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Venture capital opportunities in the Irish market

Ireland has never been such an attractive investment destination. Entrance into the Euro has promoted free and easy trade, tax rates on trading income are decreasing and the government has proved its commitment to venture capital spending with the emergence of Enterprise Ireland Fund. Eithne FitzGerald of Irish law firm A & L Goodbody, looks at the opportunities available in this region.

Ireland's strong pro business policies have long drawn interest from overseas business, helping to transform the island into an attractive location for foreign investors. The country has benefited from the global boom in high tech and information technologies. It has also risen as an important centre for international financial transactions, making it a leading location for international banking, investment funds, corporate treasury and insurance activities. A National Development Plan has been adopted with a view to improving infrastructure and government efficiency. The country's decision to join the Euro currency has dramatically reduced barriers against financial flows to and from other Euro zone countries  

Tax regime

With a view to attracting more international capital and technology investments corporate tax rates (already amongst Europe's lowest) have been cut. The standard rate of tax on trading income is currently 16 per cent. It will reduce to 12.5 per cent in 2003 and subsequent years. The rate of 25 per cent will apply to passive income such as discounts, foreign income, interest, royalties and rental income from land and buildings.

Although there is a dividend withholding tax it is subject to extensive exceptions. Where the recipient of the dividend is located in a country with which Ireland has a double taxation treaty, the withholding tax will not apply.

Legal framework

Ireland has a corporate legal framework which has many things in common with US and UK models. As a consequence concepts and structuring already familiar in those jurisdictions can usually be readily adapted for use in respect of an Irish company. A typical VC or private equity backed management buy out will be structured with a share purchase agreement containing representations and warranties in relation to the business being sold plus a disclosure letter, a tax deed of indemnity, a subscription and shareholders agreement, articles of association for the buy out vehicle, loan stock instruments (if there is loan stock) and service contracts for key individuals. The subscription and shareholders agreement may or may not also contain representations and warranties, will contain positive covenants as to the ongoing business of the group, a list of categories of actions which cannot be undertaken without the consent of the venture capitalist, often drag along and tag along rights, liquidation preferences, restrictive covenants and obligations on the part of management to sell some or all of their shares in the event that they leave. There may also be ratchet mechanisms by which management can increase their stake in the company on the achievement of certain prescribed targets over time.

The Articles of Association will set out the rights attaching to the different classes of share, whether ordinary equity, preference, preferred or deferred, pre-emption rights on allotment and transfer of shares and quorum provisions in relation to directors and shareholders meetings. Straight investments into a target company will be similarly structured but without the initial share purchase element. For companies in the technology sector at a reasonably advanced stage of development, with a US focus, registration rights agreements are not uncommon.

We are also beginning to see venture finance being used in Ireland as an alternative source of funding to equity fund-raising. Venture financing typically comes in the form of loans with detachable warrants for either preferred or ordinary shares. Although venture finance has been offered in the US to VC backed companies for around 15 years it is relatively new to Ireland. It can appeal to existing shareholders by allowing for further cash infusions while minimising dilution of shareholder rights.

Allotments of shares in an Irish company attracts capital duty at the rate of 1 per cent on the nominal value of the shares or the market value of the assets contributed for them, whichever is the higher. Stamp duty at the rate of 1 per cent on the market value of shares transferred is payable by the purchaser of shares.

Irish Mergers Act approval may be required where there is an acquisition of an interest of 25 per cent more than in a company carrying on business in Ireland were two or more of the enterprises involved each exceed financial thresholds of gross assets of E12,697,381 or turnover of E25,394,762. As a matter of Irish law title to any shares or assets concerned will not pass until Irish Mergers Act clearance has been obtained or a period of 3 months from the date of notification has elapsed.

Venture capital funding

A number of Irish venture capitalists had very successful fund-raisings in 2001 which they have largely still to spend. The state agency, Enterprise Ireland has recently announced it is investing E95 million in twelve new VC funds, E57 million of which will be allocated to VC funds whose investment focus is in companies at start up or an early stage of their development and with a regional sectoral focus. They will thus target companies located in regions outside Dublin and which operate in new sectors such as biotechnology.

A number of UK venture capitalists have been active in the Irish market for some years and more recently US venture capitalists have been directing their attention to the Irish scene. It is reported that international funders such as Summit, Spectrum and Benchmark have all opened offices in London to service the Irish market. In a relatively small country there is the possible danger of too much money chasing too few projects!  We have found, however, that frequently international funders invest in Irish companies post first or even second round financings and then where a local VC is already in place or on a syndicated basis with an Irish venture capitalist who knows the domestic market and sensitivities there and has an on the ground presence.

Overseas funders are often considered attractive to Irish companies due to their established far reaching networks and international presence which bring added value with their investments. Irish venture capitalists are also continuously working on developing good networks.

