The outlook for Irish companies seeking capital, in particular in the technology sector, has changed dramatically in recent months. A high inflation global economy being combatted by increasing interest rates has led to venture capital being more selective and cautious in deployment with many now shifting to a focus on pathways to profit rather than growth and scaling.
Recently venture capital gave its investors an excellent option for yield prospects, however as interest rates rise and yield can be chased elsewhere, venture capital firms will need to focus on its existing portfolio to ensure they are supported, thus enabling positive outcomes which make the pitch for future raises more attractive and withstand the competition from other asset classes.
Venture capital firms do have capital to deploy, with the level of ‘dry powder’ (the funds raised but not deployed) at unusually high levels. These undeployed funds are hoped to reenergise the technology market throughout 2023 however companies need to ensure their runway is strong and indeed be conscious of the other funding options available.
How did we get here – Rampant Inflation
As an economy we became accustomed to a low inflation environment, but a myriad of factors led to this changing dramatically in 2022 with the effects continuing to the present, and forecast (albeit at a lower rate) for the coming years.
The Covid impact has been threefold. The stimulus packages in particular those enacted by the US and EU were at the time well received and deemed decisive action to deal with an unprecedented crisis, however this flood of liquidity into the economies of developed countries has had an impact as consumers paid down debt and saved rather than spending thus not stimulating the economy to the extent expected. Pent up consumer demand is another characteristic with higher saving rates than normal during the pandemic leading to post pandemic consumer strength. This demand has not been met with the required supply due to the impact on global production chains in particular in China where the zero Covid approach disrupted production and distribution chains.
The war in Ukraine has had a detrimental impact both directly and indirectly on the prices of many commodities, however the main pain point has been energy, international sanctions on Russia which tightened supply of gas to the EU in particular (Russia accounted for 40% of European gas pre Ukrainian war). The knock-on increases in energy prices are well documented, however the supports provided by government to consumers to help alleviate the pain are now being removed as they also contributed to the inflation conundrum.
The global political landscape has changed as a result of Russia’s actions, however one could argue that this landscape was shifting well before this in particular with the protectionist push leading to a globalisation slowdown. The Trump government in the US drove increased tariffs in the US which have not been entirely reversed by the Biden administration.
Rising Interest Rates
Central Banks now face the challenge of reining in inflation, the main tool at their disposal is a blunt one, increasing interest rates.
ECB Overnight Deposit rates have risen from 0% to 3.25% with signs that domestic banks are also starting to increase their rates for customers albeit with a significant time lag. The impact from an EU perspective is that inflation will not be under control until well into 2024 if not 2025, with core inflation forecast at 3.2% for 2024.
Funding options for companies
The impact of the rise in interest rates for Irish companies is noticeable in two regards, higher repayments and the decreased availability of capital. Technology firms by virtue of their ability to scale have borne the brunt of tightening of venture capital funding.
IDA Ireland show that Ireland is a go to destination for the leading names in technology in particular those strategic operations bases, with a key reason being the ability of these companies to scale rapidly due to the access to talent and skills. What is inevitable is that this depth of talent will lead to Irish technology companies being created and flourishing due to the experience of working with, and for, global leaders.
It is essential that companies assess the various options available for funding, EiiS, Revenue Based Financing and Venture Debt are all excellent non-dilutive funding options.
Venture debt’s best characteristic is that is extends the runway for companies to pursue organic growth prior to an equity fundraise thus improving the metrics needed firstly to satisfy investment criteria but also driving valuation.
Revenue Based Financing is suitable when there is a strong client book with repeatable contracted income. The capital raised is normally repaid based on a percentage of overall revenue to a point where a multiple of the capital invested is achieved, 1.5x for example. The process is straightforward as there is no pledging of collateral involved, although equity warrants may be needed.
EIIS, the Employment and Investment Incentive Scheme is created to assist companies to raise finance to allow them to expand and create or retain jobs. Typically in the form of preference shares the investment term is four years and has the dual benefit of being a source of capital for the company but also a tax efficient structure for investors.
The EIIS Innovation Fund is currently deploying capital across a range of industries, with a focus on indigenous Irish companies with the potential for future growth.
Brendan Moran BSc MBA ACMA QFA is a Director of Quintas Capital. A member of The Chartered Institute of Management Accountants, Brendan brings over 20 years of experience to the team in investment structuring and corporate finance, having gained knowledge and expertise in the asset management industry and banking sector.
