How €1bn venture capital industry can learn lessons from Scandinavia

“We don’t have as much seed capital as we had before,” says Sandys. “There just aren’t as many funds coming through. The ones which the banks supported during the recession are drying up. Angels are stepping in, but it’s not as buoyant as it was.”

A recent call by Enterprise Ireland for €44m was made, but the outcome of this is not yet known.

In a country where the vast majority of funding rounds are under €3m, this could have an outsized impact on the sector, Sandys says.

However, there may also be serious supply obstacles ahead for companies seeking to access venture capital to scale.

“In Ireland the three cornerstone investors venture capital have been Enterprise Ireland, the NPRF [National Pensions Reserve Fund, now the Ireland Strategic Investment Fund, or ISIF] and the EIF [European Investment Fund],” he says.

“After that we’ve been reliant on the private sector. Banks have been important. The insurance companies don’t play in Ireland, though they play in other countries. Although there are a couple of pension funds in play with good returns, most of the defined-benefit funds are either being closed off or are being forced by the regulator to move into bonds. So you’ve got a real uncertainty now as to where money is going to come from. We have a very small investor base in Ireland.”

Sandys says that all of this is unfortunate, as European venture capital funds have performed above average compared to other investment sources over the last 10 years. However, the political and regulatory climate since the financial meltdown a decade ago has meant a careful approach in using pension funds to invest in market assets.

“The way that defined contribution funds are set up to invest is all very short-term,” says Sandys. “Those funds are measured for daily liquidity and daily valuations, neither of which is geared towards long-term investments. Some commentators think this is disastrous and that they should take a longer-term view.”

So what’s to be done? Does Ireland face an inexorable drain on venture capital just as its tech startups are starting to really benefit from the funding available?

Sandys and a handful of others in the Irish venture industry believe they may have a viable path to help foster a more investment-friendly climate here.

To do this, they have looked to Denmark.

“The Danish came up with a fund of funds,” says Sandys. “To get investors in on it, they offered them a quasi-state entity not totally unlike Enterprise Ireland, which offering them a bond with a nice coupon on it. So for an investor, half your investment was in a bond-type asset and half of it was in VC. The Danes got a good response with these incentives there. So much so that in the next round launched, they didn’t need any incentive because the investors made about 12pc from the first round.”

What works in Denmark may not necessarily only be reserved for Scandinavians, Sandys says.

“We’re trying to see whether a pool vehicle could be set up here. We’re looking at what kind of structure it might have and how it might be started. We need a vehicle where there’s greater liquidity and that’s where a fund of funds comes in. We would think that it would be an excellent idea in terms of securing a long-term future for venture capital in Ireland. It would also benefit investors to have exposure to longer-term assets that are performing well.”

Sandys says that the IVCA has raised the notion with pension funds and with the Ireland Strategic Investment Fund (ISIF), one of the biggest investors in Irish venture funds. He says that these entities have responded to the idea cautiously, but positively.

“I think people are open to the idea,” he says. “But the devil is in the detail in trying to do something like that. If you think about pension funds in Ireland, you’ve got a couple of big ones and banks. But outside that, they’re all small investment funds that don’t have expertise to appraise the funds. They really need someone to do it for them. So this is not something that’s going to happen tomorrow. It’s going to take a while if we’re to get it off the ground. And then it’s got to be marketed properly too.”

As for the mechanism that such an investment vehicle might take, a coupon such as that available from the first Danish experiment may not be necessary, Sandys says.

“As for the bond and coupon, they may or may not need to do that given that the returns are pretty good already. The bottom line is really whether or not we can get people to invest. I don’t know the answer to that.”

The same issue is being debated in Britain, which faces its own acute problems with Brexit.

At its core, however, is the question of whether Irish institutions – and small investors – are of a mind to invest their own money in venture capital. Ireland, arguably, does not have a sizeable equity-owning culture. Property, bonds and owner-manager enterprises have traditionally been outlets for those with spare cash.

