5/4/21: The Entrepreneurship Boom: Forced, Voluntary and Funded

 

My recent article for The Currency covering the ongoing global developments in entrepreneurship: The US is experiencing an entrepreneurship boom. So, what is going wrong in Ireland?: https://thecurrency.news/articles/40790/the-us-is-experiencing-an-entrepreneurship-boom-so-what-is-going-wrong-in-ireland/

1/10/18: Irish Times on Enterprise Ireland Venture Capital Programs

Recent article in the Irish Times looks at some of the industry views on entrepreneurship in Ireland and Enterprise Ireland funding programs. Some of the comments included are from myself.

Link: https://www.irishtimes.com/business/innovation/phelan-decries-scattergun-approach-to-seeding-foreign-start-ups-1.3639788.

28/6/17: Tech Financing and NASDAQ: Divorce Proceedings Afoot?

Based on the recent data from Kleiner Perkins,  there has been a substantial inflection point in the relationship between NASDAQ index valuations and tech IPOs around 2015 that continued into 2016-2017 period.

Over the period 2009-2014, the positive correlation between NASDAQ and global technology IPOs and PE/VC funding was largely a matter of regularity. Starting with 2015, this relationship turned negative. Which means one pesky thing when it comes to the real economy: the great engine of enterprise innovation (smaller, earlier stage companies gaining sunlight) as opposed to behemoths patenting (larger legacy corporations blocking off the sunlight with marginal R&D) is not exactly in a rude health.

4/1/17: In 2016, U.S. IPOs Fell off the Cliff. VCs Barely Hanging on...

The golden VC model of finance is getting hammered by the lack of IPOs. Let’s take it from the top. majority of VCs fund companies on the basis of a visible exit (at least strategic visibility), which in the vast majority of cases implies either a sale (M&A by a bigger fish) or an IPO. Rarely do they explicitly factor into company valuations a possibility of a buy-out (for if they did, their models of funding would involve debt, rather than equity) or even less frequently, a possibility of earning a return through organic growth (for if they did, their models will set RRR closer to 5-10 percent pa over a longer time horizon, not quintuple that over a short run). So VC ‘industry’ by and large depends on IPOs. And these IPOs are now exceedingly rare on the ground and their valuations are exceedingly shallower.

Here’s data from FactSet:

Per FactSet:

1) “The number of companies going public on United States exchanges amounted to 33 in the fourth quarter, which represented a 6.5% uptick from the year-ago quarter (31 IPOs), but a 5.7% decline from Q3 (35 IPOs).” Aha, you say, a silver lining! Not quite so. “Despite the increase, this number was still well-below the average fourth quarter IPO count going back to 2000 (47 IPOs).“ And worse: “On an annual basis, there were 106 companies that went public on U.S. exchanges in 2016, which was a 35.4% downtick from 2015 (164 IPOs). The number of initial public offerings in 2016 marked the lowest annual count since 2009, when the number was 64.” 2009?! Wasn’t that the year when the world was crumbling to bits around us? Yes. And 2016? wasn’t this the year when Obamanomics celebrated miracles of labour markets recovery and stock markets indices heading for all time highs? Yes. So something is rotten somewhere, right?

2) Yes, things are rotten. “Gross proceeds (including over-allotment) amounted to $7.1 billion in the fourth quarter, which was a 7.3% decrease year-over-year. On an annual basis, gross proceeds in 2016 represented the smallest total since 2003.” 2003? Was that not the year after the dot.com crash when the investors were still shying away from tech and general start ups? Yes. Which means something is really rotten.

3) Scratch deeper: “During 2016, there were only 13 VC-backed initial public offerings in the Technology Services and Electronic Technology sectors. This marked the lowest annual number since 2009 (4 IPOs).” Of the above 13, only one was in electronic technology and 12 were in technology services. Overall, technology services IPOs count in 2016 was the third lowest on record (since 2007). Technology Services IPOs total proceeds in 2016 were USD2.77 billion, down from USD6.6 billion in 2015 and the lowest reading since 2010

4) And for some more rotten tomatoes: “In Q4, the average first day performance of initial public offerings was 6.7%. This marked a decline from the average first day pop of 8.8% in Q4 2015 and a significant drop from the 18.8% in Q3… On an annual basis, the average first day performance of IPOs in 2016 was 11.7%, which represented the smallest price pop since 2011 (9.8%).”


