number of funds in Ireland, Delta among them, which have indicated they expect to begin fund raising in 2005.

Trade sales will dominate

Exits are not something being put off till next year. The feeling is that the market is open and ready for business. “Am I optimistic? Yes, absolutely,” says Kenny. “The really bad times are behind us. Corporates are back buying again. After three years of no approaches we have had a number in the last few months. A lot of this is down to the multinationals cutting back on R&D and now they have gaps in their product line and this is a gap Irish companies can fill.”

Historically, and this shows little sign of changing, companies have been sold to US multinationals, most of which still have a presence in Ireland. “Very few actually left the country,” confirms Reid. “Intel, Dell, Pfizer, they are still about. People thought that the weakness of the dollar would see them leave but they didn’t, and this is why trade sale is a good exit route. The Irish economic recovery, in particular, has been quite strong and there is a renewed interest in Ireland by the foreign multinationals.”

Tracey says: “Exits have been improving, but if you look overall, investment in M&A is still below the pre-bubble period of the mid-1990s. That said, there are increasing signs of improvement. Tech companies over the last few years, in order to improve their financial performance, have cut back staff numbers and scaled back from certain market areas. There was a focus on making cash rather than growth. This has now changed and they are acquiring companies in interesting markets.”

Mergers and acquisitions are seen as crucial to the future of Ireland’s technology industry. A report published in May by consulting and investment group, HotOrigin, says Irish start-ups must either merge or be acquired if they are to become internationally competitive. While it was positive about the activity last year when almost as many companies were founded as in the record year of 2000, more than 70% of all companies in Ireland remained in the sub-€1m sales category. The report puts this down to companies being too technology focused and noted the proportion of staff allocated to sale and marketing has decreased in comparison to last year’s survey.

The IPO route is not one looked upon with any great hope by Irish VCs. “If you were going to go public, where would you do it?” asks Tracey. “AIM is beginning to look interesting, but a company really needs around €200m of revenues to go public and there aren’t many Irish companies with those sorts of earnings.”

An increase in trade sales is on the cards for 2004, but of course with more companies and VCs looking for exits via this route, the market is going to become tougher; it remains a buyers’ market.

University challenge

One of the areas where the Irish government has focused its attention is on encouraging university research teams to spin out and become independent companies. The Irish government is pumping €2.5bn into scientific research between 2002 and 2008, and the market is just beginning to see some of these companies come to market. In May this year Celtic Catalysts, a UCD spin-off specialising in producing pharmaceuticals with reduced side-effects, raised €665,000 in first round funding from 4th Level Ventures and Enterprise Ireland.

Reid, of 4th Level Ventures, says: “The government has multiplied its investment into universities by 50 over the last few years, and it is our job to commercialise the resulting research through the establishment of new companies to provide solutions to global companies. This is something the foreign multinationals have picked up on, and I have spoken to seven or eight about companies in Ireland over the last few months.”

The increasing number of companies coming out into the market place over the coming years, as a result of the government’s programme, is going to present a challenge to the Irish VC community. On the one hand there is going to be a raft of high tech teams with good technical expertise spinning out into companies, and on the other there is the continuing reluctance of anyone actually to put money into seed. Whether the 4th Level Ventures Seed fund will be the first in a line of similar funds, time will tell.