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Red Sky in the Morning
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
August 30th, 2001

By Brent Holliday
Greenstone Venture Partners

" If it keeps on raining,
Levee's going to break...
Crying won't help you,
Praying won't do you no good.
When the levee breaks,
Mama you got to move "
Led Zeppelin, When The Levee Breaks

A year ago, I was a bit unpopular with my predictions for where technology markets and venture capital investments were headed. (A Chill In The Air) I pointed out that we were headed for a 6 month bear market in early stage investing. I received direct and indirect feedback that I was merely telling the US or Silicon Valley side of the story and that Canada was in much better shape, thank you very much. Well, I was dead wrong. It was 12 months, not six. I wasn't pessimistic enough it turns out. After the doom and gloom from last year, I'm happy to say we can start to see light for the early stage entrepreneur, in both Canada and the US. Maybe.

Let me take you through some indicators and predictions by others in the economy and the technology markets to understand why I think the next four months will be the bellwether for what direction we go in 2002.

This summer was an interesting pause in the technology world. Bad news continued to pour in and indicators like the NASDAQ dropped 14% from June 1st to now. But after the first 6 months of 2001, we kind of expected the news to continue. Next week, fresh from many long vacations, venture investors, analysts and investment bankers will do some serious navel gazing and start to indicate to the world whether we are going to climb out or recede even further into the abyss. The big enterprise buyers of IT and communications also are returning from their vacations and planning for the next 6 months. Will they buy? If so, what will they buy? The entrepreneurs, who did not have a summer vacation, are nearly helpless in their struggle to keep their companies alive. They also wait to see what will happen from the investor side and from the customer side.

Let's start with my favourite topic, venture capital. In Canada, the Q2 investment numbers were slightly higher than Q1 (CDN$1.12B to CDN$1.38B). While this was celebrated as a feat by the Canadian VC crowd, considering that the US numbers were down from Q1 to Q2 (US$10.4B to US$8.2B (PwC Money Tree)), there is more to the story. Despite the increase in total dollars in Canada, the actual number of financings dropped 23% from March to June. More money went into less deals. This jibes with another stat from Canada in the first six months of the year: 68% of the money invested went into existing companies. Two trends can be confirmed with these numbers: 1) VCs are being more selective and 2) VCs spent early 2001 shoring up existing investments because other VCs are more reluctant to do new deals.

One stat that is impossible to find, because VCs and companies keep the valuations secret, is the decline in value of the deals. Here are some breathtaking examples:

· Ottawa communications company with initial beta customers and over 100 employees starts raising money in November 2000 at US$140M valuation and receives investment at US$30M valuation in July 2001
· Vancouver technology firm raises significant initial investment at a low enough valuation that allows the investor to own more than 50% of the company right out of the gate (not typically done by VCs, who want to keep owners and founders motivated)
· Ottawa photonics firm with over US$30M invested already into the company starts at over US$100M valuation and now looking at US$20M valuation to get money.

In each case, the company is accepting harsh terms and low valuations in order to stay alive. These companies are regarded as success stories because there are many, many more stories of companies that can't get money at any price and are failing. The new term out of the Silicon Valley is the "A Prime" deal. In the vernacular of the Valley VC, companies go through rounds of investment (seed, series A, Series B, etc.) on their way to the golden IPO. With the dramatic downturn of the last 16 months, companies that raised money at high valuations then, are raising at much lower valuations now. No one is immune… it is happening in every sector in every geography. The VCs with deep pockets are starting to look at existing companies with full management teams and customers, raising their third, fourth or fifth round of funding (Series C, D, E) at Series A valuations. These are A Prime deals. In fact, a Vancouver company, Convedia (formerly Starvision), was cited as an A Prime deal that David Ladd of Mayfield Fund in the Silicon Valley wants to do (He announced it to Venture Wire last week). The Burnaby company was a complete re-start a year ago and would do well to get Mayfield behind them. But at what price?

So what happens next in VC land? Anecdotally, I have seen some amazing early stage opportunities to invest in brand new BC companies without the legacy and baggage of previous investments. For our point of view, we see some of these deals happening before the end of the year. From conversations with Ottawa VCs and US VCs, the sentiment is the same. The house-cleaning of existing companies is nearly over and it's time to move on to the new deals again. I think that the Q3 numbers in Canada and the US will trend down, mainly because activity was low in the summer. The Q4 numbers will be telling. Will investments pick up? And in what sectors?

Investing in early stage companies, whether they are A-Prime or just A, means that there is some faith in the market growth of the sector that the entrepreneur is after. Over-investment in sectors has been a problem never seen before in North America because there is so much VC money in the US to be invested. So, will the market grow? If so, am I betting on the 15th entrant into that market or the 1st? These are the two main questions that VCs will look at in executive summaries and business plans today and for a long time coming.

Wireless software is a good sector to use as an example because there is so much activity here in Vancouver. I have seen a dozen wireless software companies with interesting technology and good to great technology teams in the past 3 months. This is the fantastic legacy of the anchor companies (MDI/Motorola, MDSI, Sierra Wireless, Glenayre) that spin out expertise and innovation nowadays. The problem is that the market is crowded, crowded, crowded. Ask Infowave, eDispatch or Soft Tracks, three companies that benefited from the initial wave of investment and hype to raise money and build wireless apps/solutions, whether they have met or exceeded sales plans for 2001. All three companies have incredible technology and superb technical teams. But the customers are not buying, at least not in droves. What is the current crop of start-ups seeing in the space that we are not? 3G has been a bust to date. WAP is a disaster. The hype has died down. The companies that I am excited about in this space are looking at the market today and building/selling apps or services that work on today's network and customers are making orders. They are carving out new niches and becoming leaders in them. My biggest worry is what other investors are thinking. I can't support these companies with our fund alone. We need to attract more capital now and down the road. If the sector is perceived to be crowded, it will be very hard to raise money to lead the pack.