5) Like it or not, VCs are now being forced to wait longer for IPO exits:

So things are looking pretty barren for traditional VCs. Which might be a matter of a cyclical swing or a structural trend. Either way, the glamor of Series A-Z unicorns is not exactly shining on the proverbial hill.

15/4/16: Tech Sector Finance: Gravity of Gravy

Previously, having posted on disconnection between S&P500 market valuations and basic corporate finance (earnings and distributions) - see that post here: http://trueeconomics.blogspot.com/2016/04/15416-corporate-finance-s-and-bubble.html - it is time to remind us all what a popping bubble looks like.

Earlier this month, I was in San Francisco, the epicentre of the corporate finance-free world of tech. Not surprisingly, few smoke breaks and few chats over a glass of wine with some tech folks revealed a very interesting insight: every single one tech CEO/CFO/COO (but not CTO) I spoke to was concerned with evaporating funding in the markets for non-public equity financing around the Silicon Valley.

Need confirmation? Here is a chart through 1Q 2016 on Tech IPOs trends:

Source: https://www.theatlas.com/charts/Nkk4jHLCe

And a note from the WSJ: http://www.wsj.com/articles/startup-investors-hit-the-brakes-1460676478 on same with a handy graph:

And the numbers of deals? Why, off the cliff too:

Source: https://www.theatlas.com/charts/Vk8_bYUAl

There is not panic, yet, but there is panic already in works: techies are retrenching on new hiring and there are rumours of some layoffs in younger companies. Meanwhile, states-sponsored agencies seeking to lock start ups and existent players into relocating to their countries or landing in the countries with regional HQs are still shopping around, as if money will always be there to rent plush offices and the case-styled furniture for those whiz kids who make up apps with little cash flow behind them...

It all might be temporary. Or it might be the beginning of the real thing. But one thing is certain: on a long enough timeline, one can defy gravity of basic corporate finance only as long as the interest rates defy gravity of risk pricing.

23/1/2014: League Table of VC Funding, 2012

Remember that report from the WallStreet Journal that put Ireland at the top of the European league tables in terms of Venture Capital raised?  Reminder: http://trueeconomics.blogspot.ie/2013/12/5122013-entrepreneurship-culture-and.html

But here's the latest evidence on the same:

So we are not too low in the tables... although this still does not strip out state subsidies and MNCs funding...

5/12/2013: Entrepreneurship Culture and Policies in Ireland: Sunday Times, December 1

This is an unedited version of my Sunday Times column from December 1, 2013.


According to Shutterfly CEO and veteran entrepreneur, Jeff Housenbold, “Entrepreneurship is a state of mind”.

While measuring the extent and quality of entrepreneurship in any economy is a tricky task, Ireland is an economy with two conflicting states of mind when it comes to start-ups. On the one hand, we have the official story of an entrepreneurship-rich nation. On the other hand, there is the hard data painting a more complex picture.

The latest Global Entrepreneurship Monitor Report, published earlier this year, ranks Ireland 14th out of 22 EU states surveyed in terms of the opportunities open to the entrepreneurs. We ranked at the bottom of the EU in the share of population with entrepreneurial intentions and 17th in terms of our population perception of entrepreneurship as a viable career option. In contrast, Ireland ranks second highest in the EU in terms of media attention given to the start-ups and in terms of the positive public image of entrepreneurship.

To put it simply, the Monitor data reveals the vast chasm between the media and political cultures promoting Ireland as an entrepreneurship haven, and the realities of running and growing a real start-up venture here.

This chasm was back in the spotlight over the last two weeks.

Last week, the Wall Street Journal published the results of a study that put Ireland in the first place in Europe in terms of venture capital raised in the tech sector over the period from Q1 2003 through Q3 2013. All in, Ireland-based tech start-ups and SMEs raised some USD278.73 per capita on average. This compared to the USD68.39 raised across the European Free Trade Association (EFTA) group of 32 states. Impressive as the number for Ireland was, it still falls short of the US figure of USD660.41 and Israel’s USD1,092.52.

Much of Irish media reported the results as being indicative of Ireland’s high success in entrepreneurship. Alas, the study simply does not support such a conclusion for three reasons. Firstly, the data covers only Venture Capital funding extended to tech sector firms. As the result, it excludes the vast majority of start-ups in the economy that are either operating outside the tech sector, or raising funding through channels other than VCs, or both. Currently, VCs-funded companies in Ireland employ around 9,000 people. This a drop in a bucket, given that there are 84,700 self-employed people with paid employees (just one group of entrepreneurs) in the country. The study also covers deals involving already established firms. Lastly, the study suggests that the banking crisis, resulting in the complete drying up of new lending, could have contributed to increased demand for VC funds.

