EVENT: CVCA Insights, Data Release Roadshow (Apr 6th, Halifax)

Pleased to be co-sponsoring this event with innovacorp!

Join us for a morning of networking to mark another great year in the private capital industry.  The CVCA‘s Chief Executive Officer, Mike Woollatt, will discuss the 2015 Market Overview, including transaction and fundraising data, most active Venture Capital and Private Equity investors, top firms, rising investment sectors, and other insights.

Registration is required by March 30, 2016 and seating is limited.  Reserve your place today!

COVER STORY: Canada’s Venture Capital Report Card- Building on regional successes to stoke the long term fire

Cover story, as published in Private Capital, Q4 2015

The Conference Board of Canada’s most recent Innovation Report Card includes some impressive venture capital benchmarks, but there’s much more to consider when looking beneath the surface.

Decreased venture capital investment levels in peer global markets, which are largely a lingering byproduct of the financial crisis, coupled with brisk, but isolated investment activity in select geographies here in Canada raises questions about our ability to sustain a high ranking when conditions improve elsewhere.  Perhaps, even more importantly, these findings put the focus on what actions should be taken to bring improvement to Canada’s weaker markets, of which, there are quite a few.

The Findings

Canada

Increased venture capital investment, primarily in Canada’s large provinces, coupled with lagging investment in European countries since the recession have resulted in Canada moving from being one of the weakest performers to one of the strongest. Specifically:

  • Canada’s ranking has improved from third worst in 2009 to second best in 2014 in venture capital investment, relative to 15 peer countries. Canada earned a B grade and a fifth place ranking overall.
  • Canada’s venture capital investment has more than doubled, from nearly $1 billion (.07 per cent of GDP) in 2009 to over $2.3 billion (.12 per cent of GDP) in 2014.
  • The number of companies receiving venture capital in Canada has increased from 378 in 2009, to 416 in 2014. Peak levels of approximately 450 companies receiving venture capital in 2011 and 2012 have not been met in recent years.
  • The vast majority (80 per cent) of Canada’s venture capital investment in 2013 was later stage, with only 20 per cent taking the form of early stage financing. This falls well short of international trends where more than 60 per cent of venture capital targets early stage financing. The report notes that Canadian venture capital took a much more balanced approach in 2009, when financing was more evenly split between early and later stage.

The Provinces

Provincial venture capital investment levels and rankings vary widely, from A to D-, with six provinces receiving a D or D- ranking. Specifically:

  • Both BC and Quebec rank as A’s in terms of venture capital investment (representing .16 per cent and .14 per cent of GDP, respectively), outpaced only by the US (.17 per cent of GDP).
  • Although companies in Ontario received more venture capital money than that of other provinces, the venture capital investment level of .11 per cent of GDP was sufficient to earn a B ranking.
  • Propelled by two venture capital deals totaling $60 million in 2014, Newfoundland and Labrador received a C ranking.
  • Canada’s remaining provinces received a D ranking in venture capital investment, with Manitoba and Prince Edward Island receiving a grade of D-.
  • Substantial increases in venture capital investment levels from 2009 to 2014 have occurred in four provinces; Ontario (117 per cent), BC (91 per cent), Alberta (81 per cent), and Quebec (61 per cent). All other provinces have experienced declines.
  • In terms of the number of Canadian companies that received venture capital funding in 2014, the highest levels occurred in Quebec (151), Ontario (142), BC (60), Alberta (27), and New Brunswick (19). The remaining provinces ranged from one to nine companies receiving venture capital.

The Fuel

Canada’s much improved ranking was assisted by the fact that, with the exception of the US, venture capital investments declined in all of the other peer countries between 2009 and 2013. Canada weathered the recession better than many countries, contributing to more stable venture capital investment levels. In fact, venture capital investment levels have now returned to the pre-recession level of $2.3 billion. Contributions from the Venture Capital Action Plan (VCAP) have helped, as well as the ongoing participation of BDC Capital, which the study cites as Canada’s largest and most active early stage technology investor.

