The recession has brought tough times for venture capitalists, but there are also opportunities for good deals, writes KARLIN LILLINGTON

IN A severe recession is there still room for venture firms and growth financing? Place a bunch of venture capitalists on to a panel and the unsurprising answer is yes – but with caveats.

Four European VCs who visited Dublin last week to hear Irish companies pitch for investments as part of the annual Britain and Ireland Tech Tour investment bandwagon think there are good companies and good entrepreneurs. But it is much harder to raise money to invest and get a payback compared to a few years ago.

Growth financing is still worth doing, said Frank Kenny of Dublin-based Delta Partners. “But there’s no doubt we’re going through a very tough period. A lot of firms haven’t given great returns. It’s tough on the funding side, and will continue being tough.”

He says a lot of the large US endowment funds that would once have put money into venture funds have reduced or completely cut off their investments, taking money out of the system.

However, French venture capitalist Olivier Sichel of Sofinnova noted that his firm had raised a €250 million fund “in a tough environment”.

Seán Bolger of Dublin’s Imagine Communications said venture capital was like any industry – it has been through a recession and things have changed. The current environment created uncertainty for entrepreneurs looking for venture investors.

“It’s not clear who is in business, and who’s available to do business. And, in my opinion, a lot of VCs are not taking a long-term view. There’s a lot of cheap deals out there, and a lot of people taking advantage of that, which is not very helpful.”

The venture industry is “in flux, it needs to settle down, and people need to think about where they want to be”.

Bolger noted that many multinationals have emerged out of past recessions. “People need to start looking for smart deals, not cheap deals. You buy cheap, it breaks.”

On the plus side for investors, there is less competition and it looks as if international economies will begin to recover over the next two years, said Nic Brisbourne of UK-based venture business DFJ Esprit. VCs hope the large multinationals which typically purchase small startups, giving venture investors their exit and their profit, “would be back in acquisition mode”.

But Olivier noted that former European giants like Alcatel-Lucent were not in any position to buy. Many of the big European companies “are virtually bankrupt”.

“There are less and less European buyers. It’s all American buyers, and that’s a real problem. Should I be doing more investments in Silicon Valley where the businesses are?”

This would take further investment capital out of Europe, and transfer it over to the US market.

Brisbourne agreed this was an issue for European investors, who may be reluctant to invest in European start-ups when there is no clear exit – a buyout by the larger European companies – on the horizon. However, he still thinks the current round of European investments might prove to be “a great vintage” and produce excellent payback in coming years.

Bolger argued that many investors would look at investments they already have and into which they have already pumped cash. On the one hand they would be likely to withhold further funding with no clear signs of any near-term payback; on the other they may be reluctant to put money into new companies when their existing investments are stagnant.

Does that mean the downturn might have reached bottom, and the only way is up?

According to Olivier, the French market has its own odd twists. For tax reasons, investors actually have a lot of money available in France. The success of some French entrepreneurs in boom times had created “some very rich people – former entrepreneurs” interested in investing and in supporting new entrepreneurs.

“I actually think it’s a very good time to invest and a good time to raise capital,” said Kenny. “While some have dropped out, it’s a very fluid market and some others are coming in.” He noted that Delta partners have cash for about 10 more deals at the moment.

He says some VCs feel a bit of a bubble may be emerging, particularly in the US, around social networking companies and investments. The panel agreed that there were unsustainable investments going into social networking start-ups, businesses without any viable short or, probably, long-term source of revenue.

Bolger believes there are upsides to a downturn: many of the VCs he had spoken to over the past decade “weren’t that good”. The new, tougher environment helped to winnow out poor investors and poor investments. Investors were “more realistic, more practical”.

At the same time, he noted that there was a very different environment now for companies and investors involved in second-round funding due to overly high valuations for companies during the first round. This would make getting second-round funding more difficult.

Kenny said the current environment meant the startup landscape had changed.

“We do have some lean start-ups now. Entrepreneurs are doing a better job at getting started. And there’s definitely downward pressure on what we can receive for companies.”

Are investors selling out too soon, then?

“While we’re trying to build an ecosystem we also need to demonstrate a return from our funds,” said Brisbourne.

But the issue again is lack of buyers, argued Olivier. “So many have vanished in the past 10 years, and I don’t know how to recreate that.”

But Bolger countered: “If there isn’t a buyers’ market it’s because the price isn’t right. And if the big buyers are American, that’s where the market is.”

He said investors needed to face reality about the depleted value of many of their investments, particularly in internet companies. A lot of VCs who invested just won’t bite the bullet and accept they won’t get the massive returns they’d hoped for.

Olivier said strongly profitable exits did exist for investors in some internet companies, pointing to companies like Cisco which were making major investments in the area. However, poor investment choices by Alcatel-Lucent in the same area feed into the issue of there being fewer large buyers in Europe.

Summing up the challenge for European VCs, Brisbourne said: “European entrepreneurs and companies are good, but we’ve got to put the returns in the bank over the next 10 to 20 years.”