No one in the mainstream media noticed that less than two months ago, in its submission for Budget 2014, Irish Venture Capital Association (IVCA) said that “the shortage of entrepreneurs [in Ireland] has reached crisis levels”. Per IVCA, in 2011 only “8.5 percent of people in Ireland aspired to be an entrepreneur, down from a high of 12.5 percent in 2005.” The EU average in 2011 was 15.3 percent.

And no one bothered to cross check the results of the Wall Street Journal study with actual data on new enterprise creation in Ireland. According to the latest data from the World Bank, Ireland ranks seventh in the EFTA in the scope of entrepreneurship in overall economy. World Bank groups Ireland alongside with Russia, Romania, Hungary, Slovak Republic and Lithuania in terms of the rates of new enterprise formation.

Another piece of evidence on the gap between realities and perceptions of Irish entrepreneurship came from the CSO. Data released this week showed significant increase in employment across the employees and the self-employed. While the number of employees in Q3 2013 was up 27,300 over the year, the number of self-employed persons increased by 30,100. Traditionally, self-employment is the first step en route to entrepreneurship. The numbers of self-employed with paid employees in Q3 2013 was below that recorded in Q3 2011. This and the sectoral decomposition of the jobs creation suggests that the new employment is not being linked to entrepreneurship.


All of this suggests that we have significant road to travel before Ireland becomes a powerhouse of entrepreneurship. The good news is – there are plenty of reforms that can help us on the way.

Last week, the US-based Kauffman Foundation, the largest research centre in the world for studies of entrepreneurship, published the results of its annual Global Entrepreneurship Week survey. The study reveals the snapshot of the state of play in entrepreneurship and start-ups formation across 113 nations and 2,330 current entrepreneurs. Amongst the handful of nations that did not participate was the entrepreneurial haven of Ireland.
Nonetheless, coupled with other sources of data, the Kauffman study offers us some good insights into the role of policy and regulatory environments in supporting entrepreneurship. Many of these insights overlap with what we observe in Ireland.

One of the keys to creating an environment supportive of entrepreneurship is to incentivise equity-based investment. Instead, we have an environment that favours debt. The problem with over-reliance on debt to finance corporate investment is that it has been shown worldwide to stymie the rate of growth in firms. It also lowers the speed of transition from family ownership to professional management.

Ireland lags behind core competitors in terms of banking sector culture when it comes to funding entrepreneurs. This is a function of two factors: low lending capacity in the system that is currently undergoing deleveraging of bad loans, and the long-term historical legacy of lending against physical collateral. We can do something about both, if we get creative. A gradual improvement in lending capacity by the banks can be achieved by reducing risk profile of SME loans. For example, a co-insurance scheme for viable new and existing loans using Enterprise Ireland funds can work to free some of the better quality business loans for securitisation. Co-insured loans can have an equity conversion component for added security. Such enhancements of better loans can help start the process where the banks lend against market and product potential of the specific SMEs instead of lending against physical collateral.

Another area that is commonly identified as a strong support for entrepreneurship is cost of and access to advisory services, starting with accounting and legal services and extending into technological advice and strategy. Ireland has achieved some improvements in the accounting costs area, but is lagging in terms of legal costs competitiveness. Critically, however, there are too few private advice networks available to would-be entrepreneurs. And there are too many state-run ones, often with limited expertise and excessively costly bureaucracy.

One recent OECD report clearly states that Irish system of innovation and entrepreneurship supports is Byzantine – spanning over 170 budget lines and 11 major agencies relating to scientific innovation alone.

We need a more active system of business development and incubation centres not only for start-ups in strategic sectors, such as ICT, bio, and food, but also in domestically-trading ones. Such centres can co-locate with major MNCs and / or be a part of broader business networks. However, the key point is resourcing them. Consolidating and re-configuring currently operating systems of local enterprise boards, FAS, and numerous other quangos crowding this space can help.

Tax systems need to be reformed to support not only creation of business, but transition into entrepreneurship. Currently, transition to entrepreneurship is only made more onerous by the absurd system of USC and PRSI taxation. To do better we need to increase VAT applicability threshold to EUR80,000-100,000 of earnings for self-employed, and dramatically reduce USC and PRSI on self-employed and sole traders.
The problem of tax disincentives for knowledge and skills-intensive start-ups is solely down to ridiculously high upper marginal tax rate on income. Per IVCA Budget 2014 submission: “The effect of [high marginal tax rates] is that Ireland is becoming a “development ghetto” with high growth start-ups doing development here but building other functions e.g. sales and marketing elsewhere.”