Can this change? Moreover, should it change?

Sandys says that an alternative culture in Sweden is starting to attract significant Irish interest. The Swedish approach is to encourage small stock-market flotations and investor interest at a retail level.

The results are notable. Despite just 10m people living in Sweden, it has seen 51 stock market flotations this year. This is over 10 times the IPO rate in Ireland, despite only having twice our population.

“They’ve created an equity culture up there and successfully tapped into the retail markets,” he says. “Since the start of 2016 there’s been about €1.1bn raised in Sweden’s IPOs. It’s an extremely dynamic market. I went over there recently for a roadshow with Nasdaq’s First North [for small companies seeking stock market investment]. There were four Irish firms over there considering going public in Sweden.”

One of the incentives for small investors in Swedish stocks is a tax arrangement that replaces capital gains tax with an annual levy of 0.25pc for amounts up to €15,000.

“You create a pool of money that is CGT free so people are incentivised to go into these accounts,” says Sandys. “Add that to the good online trading platforms that they have and limited charges and you have a very dynamic market there. By comparison, when you talk to brokers in Ireland, they’ll tell you that retail is dead and that there are too many regulations.”

Despite a bull run for almost a decade in tech and tech-related investments, Sandys does not believe that there is a bubble threatening the system.

“We see no evidence of one whatsoever,” he says. “So there’s definitely no bubble effect that we can see.”

Nevertheless, when it comes to his own fund’s money – around €100m – Sandys says that Seroba may pace out investments as a prudent guard against ups and downs in the investment climate. He says that Seroba will likely do “around 10” investments with its current fund. Four have already been completed, while a fifth is on the way.

Despite all the pressure on the supply side of venture firms’ funding, Sandys says that deal amounts are definitely rising.

“We’re working on a company at the moment where the funding will be around €47m,” he says. “In the past, that company’s funding might have been €20m. But the €47m will take them a heck a lot further than the €20m would have.”

While some might see this as placing more eggs in a single basket, Sandys presents it in a different light.

“What you’re actually doing is de-risking the investment,” he says. “If you have a bigger syndicate with more money, the company can do more things. The way that works is that, hopefully, at the end of the €47m round, the company doesn’t need to do another funding round. You might have enough to actually exit.”

But mightn’t that also mean simply a bigger loss if the company doesn’t work out?

“Of course. But you’ve less chance of a loss because you’ve got more arrows in your quiver from the beginning.”

If this sounds a little odd to people from a software or web-tech background, that’s because his firm, Seroba, specialises in early-stage life science companies. This has a very different style of hit rate from a dotcom or hardware company.

“If you study the statistics on which sectors have produced the best returns, the best, most consistent returns are coming from biotech,” he says.

“The failure rates are lower than other tech sectors. That might appear to sound funny given that so many drugs fail and because only one in 10 gets to the market. But even if what you’re making for, say, a cardiovascular risk doesn’t work out, the chances are that it could also have an impact somewhere else in the body and be repurposed.”

Overall, Sandys says that the number of Irish companies coming through is positive. “There’s no shortage of deal flow,” he says.

Two things could still impact the ecosystem, though. The first is whether – and to what extent – US President Trump changes the American tax code.

“If I want to buy another company that has US revenues, I’ll want to know what the tax rate is there. So that has created a lot of uncertainty with some deal flows slowing down. There are certainly headlines in the industry saying there’s going to be a big slowdown in mergers and acquisitions, which then affects investment returns because there’s less money coming back to investors. So the tap could dry up with people investing less money.”

The other issue that could affect Irish investors – more than Irish tech startups – is Brexit.

“There’s a question over whether the European Investment Fund will continue in the British market,” he says. “From our perspective, the big concern would be that money from the EIF is connected to investing in Europe. The UK is the biggest biotech market in Europe, so if EIF money can’t be invested there, even though it’s right on our doorstep, it will be more challenging.”