Can VC Bring Sunnier Days to Ireland?

While most of the world is clawing out of the Great Recession, Ireland is still mired in a deep depression. The Irish economy collapsed 11.3% last year due to a massive real-estate and construction bubble that brought this island nation to its knees.

But one sector that has come through the crisis relatively unscathed is the local venture capital industry. Indeed, Irish startups raked in €288 million last year, up 19% from the previous year, according to the Irish Venture Capital Association. What’s more, the Irish government is seriously looking at venture capital as a way to rebuild the shattered economy and get the nation back on its feet.

The government is already a major player in the venture industry. As a limited partner, it has pumped nearly €200 million into many local VC firms. And that figure is about to go up another €40 million this year. As part of the government’s new bank bailout plan, the nation’s two largest banks will be required to provide €20 million each to local seed funds. That may not sound like a huge amount, but for a country with only 4 million people, it can make a significant difference.

“We are putting huge efforts into turning the economy around and moving away from our dependence on property speculation, which really destroyed us,” says Des Doyle, manager of the Seed and Venture Capital Programme at Enterprise Ireland, a government agency responsible for the development of the indigenous business sector. “We now have to focus on building new productive businesses, and the proper funding of those businesses is absolutely fundamental.”

To prove it means business, Ireland isn’t just backing local VCs. It is also hatching a scheme to entice top-tier international VCs to set up European operations in Ireland. Nothing has been formalized yet, but the idea is that the Irish government, presumably through Enterprise Ireland, would invest directly in any major venture firm that established a significant presence in the country.

But whether the government finds any takers is another story. “The idea of us shipping a few partners over to Ireland is a brain-dead concept,” says Tim Danford, a managing director of Storm Ventures in Menlo Park, Calif. “We’d probably be bored out of our wits because there is just not enough deal flow to justify it.”

We are putting huge efforts into turning the economy around and moving away from our dependence on property speculation, which really destroyed us.”

Des Doyle

But that’s not to say that U.S. venture firms like Storm are completely disinterested in Ireland—or that they don’t see real opportunity. Quite the contrary. Storm is seriously looking at three Irish companies right now. The firm is also setting up an entrepreneur-in-residence program in its U.S. offices specifically for Irish entrepreneurs.

Danford says he’s been watching the Irish market for five years and, in that short time, he has seen a huge improvement in the quality of startups. He notes that the startup culture traditionally had its roots in enterprise software, telecom and medical devices, largely because of the presence of foreign multinationals like Boston Scientific, IBM and Nortel. But lately the tide has been shifting.

“Now we are seeing much better quality coming out of the universities, as well as more Internet-related deals,” Danford says. He is currently evaluating several promising Internet startups, including a search firm and a cloud computing company.

One London-based venture firm that is also taking a deep interest in the Irish is market is DFJ Esprit. The firm is currently looking at two deals and ultimately wants to create a local office and staff it with a partner.

What’s the attraction? Simon Cook, CEO at DFJ Esprit, cites Ireland’s historical track record of great exits relative to its size. He also likes its young, educated and entrepreneurial population, as well as its seasoned executives who have cut their teeth at large multinationals. Cook also believes the country offers business-friendly regulations and attractive tax incentives. Finally, he loves the fact that companies in Ireland typically have global ambitions from the outset, primarily because there is no home market to speak of.

“There are not many countries in the world where you get that complete package in one place,” Cook says.

We wouldn’t turn down a deal outright if we couldn’t build a syndicate, but we would have to think about it a lot harder.”

Dermot Berkery

For such a small nation, Ireland has had its fair share of success. At least six venture-backed companies have had exits of $100 million or more since 2004. The companies include:

Havok, a gaming software firm, which was acquired by Intel in 2007 for a reported $110 million.

Spectel, a provider of conferencing software, which was acquired by Avaya in 2004 for $103 million.

• And Web Reservations International, a booking site for budget accommodations, which was purchased by buyout shop Hellman & Friedman from Summit Partners for an undisclosed amount in November 2009.

Local VCs insist that even greater successes are on the horizon. Kernel Capital, a Dublin-based firm with €190 under management, has closed an impressive eight deals in the first quarter of this year. That comes after nearly two years of waiting patiently on the sidelines and not making a single investment. The firm’s recent deals include a €500,000 investment in ResourceKraft, a home energy management company, and a €500,000 investment in Teamer, an online management system for organizing sports teams, such as the office softball league.