An income tax incentive in the form of applying only the lower marginal tax rate on earnings generated in the first three years of self-employment can rectify this problem. It will also align taxation treatment of corporate entities with that of the sole traders.


Beyond this, employees share ownership taxation needs to be revised. In fact, we can be even more aggressive here by setting a CGT exemption or a reduced rate for all companies that facilitate creation of new enterprises. This will send a strong message to foreign investors that cooperative entrepreneurship with indigenous start-ups is encouraged here. Given that many Ireland-based MNCs are actively developing partnerships involving start-ups around the world, an aggressive tax policy stance in this area can even act as an added incentive for MNCs to invest more in Ireland.
In short, there is plenty of room for improvement and innovation in terms of national policies on entrepreneurship. This should be treated as a major opportunity for Ireland, a chance expand and strengthen our indigenous enterprise formation. If entrepreneurship is really a state of mind, policy and support institutions to foster entrepreneurial culture are a matter of will. Having the former without the latter is simply not enough.

Box-out:

A recent report from the McKinsey Global Institute examined the distribution of economic costs and benefits arising from the set of unprecedented monetary policies in the advanced economies. The study found that from 2007 to 2012, quantitative easing measures deployed in the euro area, the UK, and the US yielded a net benefited of USD1.6 trillion to the Government sector. These benefits were generated through reduced debt-service costs and increased profits remitted from central banks. Even euro area peripheral states’ governments have gained from these measures by facing lower costs of funding their crisis responses and by channeling funds from the banks to the Exchequer via Central Banks. At the same time, larger non-financial corporations gained some USD710 billion due to lower interest rates on debt. The only sector of the economy that was an unambiguous loser in this game of monetary policy chairs were the households. Households in the US, the UK and the euro area lost USD630 billion in net interest income. The costs were mostly concentrated amongst older households that tend to hold more interest-bearing assets. The study excluded the adverse effects on households that arise from increased taxation, reduced public services and benefits, and from higher bank loans margins.

The latest plan is a 'white elephant'

The latest Government plan for crises-ridden Irish economy is, letter for letter, a rehashing of past clichés and a pandering to the minority interest groups in politics and business.

When the cornerstone crumbles

Perhaps the most frustrating in the entire document is its centre piece – the so-called €500mln venture capital fund which, according to the reports represents:
“…the key element in Building Ireland's Smart Economy... is the establishment of venture capital funds worth €500 million designed to lure innovative industries and boost research and development.” The Irish Times, December 19, 2008.

The fund will allow three US-based VC companies to invest in start-up Irish and foreign-owned IT and environmental "green tech" companies setting up here. The Government will provide up €25 million a year for 10 years and take a 49 per cent share in the investment companies. Investors will avail of a 15% tax rate on profits.

As quoted in the aforementioned article Taoiseach Brian Cowen said that:
"The aim is that Ireland becomes the world's leading location for business innovation, a country where there will be a critical mass of companies - both Irish and international - at the forefront of innovation, creating the products and services of tomorrow and well-paid quality employment."

It will do nothing of the sorts.

Poor record

This plan represents a clear lack of learning from the past mistakes. Our State’s record in acting as a venture capital investor is thin in experience and disastrous in quality.

Media Lab Europe (MLE) is one example that springs to mind. Some 8 years ago, the State decided to ride the IT bubble hysteria by dumping in excess of €35 million into an early-stage investment in a belief that government-paid provider of services to the various government agencies is the way to enhancing Ireland’s knowledge economy. Five years later it became apparent that the organization was incapable of delivering either commercial or academic value. MLE produced just 15 refereed papers (only 3 were published in the first-tier journals) between 2000 and 2005, signed up virtually no non-governmental business and clocked a mind-boggling loss on public investment.

Other high-tech state-run ‘investments’, inclusive of the public sector own IT programmes, fared equally poorly.

... and poor thinking

But last week’s plan is a true ‘white elephant’ of our economic development even if the record of this State in picking economic ‘winners’ is omitted. The plan fails on the basis of the Venture Capital sector own data across the following parameters:
(1) Timing – 10 year horizon;
(2) Sectors targeted for investment – IT and ‘green’ technologies;
(3) Type of investment – seed and early stage capital; and
(4) Size – €500 mln spread over 3 funds.

