Despite the presence of an established and developed venture capital sector in Ireland, small enterprises are struggling for support. Unless this funding gap is met it could damage Ireland’s smart economy agenda

A NATION DRIVEN by a smart economy and populated by innovative entrepreneurs bursting with new ideas. That’s the dream. The Government is backing these leaders with strong words. But, as with every business idea, to get from the back of the envelope, the laptop or the garage workshop and into practice takes investment. And that’s where the much-lauded roadmap out of recession starts to look a little threadbare.

Despite the presence of an established and developed venture capital sector in Ireland and an emerging business angel network, finding the seed capital to develop a business in Ireland remains a steep climb for budding entrepreneurs. Throw in the current state of our banking institutions and the task seems even more arduous.

Understandably, traditional venture capital firms are structured to take a punt on projects that have scale and provide opportunity for massive returns. For them it’s better to spend big on a few projects where they can get intimately involved, rather than spread their funding across multiple small enterprises that limit the time they can spend with each and in the end promise relatively limited returns.

That leaves the funding gap, a term that increasingly crops up in conversations with disgruntled entrepreneurs and start-ups who have bought into the smart economy ideal but are frustrated by the paucity of finance. This funding gap has yet to be met elsewhere and there is growing concern that this may stunt Ireland’s smart economy agenda. It’s a concern referenced in the Innovation Taskforce report among other places.

“A lot of people on the ground are struggling to get funding, despite the hype from the venture capitalists and those behind the business angel networks,” says entrepreneur Fergus Burns, who runs the web2ireland.org blog, which features tales of those having difficulty raising early-stage finance.

Venture capitalists, Burns maintains, like to sit on only a small number of boards, collect their management fees and typically come from non-entrepreneurial backgrounds such as law and accountancy.

“There is definitely a problem with funding. Venture capitalists are simply not as active as they were and valuations are taking a pounding but this is to be expected given market conditions,” says Norbert Gallagher of EEA, a boutique investor in green and clean technology ventures that is currently expanding its operations here. “Fortunately we are in a very specific area and have built up expertise in our niche to know where the returns are so we are active and funding.

“Generally, we wait until a green technology is well proven and pay a premium for it. This does ensure better returns but obviously some good technologies are not getting attention at an early stage. We are looking at some new fund structures that may allow earlier-stage investments,” Gallagher says.

Dr Pat Frain, director of Hothouse NovaUCD is also concerned at the lack of early-stage funding. “The further development of early-stage new ventures located at NovaUCD will depend on the increased availability of funding, including seed funding which companies are finding difficult to source in the present climate,” he says.

It’s a problem that recognised at a pan-European level as well. A recent report by the European Economic and Social Committee (EESC) on removing obstacles to investment by venture capitals sums up the problem. “Venture capitalists are interested in big deals because a small deal can be as time consuming as a big deal. Accordingly, they tend to be more interested in providing funds for the expansion of growing companies rather than providing seed money for start-ups . . . To help fill this gap, publicly funded venture capital providers can play their part, but this in turn will still leave a gap.”

The EESC recommends the provision of tax incentives for private investment in start-up businesses such as those provided by the UK’s Enterprise Investment Scheme. In this scheme, capital invested attracts income tax relief while capital gains from the venture are tax free. These incentives make the risk-reward ratio favourable for private investors who invest in early-stage companies.

By contrast, as Burns notes, private investors have been encouraged through tax relief to invest in asset-backed schemes. Entrepreneurs are often competing with BES schemes to raise funding and high net-worth individuals can still find more attractive and less risky ways of investing their money than funding a risky technology start-up.

Brian Caulfield may be the exception to the rule. An experienced technology entrepreneur in his own right, he is one of an emerging breed of business angels happy to invest in start-ups. He acknowledges the difficulties associated with venture capital financing here. "It's not so much a case of venture capitalists only wanting to make huge returns. It's a question of resource. In many cases it costs as much to make a small investment as a large one. Venture capitalists are charged with making the optimum return on capital."

Caulfield, who also sits on the board of The Irish Times, says the €250,000 to €1 million market for venture capital investment is relatively well serviced, with a pool of players willing to back ventures that meet their criteria. Those looking to raise funds under that level have a harder time, however, than those at the higher end of the scale, looking for investments in the €2 million to €3 million bracket, he says. "There's an element of being too big for Dublin and too small for London or the pan-European or US venture capitalists as well," he notes.