Why the recent spurt of activity? “For one thing, valuations have come way down now that entrepreneurs have adjusted to the economic realities of the new world,” says Niall Olden, managing director at Kernel. Another reason is the sudden lack of competition from rich individuals and private investors, who are not nearly as rich as they once were. Olden says it wasn’t uncommon to put a term sheet in front of an Irish startup only to be told the next day that the company had a better offer from a real estate magnate.

We are seeing much better quality coming out of [Ireland’s] universities, as well as more Internet-related deals.”

Tim Danford

Still, the Irish government is trying to lure private investors back into the market. It has introduced several tax policies that encourage wealthy individuals and entrepreneurs to invest in startups. Angel investors who are not controlling parties can get tax allowances of up to €150,000 per year, a figure that is six time higher than in the United Kingdom. Meanwhile, entrepreneurs who put their own money into a business can retroactively receive tax allowance on their previous six years of income, up to €100,000.

Another crucial incentive is the R&D tax rebate. For any company that invests in R&D, the Irish government will basically write a check covering 25% of those costs annually. “This gives our startups a longer runway and encourages a generation of young companies to think about R&D,” says John O’Sullivan, a general partner at ACT Venture Capital in Dublin.

Though the incentives are a good start, local VCs understand that their investments won’t amount to much if they can’t get investors from outside the republic excited about their portfolio companies. The typical Irish VC fund, of which there are only about a dozen, ranges from about €70 million to €100 million in size. They simply do not have the wherewithal to ride a startup from wire to wire.

Dermot Berkery, a general partner at Delta Partners in Dublin, says that in the past his firm would do the first round on its own, and then wait for investors from the United Kingdom or United States to come aboard in the second round. But now that so many investors have left the early stage market, there is less likelihood that even good companies can find follow-on financing. That’s why Delta is more determined than ever to build a syndicate of international investors from the get-go.

One of Delta’s most recent investments is Dublin-based software startup Clavis Technology, which closed a €2.1 million Series A funding round. Joining Delta in the deal was Scottish Equity Partners (SEP), a leading European venture capital group. “We wouldn’t turn down a deal outright if we couldn’t build a syndicate, but we would have to think about it a lot harder,” Berkery says.

Meanwhile, firms like NCB Ventures in Dublin continue to aggressively build their international networks. One of NCB’s partners, Will Prendergast, recently accepted a two-year fellowship with the U.S.-based Kauffman Foundation to raise the firm’s profile abroad. “We are using that program to network with U.S. VCs and hopefully get them to co-invest with us in Series B and C rounds,” says Michael Murphy, an NCB managing partner.

Valuations have come way down now that entrepreneurs have adjusted to the economic realities of the new world.”

Niall Olden

But foreign investment is often a double-edged sword. The money is essential for growing these startups, but it often comes with strings attached. The biggest is that foreign investors often want Irish companies to decamp for greener pastures overseas. Storm’s Danford, for example, says he is much more likely to invest in an Irish company that is moving its headquarters to the United States.

That attitude is a constant source of concern for people like Doyle of Enterprise Ireland. He’s especially frustrated when good Irish companies get acquired and end up leaving the country, just as Havok did after it was snapped up by Intel. Enterprise Ireland, AIB Equity, Bank of Scotland Venture Capital, LTG Development Capital and TVC Holdings collectively invested $9.8 million in Havok over four rounds between 2001 and 2005, according to Thomson Reuters (publisher of VCJ).

“It’s really difficult for us because we put a lot of effort in starting these companies, and then all the jobs and IP end up gravitating somewhere else,” Doyle says. “You simply can’t have a situation where a country does not have its own indigenous startups of scale and substance.”

Irish Americans, of which there are some 40 million, are starting to lend a helping hand. A group of successful Silicon Valley entrepreneurs and investors with ties to Ireland recently came together to create the Irish Innovation Center in San Jose, Calif. The center will host up to 25 Irish startups at any given time in its new 8,000-square-foot facility. The goal is to introduce these young companies to U.S. investors and tech leaders who can potentially take them to the next level. The startups can then return home with the money—and knowledge—they receive abroad.

“The Innovation Center is a way to formalize a process that has been going on informally for a long time,” says Gordon Ciochon, executive director of the center. “The underlying goal is to give these startups a springboard to success and to revitalize the Irish economy.”

If that happens, venture capital will truly be Ireland’s pot at the end of the rainbow.