Is Startup investment in Ireland Justified?

This blog intends to consider different startup investment made by founders, family, friends, business angels, Banks, Enterprise Ireland, and Venture Capital in tech start-ups in Ireland. It ascertains if the money is about to head for the doors. Is the technology boom is over for Ireland?

The technology industry employs over 105,000 people in various companies. It is responsible for 40 % of national total exports. All of the top global technology companies have a significant Irish presence and the home-grown sector employs over 30,000 people with total sales of over €2 billion per annum.

Budget 2016 had a strong emphasis on the indigenous sector with incentives on innovation and announcement of knowledge development box (KDB). While presenting the budget, the Minister of Finance, acknowledged that Ireland has an open economy and various international concerns regarding the global economic outlook.

Figures released from on 3rd November 2015 show that 1,185 tech start-ups were formed in Ireland last year. Almost 32% specialize in software consultancy and supply while 21% specialize in “other information service activities”. However, it shows a disproportionate spread in the country with 7 out of 10 start-ups opening in only 3 counties in Dublin 58% , Cork 8% and Galway 5%.

Correspondingly, considering the new companies registered in 2014, the biggest increase came in the real-estate sector, followed by construction and finance. While real estate and construction had 89% change compared to 2013, IT start-ups have less than a 15 percent chance. It doesn’t fill with confidence considering this change amounts to the biggest growth in IT start-ups company registration over the past 5 years.

Startup Investment

Startup investment options reveal strong support in Ireland.

Personal Savings is the number one financing option to start one. Another way a start-up gets capital (also known as ‘love money) is through friends, family, and colleagues. In 2011, about 28,000 ‘Family, Friends and Colleagues’ provided at least €195 million to new businesses with a mean investment amount to €26,000. Informal venture capital funds exceed formal venture capital funds with a 5: 1 ratio. About 3,000 business angels invested approximately €80 million. The idea behind investing your own money and raising capital from friends and colleagues is that there is more bargaining power with financiers with solid own capital investment.

Additionally, Banks are providing funds to facilitate startup investment with innovative ideas.

Strategic Banking Corporation of Ireland loans is currently managed by Bank of Ireland and Allied Irish Bank, with other banks expected to join. All of the main Irish banks have their own dedicated new business funds such as Bank of Ireland is engaged with Kernel Capital and have the intention to invest € 17 million in high potential start-ups to support early-stage businesses, while start-ups can also access AIB Seed Capital Fund.

With all these startup investment options, there is a risk of no guaranteed return. The success rate for start-ups  –even with VC backing – is just 25 percent. In addition, the average time to get a return for investors is five to seven years or as stated by Halo Business Angel Partnership ( HBAP ) time frame for return is decreasing, but still three to four years.

Therefore, when compared to a 75 percent success rate for traditional businesses founders and less liquidity risk, informal investors and banks are taking the risk of losing all or part of the original investment with the high failing statistics. It asks a question if there any better options than investing in such a deficit-making sector.

Bank’s investment model is predicated on the idea that the majority of lenders will pay loans on time. Hence, their strategy to wait for few years for a Return on Investment to be zero is interesting or foolish.

Enterprise Ireland is the largest seed capital investor in Ireland.

It offers Innovative High Potential Start-Ups(iHPSU)  offer to companies for 3 years and maximum funding of €1m or €1.25m. In May 2013, a new €175 million Seed and Venture Capital Programme (2013-2018) was started and up to December 2014, €99.5m has been committed.

Looking at the sectoral breakdown cumulative to December 2014 software got the most out of 712 investments at 48.38% with communications getting 9.19%. Food merely received 150,000 of the total invested. Sectoral Breakdown of Investments from 1996-2014 displays the same pattern with 71.17% for software,13.13% for communication, and 1.75% for food respectively.

Enterprise Ireland seems to have taken a concentration risk with making job creation as a platform for selling their justification for investment Also, venture capital funding in the first nine months of 2015 reached €415m, up by a third on the same last year. But seed funding was the only 6pc of this activity.

One of the emphases Enterprise Ireland puts is on job creation. In 2010, Innovation Taskforce speculated that Ireland would become a Silicon Valley adding 215,000 science and technology jobs by 2020.