In the general tech sector and big public companies, there is no hope of recovery in 2001. Write it off, folks. Continued bad news in the third quarter will spill into the November company reporting times (notice I didn't say "earnings", because there are none). I have heard about a pipeline of promising IPOs set to file at the first sniff of a market uptick. In late August 1998, the mood was miserable at the peak of the Asian crisis. On September 24th 1998, a daring attempt at an IPO was done. And it flew. eBay started the mad rush that we all now know about. Will there be an eBay in 2001? I doubt it. In reality it will be 2002 before we see some return to optimism and hope.

Meanwhile, the companies that buy the goods that fuel the communications and IT sectors are the real wild card. Will spending increase? Many companies in the "old economy" are re-tooling in the downturn in order to be more efficient and more profitable. IT efficiency gains have been proven. Outsourcing non-key IT tasks is just starting to boom. This is where I will be watching with the keen interest to see if we really will start up again in 2002. What are the buyers actually doing with their wallets? Any sign of confidence will translate into profits and then into recovery. Any lack of confidence, compounded on top of all that already ails the tech sector and we might be years away from optimism. One disturbing fact from a survey representing the 11 million small businesses in the US (<500 employees) was that 33% of them described themselves in "survival mode" when asked how they see themselves and given 4 choices (survival mode being the most pessimistic). Let's say that half of them don't make it... that's 1.5 million businesses gone and all their spending with it. Ouch.

To summarize:

1. VCs are moving from shoring up existing companies to looking at new deals again. The bottom of the trough in investments may be at hand. But they will watch the general tech market for indications of optimism before pouring open the wallets again.
2. The technology public market companies will be in the doldrums until at least early 2002. IPOs will remain a distant hope.
3. The wild card is the spending of enterprises over the next 4 months on communications and IT. If they stay active and ramp spending, even slightly, the picture gets brighter all around for 2002. If not, Yikes!

Early stage companies should remain in "survival mode" for the time being in order to be around in early 2002. Am I being too pessimistic? Or not enough? What are your thoughts?

Letters From Last Time -


Great article today. Like you, I am a true believer in process. The only way from here to there is process, process, process. If you haven't read "Strategic Selling" by Miller and Heiman I strongly recommend it. This is the bible: Process as applied to selling.

My favourite quote:

"We interviewed literally hundreds of prospective sales representatives... Not one in a hundred of our candidates was able to identify the real reason for his or her success. They talked about luck, connections, or hard work as the essential ingredients. Only a tiny fraction understood that it was they way they went about their work -- what we call their methodology or process -- that was the real clue to why they did well."

Love the process!

Regards, David.

I get a lot of eye rolling from founders when it comes to process. It sounds too MBAish for many technoids. The reality is that the best execution of a plan only comes after proper processes to ensure execution are put in place. Thanks for the book referral and the quote.

I was pleased to read your comments regarding the need to view funding of early stage companies in a different light than the "government handouts" that are recently under scrutiny in our fair province. For some years I have been involved as a volunteer peer reviewer for Science Council of BC. Although I don't speak for SCBC, I can attest to the fact that our review process, and all the regular reviewers are apolitical. The subject of politics doesn't even make it to the radar screen. We base our support on whether the proposal has technical merit and innovation, a sound business and technical plan, and a strong likelihood of success.

Most of the applicants we see are bright, hard working entrepreneurs with very little if any financial backing. As you point out, they are way too early in their development to attract private sector financing. Consequently, many of these R&D ventures are supported by sweat equity or by borrowing from family members and re-mortgaging the house. In my experience, if an applicant is an established company that is merely looking for a government handout, they are very quickly removed from consideration.

In light of the numerous success stories that have emerged from SCBC programs, this type of government funding should be recognized as an investment in a nascent technology industry - not a handout. Far from just dispensing funds, SCBC staff and volunteers work with our clients prior to and during the funding period to refine their plans and help them to meet their objectives. We make the investment of dollars and time to ensure that new technology ventures remain in BC and hopefully develop into viable companies. Perhaps that is one of the reasons we have a small, but healthy and growing BC technology industry today.

Randall Gray

The latest that I have heard is that SCBC is OK. It does fill a rel need where other don't play. In fact, there should be more money ear-marked for proper, peer-reviewed (and VC reviewed) technology commercialization. Then they should spend even more on educating and training people for the commercialization and selling process. Thanks for the very thoughtful agreement.

Great article Brent!

Many people I run into in business know they want/need a website but then do not know what to do with it once it's built. They do not know how to promote their business through it, or use it as a way to change and improve their business operations.

I enjoy your column, keep writing!

Best Regards,
Beverley Delamere

Thanks and I will. Perhaps this is why success in business is hard to achieve. You don't have to be Einstein, you just have to be prepared to do the work. If you cut corners or make too many assumptions, you fail.

What Do You Think? Talk Back To Brent Holliday


Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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