Venture capital investment in Canada from foreign sources has continued to rise. Traditionally, it has represented approximately 30 per cent of the total, but increased to more than 37 per cent in 2014 from US sources alone. Clearly, venture capital investment levels are positively impacted by foreign participation and our own public policy that encourages investment.

However, we must also be wary of the fact that Canada is currently standing out in a cohort that is performing well below its pre-recession standards. What we do next to continue to separate ourselves from the pack now could have long-standing consequences.

Viewing Canada’s current position of strength as an opportunity to make the necessary improvements to “lift the level of all boats” is a much more proactive approach than simply benefiting from the rise of the tide.

The Fire

Improving venture capital investment levels across the country and generating long term sustainability are important areas of focus. The Conference Board cites a number of factors that contribute to establishing a successful level of venture capital investment, including the presence of those with money to invest, companies that are investment worthy, and a means to connect the two.

Much could be said about the challenges of establishing venture capital pools in particular geographic areas and the difficulties of allocating a portion of funds in existing pools to investments with a higher risk profile. Regardless, fueling the venture investment process requires a stable of “investor ready” companies, enabling venture capitalists to invest well, work with high potential businesses, and generate the returns that are so important in attracting fundraising over the long term.  These are critical components in generating a sustainable venture capital environment.

Venture capitalists recognize that the presence of investor ready businesses and the right approach to get there are, in many ways, the fuel for generating a vibrant investment environment. Too often, the focus tends to be on leading with capital, and although this approach might find some initial success to “get money out”, it does little to generate the level of returns to stoke the fire for the long term.

The New Road Ahead: Implications for Canada’s retail venture capital industry

Published by the Canadian Venture Capital Association in Private Capital

Retail venture capital in Canada, where tax credit eligible money is raised from individual investors, has been a controversial topic over the years.  Since the launch of the first Labour Sponsored Venture Capital Corporation (LSVCC) in the early 1980’s, retail funds appeared across the country, providing investors with access to federal and provincial tax credits and investing capital into young companies seeking to drive Canada’s innovation economy forward.

With the announcement of the “Sunset Clause” in Ontario in 2005, eliminating the provincial tax credit for retail funds over a five year period and the significant decline of fundraising levels in the aftermath, many were left wondering what the future might hold.  The Venture Capital Action Plan (VCAP) initially arrived on the scene as part of the 2012 federal budget, allocating $400 million in new capital over a 7 to 10 year period, with the objective of attracting an additional $800 million from the private sector.  The 2013 federal budget announced the progressive elimination of the LSVCC tax credit program over 2015 to 2017, leaving an asset class that once raised billions with an uncertain future.

With limited venture capital dollars being raised in recent years and a lack of specific details around how and when the bulk of VCAP dollars will flow, there is a climate of uncertainty around what the impact might be on VC funds and, ultimately, the companies in which they invest.  Reflecting on an asset class that has been a part of Canada’s venture capital landscape for 30 years, opportunities for involvement in the future may become apparent, as further details around VCAP come to light.

The Good

Canadian retail venture capital has made a significant contribution to the financing of Canada’s early stage companies, including:

  • In terms of investment, from 1996 to 2012:
    • Retail venture capital funds invested $7.8 billion into 2,419 Canadian companies, representing 53% of all VC-backed companies in Canada at the time (1)
    • In technology sectors alone, retail funds invested $5.5 billion in 1,190 companies, or 45% of all Canadian VC-backed companies at the time (1)
  • In terms of exits, from 1999 to 2013: (i) of the 29 companies that exited by sale with a purchase price in excess of $200 million, 19 were backed by retail funds; and (ii) of the 37 companies that undertook an IPO in excess of $30 million, 22 were backed by retail funds (1)

Over this timeframe, it stands to reason that the level of fund manager expertise was increasing, as part of the typical growth and development of a young industry.  This is reflected in the trend of shifting the investment strategy to focus on later stage co-investment and investing indirectly in specialized private sector venture capital funds, thereby becoming a supplier of capital to the broader VC industry.  As an example, Quebec retail funds have committed $830 million to 59 private independent funds, of which 29 are based in Quebec, 10 in the remainder of Canada, and 20 in international locations. (3)

