Thursday 8 December 2016

We're missing out on the bigger picture when early stage tech firms sell out

Start in Ireland, move to the US, then sell the company - is that really the best we can hope for, asks Ronan Perceval as he looks at the recent sale of Logentries for $68m

Ronan Perceval

Published 01/11/2015 | 02:30

Building a long-term robust tech eco-system needs both start-ups and large, established acquiring companies
Building a long-term robust tech eco-system needs both start-ups and large, established acquiring companies

In mid-October, one of Ireland's hottest tech start-ups - Logentries - was bought for $68m by a US public company, Rapid7.

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The mainstream view of an acquisition like this is that it is a great exit for the founders - Trevor Parsons and Viliam Holub - from what is only a five-year-old firm.

It is also good news for UCD where the idea was hatched in their Performance Engineering lab and a great (and rare) example of a academic to business spin out in Ireland.

For Frontline Ventures, one of Ireland's newest venture capital funds, it is their first significant exit. This is important both for their reputation and to give their limited partners (the organisations that provide VCs with their capital) confidence that their more innovative model of venture capital is working.

Frontline's philosophy, when it launched a number of years ago, was novel to the European VC scene. Traditional VCs provide support to their investee companies by appointing one of their firm's partners to the company's board. Frontline, on the other hand, set out to build a community of peer learning and support for their portfolio companies where management teams could learn from each other.

This approach aimed to scale the value the firm could bring and make bigger and better companies, more quickly.

The thinking behind this strategy is similar to what well-known firms such as First Round Capital and Union Square Ventures have successfully been doing in the US for the last decade. If the Logentries deal is a sign they can pull this off for the rest of their investments, then it bodes well, potentially leading to more investment in Irish start-ups in the future.

Another bonus from a deal like this is that the founders, once their earnouts are completed, have significant cash in their pockets to invest back into the ecosystem. They will also get to bring their experience to bear for up and coming start-ups.

So all in all a good thing right?

Actually, there is another view. It is one that sees Logentries as a missed opportunity to build a large, self-sustaining, indigenous tech company. The business had an excellent product, and while it had some competition, it was the slickest offering on the market in a fast growing sector.

They were at the beginning of their story and to an outsider, appeared to have a real shot at being their market's number one or two solution over time - potentially a hundred million or even a billion dollar company. But now that it has been acquired by a US rival, we will never know if this could have happened.

Despite Rapid7's indications to the contrary, it is quite possible that the Logentries product will slowly fade and disappear like 95pc of Irish acquisition to US companies.

I'm not privy to the actual performance of Logentries and it could be that they weren't performing at a high enough level to justify the $10m they had received in investment in 2013.

For example, on the Rapid7 website, it implies that Logentries would have had less than $2m in annual revenues this year, in which case their investors would have been delighted with the 3-5x return on their money that a $68m valuation brought.

But this is the challenge in building long lasting large businesses. If the company had been funded through means other than VC, they could have taken the long view and been given the time and space to have a shot at becoming the market leader.

It usually takes a long time to create such a business and when things get tough, you have to work through it. Just look at the INC 500 list of fastest growing private companies in America, less than 7pc are venture backed. And many have been around for decades.

Building a long-term robust tech eco-system needs both start-ups and large, established acquiring companies. The former is obvious - but the eco-system also needs the latter because these larger companies acquire start-ups and retain the talent within the ecosystem, rather than losing them to the US.

Silicon Valley, the ultimate tech eco-system, has both in abundance. Along with an infinite number of start-ups, it has its Facebooks, Googles and HPs. As a company scales in the Valley, it can acquire the talent and know-how it needs from the behemoths that have gone before. This allows Facebook to follow in the footsteps of Google and for Snapchat to follow in the footsteps of Facebook and so on.

In Ireland, unfortunately, we only really have the start-ups. The model for success is starting in Ireland, moving to the US, and then exiting before you really get going. Not enough talent is really developed or retained in Ireland to allow the next generation of companies to grow and take it one step further.

So what can we do about this? In the UK, they have set up something called the Business Growth Fund to promote indigenous long term companies. This is a progressive step but in Ireland a lot of the government support appears to tend towards investments into venture funds - for example Enterprise Ireland's €175m Seed and Venture Capital Scheme.

Don't get me wrong, this type of support is important - but on its own we have to face the fact that the very nature of these funds is that five to seven years after an investment, the fund will be looking for an exit, usually by selling the company to a bigger US rival.

If we really want to create a strong tech eco-system then we need to put in place supports to encourage the development of start-ups into large indigenous tech companies rather than simply supporting the creation of start-ups to be acquired by large overseas competitors.

Enterprise Ireland talks about wanting to create our own Facebook or more likely our own breed of Mittelstand software companies but where is the strategy to back this up?

Ronan Perceval is founder of Phorest, a salon software company based in Dublin. He tweets at @ronanperceval

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