In the previous article in this series, we looked at Invest Northern Ireland’s strategy for using taxpayers’ money to protect private investors from losses made by under-performing fund managers, a technique known as subordination. This article looks at another element of InvestNI’s intervention strategy, “IRR=0%”, an innocuous term in accountant-speak that means “you don’t have to make any money”, and at E-Synergy, the second largest recipient of InvestNI fund and a fund manager that takes not making money to new extremes.
E-Synergy was awarded the contract to manage four funds, totaling £10 million, known collectively as the Northern Ireland Spin Out Funds (NISPO): The Invest Growth Fund (£5 million), Proof of Concept (£3 million), the UU Innovation Fund (£1 million) and the QUB Innovation Fund (£1 million). Since the funds allocated for “proof of concept” are more like a grant than a fund, the following discussion will omit that allocation.
After years of bureaucracy and internal deliberation, E-Synergy was announced as fund manager in April 2009. In theory, these funds could have great potential for Northern Ireland’s technology entrepreneurs and start-ups, but only if the fund manager was motivated to perform. Before getting into the performance of E-Synergy, understanding the InvestNI strategy for incentives will help bring this discussion into perspective. Here’s an extract from the response by InvestNI to a freedom of information request:
The Key Performance Indicators (KPIs) for E-Synergy for the Invest Growth Fund (IGF) are:
- Internal Rate of Return (“IRR”) of 0%
- Minimum of 5 Investments made per annum for 5 years from the Initial Closing Date
- Minimum of 25 Investments made in total over the 5 years from the Initial Closing Date
- Total of £5 million invested by the expiry of 5 years from the Initial Closing Date
For both UU and QUB Innovation funds:
- Internal Rate of Return (“IRR”) of 0%
- Min. of 5 spinout companies in total over 4 years
- Total of £1m invested by end of year 4″
If anything could be more disastrous for Northern Ireland’s investment ecosystem and start-ups than the practice of subordination, perhaps it is that IRR=0%.
The people who put their money into investment funds are known as Limited Partners (LPs), and when they hand it over for fund managers, such as Crescent Capital or E-Synergy, to invest in start-ups, they expect returns commensurate with the risk they are taking. Spoiler alert: investing in technology start-ups is very risky.
In the heady highs of recent bubbles, people talked exuberantly of profits of 20 per cent for venture fund LPs. Today, investors would be very happy to get 12-15 per cent profit returned. But 0 per cent? Nice work if you can get it. What fund manager wouldn’t be delighted to be given £10 million and told there was no need to make a profit? In the case of E-Synergy, in order to keep getting their management fees from InvestNI, all they have to do is make five investments a year.
Unfortunately, for E-Synergy, even that has proven challenging.
In the three years of operation of the NISPO funds, there has been quite a revolving door in the Belfast office: six investment managers have come and gone. Staff have been sent to the Belfast office from E-Synergy’s bases in London and Nottingham to make up the shortfall and the current investment manager has been in place for a just eleven months. Perhaps the high staff turnover explains why E-Synergy has failed to meet its obligation to make a “minimum of 5 investments per annum”.
InvestNI responded to FOI 504, after two attempts to avoid the question: “Missed KPIs – ES [E-Synergy] did miss its KPI for 10 investments by the end of March 2011, however this was remedied on a cumulative basis by 31 March 2012. At present there are no missed KPIs.”
In fact, E-Synergy achieved only four of five investments in each of the two years of operation. And while E-Synergy were missing their KPIs and failing Northern Ireland’s start-ups, they were paying their directors, in 2010, emoluments of £232,911. In other circumstances this would be considered a serious breach of contract.
Since they now cumulatively compliant, one assumes that InvestNI gave them a rocket up the backside at some point. But, as with almost all of InvestNI’s intervention, dumb becomes dumber, and the law of unintended consequences bites again: wth no incentive to make profitable investments, but a royal spanking for missing the first two years of investment targets, what might you expect E-Synergy to do? Correct, they went out and started making investments. Let’s take a look at some of them.
Their first investment, Sonic Academy, no longer has its founding CEO. E-Synergy no longer has a stake in the company. We’re told “it’s complicated”. Another, StreamOn.net, is in liquidation. A third, Vykson, has been sold off for scraps. So that’s 20 per cent of the portfolio gone, in under 30 months, under E-Synergy’s stewardship. Two other businesses have been in operation for a combined 18 years. They can hardly be classed as start-ups in any conventional sense.