Retail venture capital funds have played a key role in generating investment in areas that are typically undeserved.  As an example, retail funds in Saskatchewan have invested an average of $80 million per year over the last three years and $600 million in 193 companies since inception, while leveraging significant co-investment from outside of the province.  Saskatchewan’s residents and economy have benefitted, in terms of companies being able to remain in the province and the employment that has been generated as a result. (2)

The Criticisms

Although varying themes may exist, criticism of retail venture capital funds includes poor performance levels, inappropriate structures and governance models, fund managers lacking the necessary expertise, and funds being too small to provide a sufficient amount of capital to support the developmental needs of early stage companies.

Research into these areas, among others, indicates that although there is room for improvement, a number of the typical criticisms may not be entirely valid (and, at a minimum, are outdated).  Consider the following:

  • Although the performance of Canada’s retail funds has been poor, it has been comparable to the rest of the Canadian venture capital industry.  The net 10 year return as of June 30, 2005(4) for retail funds was -1.4%, compared to private independent funds at -3.9%, other captive funds at -3.6%, and an overall industry return of -3.0%.  The issue of poor performance is not due to the retail sector alone, but rather, is driven by broader factors, including timing, fund size, and a lack of experienced fund managers during the period. (5)
  • Given that the Canadian venture capital industry is significantly younger than that of the US and Europe, it is not entirely surprising that the level of experience and expertise among fund managers would require additional development.  This issue, however, is not unique to the retail segment, as other venture capital funds in Canada were arguably facing the same challenges, especially back in the 1980’s and 90’s.
  • The structure and governance model of some retail funds may have been less than ideal, in terms of areas such as fee arrangements and independence.  Although this criticism should not be generalized to all retail funds, even a limited incidence of this type of weakness can reflect poorly on a broader group.
  • Although some retail funds have been challenged by a lack of size and ability to provide the degree of capital that early stage companies often require in order to fully develop, research has indicated some improvements in this area.  In addition, considerable consolidation occurred in the industry several years ago, reducing the number of small funds.

Despite the foregoing, the retail venture capital industry has been challenged by an overall decline in appeal from the channels in which capital is raised, a situation that has been difficult to overcome.  The reality of this type of circumstance is that it can be difficult to find a way forward, regardless of positive achievements and the presence of change.

The Future

It’s no secret that Canada is significantly underserved in terms of venture capital, lagging behind that of key global markets.  Early stage companies that seek to drive the innovation that Canada requires in order to be globally competitive have a critical need for financial support, particularly in terms of venture capital.  Under the circumstances, Canada needs more venture capital, not less, so it’s important that new initiatives such as VCAP truly represent an incremental source of capital, particularly given the phase out of retail tax credits.

Retail venture capital funds have demonstrated the ability to support private (non-retail) funds, invest in and play a key role in developing early stage companies, and effectively benefit regions that are typically underserved.  The opportunity to work in concert with VCAP in some manner seems worthy of consideration, to preserve and continue to grow these important strengths.  Funds that have had some success and continue to have the opportunity to reinforce their achievements through good performance may be well positioned for collaboration going forward.

Change and evolution are often two-fold, where the increase in ability that is gained through experience raises the opportunity to develop and implement strategies that better serve the future.  This occurs in many industries and is a necessary part of growth.  Blending the best of both worlds into the future may be an important step in moving Canada’s venture capital industry forward as a whole.

Sources:

(1)  Thomson Reuters

(2)  Thomson Reuters and Saskatchewan retail funds

(3)  Retail Funds and Teralys

(4)  Represents the only hard data that compares retail venture capital with the rest of the Canadian venture capital industry undertaken by Thomson Reuters in 2006 for the CVCA.

(5)  Review of Main Criticisms Concerning VC Investment by Canadian Retail Funds (G. Durufle, 2013)

Go Big or Go Home: What does it take to build a great company?