Report by Global Entrepreneurship Monitor (GEM) in 2014 showed that out of 20,400 individuals who started a new business about two-thirds are the sole owner of the business. Most of the new business owners (63.5%) do not have employees; most are in low or non-tech sectors, with 15% in medium or high-tech sectors.

More evidence comes from research by a US IT firm which estimated in 2013, there are 46,000 tech professionals working in the ICT sector — just over half the sector total and the rest worked in administration — there were 25,000 tech professionals working in non-ICT sectors. U.K. start-ups as an example, where after 10 years of creation only 4% have 10 or more employed, job creation doesn’t seem a valid justification for making an investment by Enterprise Ireland.

As for innovation in iHPSU, the Irish patent level is low. In 2014, Ireland ranked 12th in Europe with a ratio of 126 per million. European Commission’s Joint Research Centre ranked Dublin as 16th among Europe as a top tech hub. Furthermore, data published last by GP Bullhound, a British investment bank, show that Ireland has only 1 (it’s an American company, Fleetmatics) one-billion-dollar start-up (“unicorns”) since 2000.

The problems seem to be the limits on the Irish local market, innovation, public spending, and scaling due to the lack of being able to learn without any domestic experience. As well as most global tech start-up exits have no venture capital funding.

Another trend seen similar to the pre-economic crisis is wage inflation. The CSO reports that in the five years to Q2 2015 overall average hourly earnings decreased by 0.5% (€0.10) from €21.95 to €21.85. However, The largest percentage increase was recorded in the Information and communication sector (+15.9%) rising from €25.59 to €29.67. Labour productivity is no longer increasing while wage increases are threatening competitiveness for start-ups.

Global ICT service sector hype is delivering more and more Foreign Direct Investment (FDI) in Ireland. At the end of 2013, Ireland has a net FDI (asset) surplus of € 102 billion up from € 66 billion from the net position in 2012.US firms have invested more than $ 277 billion here since 1990 making Ireland number one destination in the world.

However, the flow of direct investment into Ireland in 2013 was down € 35bn and direct investment abroad increased by €77bn than in 2012. Also, investment from Asia was down to the disinvestment of €1bn in 2013. Earnings of foreign-owned direct investment companies were down €3bn and the income earned abroad by investors in Ireland was unchanged since 2012. Equity invested amounted to €7bn while reinvesting earnings to €18bn and other capital amounted to €3bn. This suggests that there are few new investments with main companies reinvesting in the country or balancing books to help in avoiding US taxes as revealed by Apple’s hearing of a US Senate investigations committee. This ever-increasing international exposure of the Irish tax regime makes start-ups be open to the same detrimental opinion. For them, even a small contraction in global economics can lead to sliding dangerously to posting a negative current account balance.

Moreover, according to a document on the development of a new science strategy very little is spent on research and development with 54% of foreign-owned firms not being R&D active and only 13% of foreign-owned firms spending  €2m in 2012. Therefore, “The Minister for Finance announced the introduction of a KDB that will be in compliance with the OECD “modified nexus” model. The Irish KDB will be the first OECD-compliant intellectual property (IP) box regime in the world and is intended to offer certainty to taxpayers. The regime also aims to enhance Ireland’s popularity as an IP location, in conjunction with the 12.5% corporation tax rate, the R&D tax credit, and the IP amortization regime.

The KDB will provide for a 6.25% corporation tax rate to apply to the profits arising from research and development projects relating to certain patents and copyrighted software carried out by an Irish company”. Therefore, the Irish economic strategy forward remains focussed on the ICT sector to deliver growth in the foreseeable future.

Overall, there is a need for balance in providing funds to disruptive tech start-ups for growing their investment while protecting their interest. The decisions should be based on sound evidence. There seems a trend by foreign direct investments to prevent financial assets lose their nominal values. The foreign investment seems to inflow less as well as the formation of new tech start-ups is not excessive.

Numerous multi-annual initiatives by the government and other business lobbies are still focused on providing tax incentives and funding to support the ICT sector. Post-crisis thinking seems much like a property and construction boom with initiatives to fund and attract smaller and less established firms by various investors.

However, there seems to be a soft-landing for the ICT sector with slow growth with ample funding options available. There is over-enthusiastic support from the government which is leading to clusters to ICT enterprises with innovation as a major snag to justify all the investment. It entails new and higher risks as these investments with no physical assets, employ few workers, and has no technology.

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