Gap emerging in Irish VC funds ?

My article below appeared in last Friday’s Irish Times Innovation Magazine

Last April, I discussed Enterprise Ireland’s assertion that it is the largest venture capitalist in Europe. At the time, I found this surprising because I had always thought the largest European funds available were in Israel, but Enterprise Ireland presumably excludes Israel as outside of the European Union! More recently, I have heard concerns from the start-up sector that, although Enterprise Ireland has done valuable work to improve the seed and early-stage funding of new ventures, there may be a dearth of funding for follow-on and growth-stage development.

Enterprise Ireland has committed €175million of taxpayers funds into its 2007-2012 Seed and Venture Capital Scheme. As of December 2010, Enterprise Ireland reported that nine new funds had been launched as a result, with a total capacity collectively across all of them of €551million, of which €152million has come from Enterprise Ireland. As of the same date, these nine funds had so far invested in total just €80million.

There are a further 15 funds, with a total capacity of €473million, still operating under the corresponding Enterprise Ireland scheme which concluded in 2006. These funds had invested €345million, as of December 2010.

Thus in total, the Irish indigenous seed and venture capital sector had (as of the end of last year) approximately €1,024million available, of which €425million had been invested.

In the first six months of 2011, the Irish Venture Capital Association has reported further investments of €162million by its member firms. Thus a total of some €587million has now been invested, out of the €1,024million available.

At first sight, it would thus appear that the indigenous venture capital industry is reasonably well positioned to both continue to engage in both early-stage and follow-on financing, with just over 43% of the total funds raised yet to be invested.

These figures are for the domestic seed and venture capital industry, and exclude the Innovation Fund Ireland initiative which targets international venture capital firms to establish an Irish presence. Enterprise Ireland has allocated €125million of taxpayers funds to this additional initiative, with a further €125million of public funds from the National Pension Reserve Fund.

There has been strong interest by Enterprise Ireland in supporting seed and early-stage companies, particularly via its High Performance Start-Up (HPSU) programme. Its 2010 annual report notes that 80 HPSU companies received seed-stage funding during that year (for a total investment of €19million), and a further 17 received follow-on funding of (just!) €2million.

Some of the domestic funds have responded to this emphasis on seed and early-stage funding. As just one example the Equity Fund III LP, a €105million fund run by Delta Partners, had made 31 investments in seed and early-stage companies by the end of last year, investing in total some €25million. The fund thus still had an €80million in reserve for follow-on funding of at least some of these 31, along with any further new investments which the fund may make. However there are industry rumors that some of the other indigenous venture capital funds may not be so well placed: in some cases there are issues with small fund sizes, and in others over-commitment to earlier investments which have yet to exit.

Clearly, managing financing over the life-time of a start-up company requires some careful strategising. A classic funding sequence for an innovative company is first the seed-stage, to build a proof of concept for the venture; then a Series A investment to start to build out the initial revenue; then a series B investment to further grow the company; then a series C investment to prepare the company for an exit by way of a public offering or possible sale to another company; and perhaps a series D or even series E if the company has still not developed sufficiently to be able to exit or to be self-sustaining. Some industries – in particular web, gaming and social software – may require relatively little investment and rapidly proceed to either successfully grow or fail. Others – particularly pharmaceuticals and biosciences – can require substantial investment sums and in general proceed relatively slowly over several years.

The actual size of the various rounds can vary tremendously. US funded rounds tend to be larger than European ones, and capital intensive sectors, like semiconductors and bio-sciences, tend to require higher amounts than other sectors. A Series A round may typically vary from between €1 and €10million, and a Series B from €5million to €50million: although higher Series B are possible – for example the recent €80million Series B transaction for Airbnb (an accommodation service). In general, Series C, D and E tend to be within a similar range, ie €5million to €50million. It is very rare for a single venture capital firm to exclusively fund any particular round, and thus a small syndicate of venture firms typically co-invest for each transaction, sharing the risks and rewards.

When a venture capital or seed fund makes an early-stage investment in such a company, it is clearly important that it can “follow its money” and invest as necessary in the subsequent funding rounds. If it cannot do so, then there is a danger that new investors (such as other venture capital firms which specialize in opportunely picking later-stage, rather than early-stage, investments) will substantially dilute the position of the early-stage fund. Furthermore, it is not unusual for later-stage investors to demand a preferential position over other investors, particularly if they sense that the earlier investors are in a vulnerable or weak position. When a company is eventually sold for some sum, such “preference shares” may result in later-stage investors not only getting their own investment back in full ahead of earlier-stage investors, but also then profiting from the division of any remaining sum even as the earlier-stage investors have yet to recoup their own investment, let alone make a profit. Given the relatively small sizes of some of the Irish venture funds by international standards, and the need for high potential companies to be well funded to be able to globally compete well, clearly there can be challenges in developing the optimal investment strategy for an Irish fund.

While a weak early-stage funding strategy may be damaging for the seed and venture capital firm concerned, it is all the more concerning if Enterprise Ireland funds – taxpayers money! – are involved. Every fund which receives support from Enterprise Ireland has a clear obligation to the Irish taxpayers to ensure that there is the best return for the State. Any fund manager which takes Irish public funds but does not ultimately generate a reasonable return on those funds back to the State, as a consequence of a poor investment strategy, would clearly be failing the national expectation.


About chrisjhorn
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