According to the European Commission DG for Enterprise and Industry (DGEI) analysis of seed capital funding, for the period of 1994-2003, 5-10 year seed and early-stage development capital funds average internal rates of return were -1.8% and 1.3% respectively. Almost exactly the same returns were recorded for the period of 1983-2003. This included better-performing US-based funds and covered the era of the IT bubble, when tech valuations reached stratospheric proportions.

European Private Equity and Venture Capital Association (EVCA) confirms the above results for more current data. As shown in Table 1, 10-year returns averaged -1.1% for the early stage investments – the same type of investment envisioned in our State plan. In contrast, development finance might have been a safer bet for taxpayers money, but considering the dire shortage of high-quality early-stage domestic firms, this would require us to “pay” established foreign firms to locate here – something that is not kosher under the EU regulations.

Table 1: Funds Formed since 1980, top quarter returns as of 31 December 2006
http://www.evca.eu/knowledgecenter/barometer.aspx?id=462

Figure 1 illustrates two major EU-wide market trends in VC investments:
(1) Fewer and fewer private funds invest in high-tech start ups (due to higher risk, lower returns to these investments); and
(2) Both the seed and start-up capital shares of total VC allocations have been falling precipitously over time.
The Irish Government plan runs precisely against these two trends.

Figure 1: Allocation of funds raised 2002-2006, €bn
Sources: EVCA and PEREP Analytics for 2002-2007 figures

Another report compiled in March 2006 by DG for Economic and Financial Affairs (DG EFA) concluded, among other things:
“As a whole, the returns produced by European venture capital funds specialising in early stage (seed capital and start-up) investment have been disappointing. …taking into account the relatively high risk of this type of investing, the IRRs recorded do not appear competitive when compared to the more predictable buyout investing. …The difference in performance between venture capital and private equity may well be the main explanation for the recent trend for European investment activity to focus on less risky buyout investment rather than venture capital.” As Table 2 shows, even accounting for distributions to investors, early stage financing simply does not pay off when compared to development stage investments.

Table 2: Cumulative investment multiples for EU funds formed in 1980-2003
Source: DG EFA 2007

What about the risks associated with the plan? Again, using the DG EFA data, as Table 3 states, European VC investments underperformed the equity indices in all instances, with exception for the period of post-bubble recession in the US.

Table 3: Public markets returns vs. VC investment

Source: DG EFA 2007

Suppose that the Irish Government fund performance matches the peak past returns for EU VC funds. This implies that at the end of 10 years period we attain a cumulative total value per €1 invested multiple (inclusive of disbursements, etc) of ca x2.9 (as consistent with vintage 1995 funds). This delivers an annualized rate of return of 6.6% or risk-adjusted annualized return of only 3.7-4.8%. This is worse than putting the taxpayers money into a termed deposit with the Anglo Irish Bank. Now, considering the business cycle dynamics, the current investment, assuming 2009 will be the last year of economic contraction in Ireland, implies a historical valuation coincident with the VC funds of vintage 2000-2001. In this vintage, the EU funds yielded a cumulative total value multiples of ca x0.8 and x0.65 respectively, giving a compounded rate of return on the planned state fund of -35% to -20%. Risk-adjusted, this implies a range of -58.3-87%.


Destroying the market

In 2006, a DGEI workshop on seed finance has concluded that “Public intervention needs to take place in a way that avoids the risk of crowding out the private sector.”

To date, Irish VC markets have been characterized by monopolistic competition with Enterprise Ireland (EI) capturing a lions’ share of total investment and private VC firms acting as a competitive minority fringe. Thus, even at the times of plenty the Irish market can hardly be described as that with sufficient demand/supply clearance. In other words, during the time of the robust entrepreneurial activity, Irish start-ups have shown only minor ability to attract private VC capital. Of course, the presence of a state lender with soft budget constraints (EI) helped to undermine domestic VC services.

This structure of the market has hardly changed to warrant a new intervention by the Irish Government. Indeed, if capitalized as planned, the new plan will deliver a re-enforcement of the already unhealthy degree of state monopoly power over the VC market in this country. In the end, there is very little difference between the Irish Department of Finance boffins picking the ‘winning’ start-ups or appointing three US VC funds to do this for them. After all, the rules of the game are fixed (remember those IT and green-tech ideals?) and the losers are known in advance (Ireland’s taxpayers and entrepreneurs).

It would have been simply better for the Government to drop the CGT to match the 12.5% corporate tax. At least this would have assured that private gains yield returns to the Exchequer, without socializing private losses.