Published by the Canadian Venture Capital Association in Private Capital

If early stage companies know little about the expectations of venture capitalists (see Bridging the Gap, Spring 2011 edition of Private Capital), they probably know even less about the working relationship between the two parties post-investment.  While VC’s might see the next steps as obvious (“let’s go and build a great company!”), early stage companies may be exhausted and overwhelmed from the due diligence and closing process and may simply be wishing for things to return to normal; but will their world ever be “normal” again?  Most VC’s certainly hope not.

If the devil is in the details, the challenge is in the goal: taking a largely unproven, early stage business and building it into a great company.  To a VC, this means the elusive “big win”; the company that grows from mere obscurity to sales of $50 million, $75 million, or more.  Beyond the cash that is generated, these winning companies are leaders in their markets, innovators in their industry, and perhaps, most importantly, they share in this powerful vision of top tier growth.  They too want to build a great company, and will take whatever assistance and valuable insight they can find in order to get there.

If a journey begins with a single step, where do you start?  Surprisingly, there may not be a lot of magic in terms of starting the relationship with a new portfolio company off on the right path.  As with the preparation for raising early stage capital, the fundamentals also matter when building a business.  Although strategy is important, what can be even more critical is successful implementation (i.e., getting it done!), while being in tune with the industry and market to know when to shift gears and make the necessary changes.

Investee companies need to take the necessary steps to build the business to support future growth, and not get caught up in the status quo.  And while distractions often arise, it is critical to focus on the fundamentals and the ultimate goal, a discipline that can be difficult for young companies.

As part of this process, a number of key areas require careful and consistent attention, including:

Fundamental Area Critical Success Factors
Aligned Objectives Management buy-in to the short term and long term objectives, as well as the exit strategy.  Willingness to use experienced resources/advice to grow the company.  Consistent focus on what is in the best interest of the business
Product Focus on sustainable competitive advantage. Strong understanding of industry and market developments to guide future product development efforts.  Ability to deliver new products and product enhancements on a timely basis
Market Demonstrated ability to reach and penetrate target market(s) through an appropriate strategy (i.e., pricing, advertising, promotion, distribution, etc.).  Strong focus on competitive landscape and market developments, making necessary adjustments to grow market position
Management Management team includes those with aligned objectives, the right skills and expertise, and strong implementation skills.  Problem areas are addressed on a timely basis
Financial Results & Capital Requirements Timely and accurate financial information that is used to track progress and make adjustments where needed.  Established short term budgets and long term financial targets, as well as the necessary capital to achieve results
Exit Strategy Well developed strategy, including estimated timeline, key milestones, and exit approach.  Should consider market and industry trends and outlook

Given the importance of building the business to support future growth, management may lack the experience to do so, but can gain valuable assistance from the expertise that VC’s bring to the table.  In order to raise the likelihood of success: (i) management needs to be receptive of this type of assistance; and (ii) VC’s need to take an active role in providing it.  Although it is a given that VC’s don’t run companies, this process can mean that early stage investors might have to roll up their sleeves more than they would like, particularly when difficulties arise.  Failing to do so could result in a company that never really reaches its potential, falling well short of “great”.

Beyond providing assistance with the fundamentals, important problem areas for VC’s to play an active role in resolving include the following types of situations:

When the founder flounders Just because a CEO has what it takes to start a business and manage it in the early days does not mean that they have the skillset and desire to build a company.  It’s been said that many high growth companies have at least three CEO’s during the course of their history: one to start the business, one to grow the business, and one to position the company for exit.  All of these situations have a different focus and require different skillsets.  Chances are that all of these skillsets do not reside within a single CEO, so a change in leadership as part of the strategy should not be surprising.  It can, in fact, represent an opportunity to drive growth in each stage of development.

Where the issue can become really problematic, however, is with a CEO who is truly out of their element.  This situation can be typical with early stage companies, where: (i) one of the founders was arbitrarily put in the CEO position, but clearly lacks the necessary skillset; or (ii) the investee company hired the best CEO they could afford, on a very limited or part time budget, and got what they paid for.

