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



Something Ventured:
December 16th, 2005

By Brent Holliday
Greenstone Venture Partners


Money In Your Stocking


“Look at them yo-yos,

That’s the way you do it…

Money for nothing,

And chicks for free.” – Dire Straits, Money For Nothing


As we drag ourselves between holiday parties, slogging egg nog and dreading the last minute shopping, I thought I’d talk about something we all need a  little more of in the New Year, money.  Specifically, money that you may have in your business that you haven’t tapped yet and money that you are spending more of versus your competition.  To put it another way, as you plan your 2006 budgets, let me add some tidbits for you…


First from the news last week:


“Tropic Networks (Ottawa, ON) is proposing to acquire two Canadian energy firms in a deal that would give the optical networking vendor enough cash to last nine more months, the company announced today.”  Huh?


I knew optical networking was tough, but why are they becoming an energy firm?  The answer is accumulated tax losses.  Tropic doesn’t need them as they won’t be profitable anytime soon, certainly not before they would die without more cash, and energy companies are so profitable right now they are looking for a way to defer taxes. Essentially, Tropic, which has raised over $150M, will sell its losses to companies with profit in a transaction that is currently completely legal in Canada.  The losses sell for about 4-5% of the total value, minus any SRED credits.  Tropic raised $8M in this transaction, so they had about $160M in tax losses since they started in 1999.  Interesting way to release money form your company, isn’t it?  This is what Bookham plc did in June in England to raise $20M more in its bid to stay alive in the optical space.


Here’s the catch(es):  First, you have to have at least $10M in losses before any middleman will affect this transaction.  Second, it may not be here for much longer because CCRA is not happy about the loophole that allows completely un-related companies to amalgamate for the sole purpose of sheltering tax.  I’d give it a year at the most until Canada becomes like the US and restricts these transactions to those that are in a very similar business. Third, it is rarely used in the course of an operating company and is usually a last gasp of a dying company to get money for its creditors or preferred shareholders (read: VCs).  Fourth, it is a horribly complex transaction that will have the lawyers rubbing their hands together.  But, nonetheless, it is a way to find money in your company today that might be more useful now than in the future to offset tax.  If you have exhausted all other forms of finding cash, you can look into this type of sale.


The other source of money often overlooked by companies as they grow is receivables financing.  Many of the big banks and smaller merchant banks will finance your receivables, both trade and government (SRED).  Of course, you have to have receivables and they have to be from reputable companies that you are selling too (another good reason for selling through big strategic partners who give you your cheques).   Getting cash now for money you don’t normally collect for 90 to 120 days is a good thing, as long as you are paying reasonable interest rates and covenants on the loans won’t slow you down.  This is short term financing to be sure, but helps release cash that you otherwise wouldn’t have tapped that is sitting in your company.


There are many other sources of cash, from leasebacks of depreciated (or new) equipment to sub-letting office space.  All of this speaks to your need for a very good VP, Finance, Controller or CFO that is on top of this and can help you find the cash now for your important investments, like new hires or new capital expenditures.  They can also help you hedge against the biggest source of money out your door as a Canadian technology company today: The strength of the CDN dollar.


With apologies to my friends at Leading Edge BC and their attempts to show the lower cost of business here compared to other regions, here is why being headquartered anywhere in Canada is a huge pain right now:


A Senior Engineer in California US$120,000/yr in 2003 and today.


A Senior Engineer in Vancouver CDN$100,000/yr = US$87,000/yr (1.15 exchange rate today)


In late 2003, the same engineer in Vancouver was US$58,000/yr


That’s a move from 48% of the cost of a CDN engineer to 73% of the cost of a US one, or a 52% jump in labour cost versus a California company.  If we compete for customers and profitability versus our US brethren, then we are about 50% more expensive than just two years ago if you assume that the major cost of operations in labour.


This rapid change has no doubt been felt and many entrepreneurs here affirm that it has been tough on the bottom line when you sell your product in US dollars and your labour costs have gone up versus your competition.  This “inflation” of labour costs means that you need more cash to get to where you need to go.  Interestingly, VC rounds in Canadian companies have trended towards larger rounds of financing in the past two years.  In 2003, the average venture round deal size was CDN$1.9M.  Over the past 4 quarters, the average deal size has crept up to CDN$2.2M, a 15% increase.  But 15% more money for an entrepreneur is not enough when labour inflation relative to competitors in the US has been 50%!  Add that to the fact that average US VC round deal size in 2005 is creeping towards US$10M and your competition has more money to spend on their labour.


As a VC that bought a lot of securities in US dollars in 2002 and 2003, supporting our companies, I can tell you that selling those securities today requires a huge premium just to offset the loss created by the exchange rate.


So what does the smart company do to stop the money bleeding away from currency value fluctuations?  Hedge.  No, not a shrub.  A hedge.  Buying and selling futures in currency is a sophisticated way of minimizing currency risk, sort of like buying insurance.  But it only works if you have lots of idle cash to put to work (say, if you were just financed for instance).  You can pay attention to the pundits and guess when is the best time to buy or sell US dollars or supplies denominated in US dollars, but, once again, if your biggest cost is labour, you are paying every two weeks and are exposed to every swing in the currency markets.  The other method to try is to adjust pricing and be tougher on suppliers on costs.  But, as we talked about, your competition might not have the same cost pressure and will not have to adjust prices.  Welcome to Robert Friedland’s Flat World… globalization can hurt sometimes.


Your last method to reduce your exposure to the US market is to sell to other markets and sell in other currencies that aren’t changing as rapidly against our own dollar.  In the last year, Canada’s dollar is one of the 10 strongest performing currencies.  So your choices are limited as to which country is staying relatively flat versus our own currency.  But diversification of your sales regions is just like diversification of your stock portfolio… it dampens risk.


At the end of the day, all Canadians face the fact that our resource strong economy (some call our dollar “petro-dollars”) has created a huge hill for entrepreneurs to climb.  The only way to effectively remain profitable and competitive in the global markets is to increase productivity and efficiency.  Productivity is the output you get per unit of labour.  Canada is way behind the US on this score.  When labour is your main cost as it is in technology, well, you had better figure out how to get more production out of your teams. 


Something to noodle on over the holiday and to plan for in the coming year.  After all, who doesn’t want more profit in the New Year?


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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