Caulfield says start-ups looking for funding should consider looking for angel investors, ideally a syndicate of private investors. He is involved in a number of these with investments in technology companies including web company Teamer and storage solutions firm Gridstone. "My advice to an early-stage company looking to raise €200,000 would be to get a syndicate of five to 10 private investors willing to invest. It's much easier to go back down the line to the syndicate if you need another €200,000 at a later stage rather than looking for one investor to stump up the lot. That's good for the investors as well – they are not putting all their eggs in one basket and can develop a portfolio of investments in a sector they are familiar with."

Angel is not a term Caulfield particularly likes. Private investors may not have the "vulture capitalist" image of their counterparts in the VC industry but they are looking for a return as well. There is a different mind-set with a private investor, however, he acknowledges. "A business that can throw off a couple of hundred thousand in profits every year will not be of much interest to a venture capitalist, but the opportunity to take regular dividends may appeal to a private investor."

His criteria for investment, he says, is typical of most people in his position. "I'm looking to see if there's a real market opportunity – an unsolved problem with the opportunity to scale. Then I'm interested in the people; do they have integrity and the ability to think commercially, rather than just being in love with their technology? Then there's the exit strategy. I'll always ask from the outset who might buy this business a few years down the line and why."

Diana Roberts runs the Halo Business Angel Network (HBAN), the national network for angel investing. HBAN recently called on the Government to utilise monies to be set aside by the two main banks for seed capital financing to create a multimillion euro co-investment fund, to help support early-stage technology and life science enterprises and said that the combined €40 million sum that is to be used by Bank of Ireland and AIB as seed capital for Enterprise Ireland-supported ventures should instead to be used to set up a co-investment fund, along the lines of similar initiatives in other European countries.

The proposed co-investment fund should work on the basis that any investments by business angels through a formalised syndicate will be matched under the same terms by public sector funds.

"We believe that an Irish co-investment fund would allow for individual investors and investment syndicates to be systematically matched with appropriate opportunities. In turn, this would support the creation of an angel capital industry in Ireland, where high-tech entrepreneurs will be able to access essential working capital," Roberts said.

This co-investment fund model is already working in a number of countries, including Belgium, Portugal and Scotland, she notes, where governments have all announced co-investment funds as a means of promoting activity in those countries. Roberts says that HBAN has identified around 150 business angels in Ireland. "There are investors there and they are looking for deals. Many promoters may not be aware of this if they are now networking in the right areas. The key issue for promoters is can they show that they have revenues."

Fergal O'Byrne, chief executive of Wexford-based Sonru, agrees. Sonru has developed an online recruitment screening tool and has required several stages of funding including €270,000 via a BES scheme along with small angel investment at the outset. It is currently closing a €500,000-plus funding round made up of a mix of public and private investment to take it to the next level.

"We've pitched to around 20 investors since April. The common denominator is that everyone wants to see evidence of revenues and if we didn't have those, it would have been a problem. Thankfully we have a good story to tell. What the investment market wants is a great product, a good marketplace and paying clients. It's much harder to get money now if you just have a good idea."

O'Byrne believes that the angel community is active. "A lot of the high net worth individuals are no longer investing in property like they once would. They are prepared to invest in start-ups and early-stage businesses but they need a very compelling proposition."

That's a view echoed in the venture capital industry. Regina Breheny of the Irish Venture Capital Association suggests that the industry would like to see more viable entrepreneurial opportunities coming forward. She says 2009 was a peak year for venture capital investment in Ireland at a time when levels in the US and UK were falling. She accepts, however, that there has been a move away from seed capital investment in recent years as firms look to balance their portfolios.

The view that venture capital firms are not interested in early-stage investment is one that is challenged by Niall Olden of Kernel Capital, one of the more active VC at the moment who describes his firm as a "seed to exit investor". Last year it teamed up with Bank of Ireland to form a Seed and Early Stage Fund specifically to target investments in the €100,000 to €500,000 range. So far this year through this fund it has invested in the aforementioned Sonru, Cork-based Wavebreak, Limerick-based Resourcekraft and Dublin-based start-ups Teamer and Inishtech.

"In general we are the first institutional investor in our portfolio companies," he says, citing examples such as Farran Technologies where it invested €250,000 initially and an initial investment of €300,000 in Stokes Bio. In both cases, the businesses were sold on to international publically quoted companies at a tidy profit. "We anticipate allocating €4 million to seed investments this year alone, in addition to the further €22 million of early-stage deals," he adds.

Kernel has had around 300 applications for funding over the last year but only a very small proportion of these received funding. "Venture capital has a reputation as black art but we see it more as a science," he says. "We have a very thorough screening process with an application form that asks 200 very specific questions. If you are looking for significant amounts of funding, its only appropriate that you will be asked some very invasive questions. Telling us it's all 'in the business plan' doesn't work," he advises.