Start-ups face major drop in funding from VCs

Relatively poor returns on investment at the height of the technology bubble are thought to be behind the expected fall in funding, writes John Collins.

They may not be shouting it from the rooftops but some of Ireland's leading corporate financiers and venture capitalists are suggesting that local venture capital funding - the main source of finance for growing technology and bio-science companies - is set to fall off dramatically this year.

Some of the leading venture capital firms will be unable to make new investments in start-up companies for at least another three to six months.

Three of the largest firms, Trinity Venture Capital, Delta Partners and ACT Venture Capital, are coming to the end of the window for their current funds to make new investments and have little or no funds for new investments.

Although the three, who between them manage funds of around €600 million, have retained capital to continue to support their existing portfolio companies, they will not be making any new investments until they launch their new funds. Typically it takes between three and six months to put a new fund in place. John Tracey, chief executive of Trinity Venture Capital, confirmed that its Trinity Fund 2 was closed for new investment, but said the company was starting to raise new investment.

Frank Kenny, founder of Delta Partners, said the firm has capital for a few more new investments but added the firm was "in a fundraising cycle as others are".

The major firms raised their last funds in 2000/2001 at the height of the technology bubble and as a result it is believed their returns have been relatively poor. Kenny declined to comment on the performance of Delta's current portfolio, but said company valuations had improved in recent years and pointed out it was a seed investor in Similarity Systems which was sold for €45.4 million last year with Delta receiving about €17 million.

Mark Fenelon, director of corporate finance firm Whitebridge Capital, said the amount of venture capital investment that start-up Irish firms manage to raise this year is set to fall by half, to approximately €100 million.

Fenelon said that ACT, Trinity and Delta account for 80 per cent of deals in the Irish market.

Regina Breheny, director general of the Irish Venture Capital Association, concedes it is a "structural problem" that so many of the venture capital firms are fundraising on the same cycle and suggests it would be better if their efforts were staggered. She says the international "funds of funds" would prefer that scenario, but that many Irish pension funds prefer the current beauty parade arrangement, as it enables them to make decisions about venture capital funding over a concentrated period.

Macro-economic issues will also affect the ability of venture capital firms to raise new funds this time around. In Ireland property-backed investments still command the lion's share of money. Internationally property may not be so strong, but leveraged buyout funds have been delivering better returns than venture capital in recent years and fund managers and extremely high net-worth individuals have been favouring these asset classes. As a result, a number of large European venture capital firms have found it difficult to raise new funds in recent months.

"The indications are that venture capital internationally is having difficulty raising funds and that won't help the Irish firms," says Breheny. "While it may be harder, it will happen."

The Government has identified venture capital as a key factor in developing Ireland's knowledge economy. In the recent National Development Plan 2007-2013, it is stated that "the continued development of the venture capital sector will be an essential component of Enterprise Ireland's strategy".

It is understood that the delay in fundraising by the major firms could see a knock-on delay in Enterprise Ireland's Seed and Venture Capital Scheme (2007-2012) being launched. Under this scheme, the State agency co-invests with venture capitalists, typically providing 15-20 per cent of what the private sector invests.

An Enterprise Ireland spokesman said that any potential gap in funding would be met by the State agency taking equity investments as part of its normal funding process. It has approved eight funds to take part in the scheme which "are now in the process of raising private sector money". He said he hoped an announcement could be made in two to three months about the successful closure of some of these funds. However, he did acknowledge the possibility that some of these firms may not be able to raise the necessary matching finance.

Enterprise Ireland has earmarked €175 million for the scheme which it hopes will leverage an estimated € 1 billion from the private sector.

Brian Caulfield, an investment director with Trinity Venture Capital, says the funding environment is now relatively healthy.

"The environment now is not bad," says Caulfield. "The exit market is back with quite a bit of merger and acquisition activity and the IPO market in Europe through markets like AIM is healthy. I'd say the environment is as good as has been since 1999/2000."

But Caulfield does acknowledge that if the bigger firms are out of the market for a period it could cause a problem for start-ups that have progressed beyond seed funding and now need to raise their first round of venture capital. There are still a number of firms that manage smaller funds of €20 million or less with money to invest, but Caulfield believes these outfits are of limited value for companies with big ambitions.

"You want an investor with the firepower to continue to support the company as it grows," he says.

"With the smaller funds you can end up with a scenario where your existing investor may not want you to raise funds as they don't want their shareholding to be pushed down."

With so many issues associated with Irish venture capital firms, start-ups may look overseas for additional investment, and historically US venture capital firms have been active in the Irish market.

But Fenelon cautions that it essential that start-ups know which individuals to target in US firms, as even within the same firms there are different viewpoints both on international funding in general and Ireland as a location to do business.

In Fenelon's experience there are a number of areas where Irish companies score highly with US investors - the technology is usually strong and the management teams are experienced - but despite this, he says international venture capital participation in Ireland is "frighteningly low".

In 2006, he says, the amount of international investors making new rather than follow-on investments was minimal, which is why he believes that with the larger Irish firms not making new investments for at least the first half of the year, overall venture capital funding raised will fall dramatically.