9 December 2002
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There is no doubt that Irish and international venture funds have plenty of money to spend. From 1999-2001, members of the Irish Venture Capital Association (IVCA) raised funds in unprecedented amounts (see the IVCA report on venture capital activity in Ireland, produced by Matheson Ormsby Prentice (the report)). Internationally, of course, the picture remains the same.
So, what is the venture capital industry doing with these funds in the Irish market?
To answer this question, one must distinguish between the information, communications and technology (ICT) sector, which has in recent years received the lion's share of investment from the domestic venture capital industry, and other industries.
As the report highlights, the number of investments made in high-tech companies comprised 85 per cent of the total number of investments made in 2001. As is often with statistics, this is slightly misleading, as the amounts invested in start-up and venture investments (the principal focus of high-tech investors) are typically a lot smaller than those in development capital or buyout transactions. Nevertheless, the report discloses that the expected application of funds by Irish venture capitalists in future years is predominantly in the ICT sector (64 per cent).
It is also important when analysing the Irish market to draw a distinction between early stage and venture investment on the one hand, and buyouts on the other. This is because although the substantial majority of companies that receive funding are ICT companies, there is no doubt that, when international investor activity is taken into account, the substantial majority of private equity funds invested in Ireland are in buyouts of one form or another.
In tandem with the economic downturn, there has been a reduction in development capital investment activity.
This, of course, is a relative thing - as the report illustrates, despite a significant drop from 2000, the amounts invested in 2001 were more than three times the level of 1997. When aggregated with investments by UK, US and other international institution investors, the overall picture is starkly different to that shown by the statistics provided for 1997, the first year of the report.
Nevertheless, venture funds are certainly adopting a more cautious approach when reviewing the risk profile of prospective investments. More time has been taken in financial and legal due diligence, and a management team that has succeeded in raising funds previously is less likely to encounter difficulties in the fundraising process. While this was undoubtedly always the case, in the context of the current global economic circumstances these distinctions are accentuated. Investors are focused more keenly on quality in all aspects of a potential investment.
This is particularly notable in the ICT sector, where there has been a more marked diminution in levels of activity. As the report discloses, the number of seed and start-up investments has diminished. Given that most Irish private equity investments (in terms of number, rather than quantum) are made in ICT companies, this has had a significant impact on the general level of activity. Nevertheless, high-quality companies with proven technology and business strategies are attracting significant interest from Irish and overseas venture funds, albeit with the valuations inevitably being under significant pressure.
None of this, of course, is surprising. Given the downturn in the ICT sector, venture funds have been focused on helping existing investee companies reorganise and restructure to reflect the new realities. This was certainly the experience of Matheson Ormsby Prentice throughout 2001. Since then, however, there have been signs that the ICT-focused venture funds have substantially completed this process and are now increasingly active in concluding new investments.
Despite all this, there have been a number of notable fundraisings in the Irish private equity markets during the course of the year. Companies including AEP, Information Mosaic and 2PM Technologies have successfully raised private equity finance.
In the buyout market, however, the picture is considerably healthier.
Domestic and international buyout funds are increasingly active in the Irish market. There has been consistent speculation over the last few years that a greater number of public-to-private transactions would occur, given the relative illiquidity of small and mid-capitalisation stocks on the Irish Stock Exchange. However, until 2002, the increase in transactional activity in this area, which many saw as inevitable, never really materialised.
This year things have changed dramatically. The recent public-to-private acquisitions of Smurfit (backed by Madison Dearborn) and Green Property have now been followed by other announcements by Irish listed companies of actual or potential management bids. These companies include Riverdeep, Alphyra and (very recently) Conduit. Interestingly, these three are all operating, to a greater or lesser extent, in the ICT sector. The damage that has been done to stock valuations in these sectors has of course been extensive, which has no doubt encouraged management teams to look to take these companies private.
On the private company side, there has also been a very real increase in activity levels, giving rise to healthy levels of venture investment activity.
The table, which is taken from the report, illustrates the change in buyout activity so far as domestic venture capitalists are concerned (the report encompasses venture capital activity of Irish venture capitalists only).
As the table illustrates, the historic level of buyout activity was quite small, representing less than 3 per cent of the companies receiving funds (and 13.95 per cent of the total amount invested by Irish venture funds) in 2001. Undoubtedly, when the 2002 statistics are published, buyouts will comprise a substantially greater proportion of the total amounts invested in Irish companies by Irish venture capitalists.
Globalisation is likely to assist the flow of capital in the Irish private equity market. In recent years, not only have US legal and commercial practices in the private equity market become commonplace in the Irish market, but so have US venture funds.
Many of the leading US funds, having established a presence in London, are spending considerable time in the Irish market seeking out investment opportunities. The international venture capitalists (whether UK, US or otherwise) that do not spend time in Ireland have nevertheless developed strong links with Irish corporate finance houses. Thus, where a suitable investment opportunity arises, it is likely to find its way to the desk of a suitable investor. Indeed, the Irish venture capital industry received a significant vote of confidence when 3i established an office in Dublin in 2001.
Co-investment by international venture funds with local venture capitalists has also become quite common. This is particularly so in the ICT sector. For example, Amadeus and leading Irish technology venture fund Trinity Venture Capital co-invested in one of the stars of the Irish ICT sector, Network 365.
International venture funds' increased focus on the Irish market seems in recent times to have been matched by a decreased interest on the part of Irish venture funds to look internationally for investment opportunities. Interestingly, in 1999 and 2000, 7.85 and 7.6 per cent respectively of companies invested in by Irish venture capitalists were outside the island of Ireland. This dropped quite significantly to 3.7 per cent in 2001 - less than half of the totals for each of the previous two years.
Corporate activity - in particular buyout activity - in the Irish market has increased substantially in the last quarter. It seems that sellers' valuation expectations have realigned to a level that provides buyers (and specifically venture capitalists) with opportunities they consider to be well priced. This has led to a significant increase in corporate work for Irish lawyers generally, and in particular private equity work.
As a proportion of overall M&A activity, buyout transactions are undoubtedly on the increase, and this is likely to continue for the foreseeable future.
So far as the ICT sector is concerned, most of the pain has been suffered and venture investors are now increasingly investing in quality companies with a proven management team and a clear and visible strategy for profitability (or increased profitability).
Andrew Doyle is a partner in the corporate department at Matheson Ormsby Prentice