In any event, VC’s need to recognize situations where the “CEO has to go” and take swift action.   Weaknesses at the top normally don’t turn around, and sub-par performance results in opportunity that is forever lost.  Although CEO recruitment is often a time consuming process, leadership is beyond important and maintaining a poor CEO and hoping for improvement does not represent a strategy for resolving the problem or for generating solid financial results.

When financial management gets no respect Many young companies underestimate the importance of the finance function, including the critical nature of timely financial information as a management tool, as well as in terms of attracting capital.  Companies with a significant technical or intellectual property component, in particular, tend to put the majority of their resources into technology or product related areas, while downplaying the need to hire a qualified Controller or CFO.

It is often up to the VC to drive change in this area, as they truly recognize just how much a good CFO can do for a company, especially when there is more capital to raise.  VC’s need to ensure that companies build a finance function that can support future growth and create the necessary level of confidence to attract future investors.  The bottom line is that sound financial management is always critical, and you simply won’t build a great company without the right resources and systems in the finance function.

When the culture isn’t a learning one Building an early stage business can be an isolating process and the founders and their team can become overly focused on internal activities.  Growing a business requires a more balanced approach, with sufficient focus being paid to customers, competitors, and market developments, as well as to internal matters.  CEO’s who tend to rest on their laurels and what they already know, without upping the knowledge ante, can be a problem, as well as a sure fire way to get stuck in the status quo.  Successful businesses are always learning, from the CEO’s office throughout the ranks, and building for growth requires new knowledge and skills.

VC’s can be an important catalyst in this regard, setting expectations for CEO’s to actively network and stress the importance of continuous learning throughout the company, as well as seeking out collaborative relationships, perhaps with other investees.  VC’s have almost constant access to industry events and professional development opportunities crossing their desk, and taking a moment to invite portfolio companies along can help to set these important expectations and fuel growth.

When the company needs more help than a VC can provide Early stage companies often lack the experience to address issues that arise, while maintaining forward motion.  This is often the case in “business as usual” situations, so imagine how much of a skill and knowledge shortfall could occur when building a company to support significant growth.  Assisting an investee company in this area could become a full time job for a VC, and that’s just not workable for the long term, given that there is an entire portfolio to manage.

Hands on advisors can be a real help in this type of situation, and VC’s should play an active role in making it happen.  Early stage companies may lack the experience to fully understand the type of resources they need to assist with a particular situation, and as a result, are often not well equipped to identify the type of assistance they require.  VC’s, on the other hand, have typically seen the same situations many times, understand what is needed to support growth, and can be in the best position to diagnose the problem and suggest a handful of qualified advisors who can help; they just need to make the effort to do so.

Helping portfolio companies go from good to great is not just about the big moments; it’s also about paying careful attention to the fundamentals and taking timely corrective action when needed.  Setting expectations of disciplined implementation, seeking out the right resources for assistance when needed, and not tolerating sub-par performance can help to make the most of investment opportunities.  It could be the difference between a breakout company and those that just plod along.

Bridging the Gap between VC’s and Entrepreneurs: A fresh look can be well worth the effort

Published by the Canadian Venture Capital Association in Private Capital

There has been plenty of talk about the state of Canada’s venture capital industry over the last few years; Are returns improving? When will fundraising levels increase? Are more deals getting done?  Although the industry, like many others, moves in cycles, there are some things that seem constant: the gap between the expectations of venture capitalists and how entrepreneurs approach fulfilling these requirements is a good example.

In times of limited capital, bridging this gap to establish the necessary common ground for an investment to occur is critical, particularly for entrepreneurs.  The great divide may be as simple as this: entrepreneurs often focus on building technologies, while VC’s focus on building companies.  Although both aspects of the equation are required in order to capitalize on a market opportunity, why is it so often a zero sum game?

While entrepreneurs are busy perfecting existing technologies, developing new ones, and perhaps focusing on securing support for ongoing research and development, venture capitalists are focused on assessing investment opportunities in terms of key business fundamentals: Product, Market, Management, Financial Requirements and Potential, and Exit Strategy.  VC’s focus on all of these areas, as each one is integral to building a business to capitalize on a market opportunity and generate growth to the point where a successful exit can be achieved.  Many entrepreneurs, however, concentrate their efforts on one or two of these areas, most often the Product category.  Is it any wonder that so many transactions fail to occur?