With the current state of the markets IPO activity has slowed right down from what it has been for Irish companies over the last few years. It is expected there will be some interesting mergers and acquisitions between businesses in the technology sector which have good synergies, possibly with a view to an IPO a bit later down the line.

Public to private transactions

According to their predictions for 2002, a number of Dublin's corporate financiers believe that some of Ireland's publicly quoted companies may fail to see out the year on the stock exchange. Commentators believe that up to 20 quoted companies may be unsuited to public life. Whilst there has been an increase in recent years in public to private transactions in Ireland with companies such as Clondalkin, Adare Printing and The Jones Group all going private, despite predictions last year that many companies would go private, ultimately few companies made this move. The Irish telecom's company, Eircom did of course exit the stock exchange via the sale to Valentia backed by Providence Equity Partners, Soros Private Equity and Sir Anthony O'Reilly.

The lack of interested investors in many small to medium sized Irish public companies has limited their ability to raise capital required for expansion. Low share prices and poor returns on investment is frustrating for management who have to contend with the additional layer of corporate governance rules imposed on public companies over private companies. Often an exit via the trade sale route has been tested but not brought about a sufficient degree of interest. Restructuring a company is easier to achieve in the private rather than in the public arena. Accordingly a public to private take-over is increasingly seen as favoured means of unlocking shareholder value. Furthermore, the availability of funding which, despite the economic slow down, was recently reported to be in or about $500,000,000 for technology investments, buy outs and take privates, makes the go private route increasingly attractive for many management teams.

A public to private transaction in Ireland, is, in effect, a combination of a management buy-out and a public take-over governed by the Irish Take-over Rules which are similar to the London City Code. The timetable for achieving such a transaction and manner in which it is achieved is dictated by these Rules.

Most public to private transactions involve a newco bidder whose shareholders comprise certain of the target company's management and equity providers. Additional financing of the bid will normally come from a debt provider (usually a bank but it may also include a private equity backer). Such transactions have a greater chance of success if the target has a significant shareholder or shareholder group prepared to give an irrevocable undertaking to accept the bidder's offer. That group may also agree to underwrite some of the transaction costs if the bidder is not successful.

Many of the same issues which arise in a UK public to private transaction, similarly arise in an Irish context. Accordingly issues which one needs to be aware of include the obvious conflict of interest which arises where some of the directors of the target company involved in its management are also directors of the bidder. As a result there is a need to appoint an independent committee of the board which considers any bid proposal separate from the MBO team directors. Due diligence investigations can also be constrained by virtue of the fact that the Irish Take-over Rules require that irrespective of any preference which a target board may have for one bidder over another, any information generated by the target company, including that which is generated by the management acting in their capacity as such, which is provided to the backers or potential financial backers of the MBO team is, on request, to be equally and promptly provided to other bidders or potential bidders. There are also constraints under the Rules in relation to special deals available to the MBO team who are also shareholders in the target which are not going to be offered to all the other target shareholders.

MBOs tend to be highly leveraged and so the principal source of financing is usually from a debt provider such as a bank. Under Irish law a public company is prohibited from giving financial assistance in connection with the purchase of its own shares. Private companies may give financial assistance such as, for example, the provision of a loan or a guarantee provided shareholder approval is given and the directors of the target swear a statutory declaration that the company, having given such assistance, will be able to pay its debts as they become due. Accordingly security required by the bank will normally be three tiered. The first tier is granted at the date of the announcement of the offer, which is usually in the form of the debenture granted by the bidder in favour of the bank over its assets. The second tier of security is granted when the offer is declared unconditional in all respects and involves the target company granting a debenture in favour of the bank to secure further working capital advances, as opposed to the acquisition costs of the transaction. The third tier of security comprises a further debenture over the target company's assets to secure such acquisition costs. For financial assistance reasons it is not possible to enter into this third debenture until the shares in the target company have been delisted, the target company has been re-registered as a private company and has gone through a whitewash procedure.

MBOs of private companies

Management buy-out's of private companies are also expected to continue, especially in an environment where many business are looking to spin-off non-core activities or international companies wish to divest themselves of local businesses which local management are happy have a viable future, perhaps with a bit of a change in the business model.

There are still a considerable number of venture capital or private equity opportunities in Ireland for domestic and international backers. Due to their location in a small country on the western edge of Europe, indigenous companies know that to grow they need to look beyond their domestic market and so are usually very open to new ideas and have an international focus. The Irish business and legal framework is a fairly flexible one and, in general, not alien to the US/UK way of doing and structuring deals. The Irish legal firms which specialise in this area have an in-depth knowledge of the local market, an international orientation, and are also at the forefront of legal developments, which greatly assists the ease with which deals can be done.

 © Copyright A&L Goodbody Solicitors 2002

A& L Goodbody is Ireland's largest law firm. Based in Dublin, the firm has offices in London, Brussels, New York and Boston. With 250 legally qualified personnel and a total staff exceeding 450, they have a range of specialists available to meet the specific needs of each industry sector.