And then there is Life Science Hub. According to InvestNI, E-Synergy has invested £250,000 in Life Science Hub UK Ltd. (NI606269). The address is 54 Lisburn Road, Belfast, BT9 6AF. But all three directors appear to be Irish, not Northern Irish. 100 per cent of the shares are, or were, owned by Venn Life Sciences Holdings Ltd. (Life Science Hub UK Ltd. was renamed from Venn Life Sciences UK Ltd in 2011.) But Venn Life Sciences Holdings Ltd. is an Irish company (IE471479) and all current directors are Irish.
Two facts give reason for concern. Firstly, the initial investment of £250,000 looks like the biggest single initial investment in E-Synergy’s portfolio. Dare one speculate that this was a move to demonstrate to InvestNI that they are truckin’ right on along with their investment targets? Secondly, based on the limited information available about Life Science Hub, although the company is registered in Northern Ireland it appears to have very little to do with Northern Ireland, and thus would not appear to be an appropriate target for public funds aimed at invigorating the local technology ecoystem.
The more you examine the activity of E-Synergy, the more you realise that they are rewarded by InvestNI for just that: activity, rather than results.
Trebles all round
A free market, one in which blundering intervention by InvestNI didn’t protect underperforming fund managers, would have taken care of this naturally: managers that don’t deliver wouldn’t get a second chance to lose money again. A diligent overseer might even have jettisoned them early. In order to explain what has been going on, it’s necessary to examine E-Synergy’s incentives again.
Real VCs make their money by taking the first 20 per cent profit on every deal. This is known as carried interest or “carry”. E-Synergy are not permitted (by InvestNI) to take this. Since making profit could possibly be interpreted as a failure to meet a KPI, would E-Synergy be in breach of contract if they made money? Setting aside this problem, what’s left are the fat management fees paid by InvestNi and applied to every deal E-Synergy executes.
E-Synergy are paid management fees by InvestNI exclusive of the £10 million given to them for grants and investments. InvestNI declined to provide the actual numbers, citing commercial sensitivity, but it has been suggested the company is currently making up to £874,900 a year in fees. If this is close to accurate, it is out of line with even the best Silicon Valley fund managers, but that may be interpreted as compensation for E-Synergy’s inability to take carried interest. That said, assuming declining fees in later years, this equates to a whopping £5-7 million over the life of all those funds.
In other words, InvestNI has given E-Synergy up to £17 million of taxpayers’ money – £10 million for grants and investments, and up to £7 million in fees for managing those grants and investments. Not bad, given that E-Synergy need never make any money and only has to do five deals a year.
The world is not enough
You’d think E-Synergy would be happy to make between £5 million and £7 million in management fees, but apparently not. In providing investments from the IGF, they charge start-ups additional fees they describe as “legal costs”, “board fees” and “deal fees”. While this is not uncommon for fund managers, it’s hard to justify them when you consider that E-Synergy are being paid excessive management fees directly from InvestNI, and InvestNI’s stated intention is to help start-ups.
We estimate that the fee structure E-Synergy impose on their investments – paid by the very start-ups that the investment is supposed to be helping – can account for between 15 and 28 per cent of the money raised. So, just for the IGF, that’s approximately £1.5 million in board and deal fees to E-Synergy. That’s correct: almost 25 per cent of the available investment funds go straight back to E-Synergy in the form of fees.
Luck of the Irish
InvestNI are paying an estimated £7 million to E-Synergy for making regular investments, and only expect to lose £10 million of taxpayer’s money. Owing to inflation, that is really only £5.2 million. But if E-Synergy continues to destroy wealth in their portfolio companies there will be even greater losses for taxpayers.
By yoking E-Synergy’s compensation to profitable investments, there would be an incentive to make good investments that return money. As things stand, E-Synergy’s employees are making a killing just by showing up for work. Even more worrying, since the IGF requires a 30 per cent match from private funds – angel investors – what incentive is there to invest or continue to invest alongside a fund manager that is compensated to make no profit?
Surely someone in Northern Ireland’s Department of Enterprise, Trade and Investment should be asking these questions too?