The very fact that this gap still exists makes it worthy of a fresh look.  The crux of the issue is the opportunity that is lost when an investor and entrepreneur simply are not on the same page, each having different expectations and requirements in order for a transaction to occur.  How often have venture capitalists mused “great product; but they just don’t have a clue about business…”?  In cases like this, they might as well be speaking different languages (and, in fact, they probably are).

Entrepreneurs need to do their part; by taking the time to increase their level of business and financing knowledge and to actively listen to what a VC requires in order to move forward.  Expecting the process to change and balking at the requirements is not realistic or constructive; not as long as VC’s have the money.  Entrepreneurs need to make a conscious decision in terms of whether or not they are truly committed to fulfilling the requirements of the financing process and stick to it.

Venture capitalists, on the other hand, may not have the time or resources to address the areas of development within a potential investee company; and it is not typically their role to do so.  However, there is much that a VC can do to positively influence and expedite this process.

Recognize the language gap:  Venture capital is a complex business, and it does not take much to confuse those who do not work in the industry.  Given that many entrepreneurs lack knowledge of the financing process, they can quickly become “lost” in discussions with potential financial partners.  A VC might think they have been clear in their expectations with an entrepreneur and may be surprised to learn that only a small percentage of their message was actually heard.  Although it may sound simplistic, making a conscious effort to communicate expectations in a plain and straightforward manner increases the likelihood that the message will be both heard and understood.

Demonstrate the fundamentals:  Many entrepreneurs wonder what it is exactly that venture capitalists are looking for in an investment opportunity.  Although the final analysis may be in the eye of the beholder, as much as things change, the fundamentals stay the same.  Articulating the fundamentals in a clear and concise manner is much easier for an entrepreneur to absorb and fulfill.  A simple table, such as the one shown here, not only can help an entrepreneur to better understand the requirements, but also to identify the areas where assistance is needed.

Fundamental Area Items to Address
Product Proprietary technology (i.e., patents, etc.); stage of completion (i.e., market readiness); sustainable competitive advantage; future product development opportunities and capability
Market Demonstrated market need for the product; identification of primary and secondary markets; competitive landscape; strategy to get the product to market (i.e., pricing, advertising, promotion, distribution)
Management Management team members; qualifications; roles and responsibilities; gaps in management team and how they will be addressed; board of directors/advisory board members; advisors under contract
Financial Requirements & Potential Current and projected financial results (including Income Statement, Balance Sheet, and Cash Flow); schedules and key assumptions; sensitivity analysis; estimated valuation; amount of financing required and use of funds
Exit Strategy Industry life cycle/outlook; timeline; key milestones; and exit approach

 

Provide clear action items:  After meeting with a VC, an entrepreneur might walk away with the basic understanding that they “need to improve their business plan” in order for an investor to take the next step.  In practical terms, what does this mean?  Although the VC might have made reference to particular areas, the entrepreneur may simply be at a loss in terms of what they need to do to fulfill the requirement (or simply, how to start).  Providing clear action items (i.e., “develop a table that summarizes competitors in the following categories”, etc.) can help create the “to do” list for an entrepreneur to fulfill what is being asked of them.  Examples can be particularly helpful.

Suggest practical, hands on assistance:  At the end of the day, some entrepreneurs lack the experience and focus to address the needs of a venture capitalist.  Utilizing an experienced business advisor who understands both the early stage financing process and building a business can be an effective way to bridge the gap and a valuable resource when the going gets tough.  An advisor with this type of experience understands both sides of the coin; in terms of where the business needs to “get to” in order to meet the expectations of the VC, and how to work with an entrepreneur to get the job done.  This role can also be the translator between those who speak the language of venture capital and those who do not.

Is it worth the effort?  Sure it is.  Aren’t we all looking for that one great deal?