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bi-weekly column with timely,
relevant and possibly irreverent
insight into the BC technology
industry.
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Something Ventured:
July 25th, 2008
By
Brent Holliday
Greenstone Venture Partners
How To Fix Venture Capital in Canada, Part 1
“But it don't make no difference,
The past can't be rewritten,
You get the life you're given.
Oh, some pages turned,
Some bridges burned,
But there were,
Lessons learned.” – Carrie Underwood, Lessons Learned
Danny Robinson and Boris Mann have an interesting new
venture called Boot Up Labs. They are trying to foster
a more efficient start and easier early growth for
Internet, mobile and gaming companies here in
Vancouver. On the Boot Up Labs site, Danny recently
posted a thoughtful rant on the fact that
Venture Capital (VC) in Canada is broken and
suggests ways to fix it. This rant has generated much
discussion. Before I weigh in with my thoughts in the
next column, I thought I’d begin this week with a
history lesson. As the poet and philosopher George
Santayana famously said (and everyone has pretty much
butchered since), “those who can not remember the past
are condemned to repeat it”.
Before we can understand what is wrong with VC in
Canada, we need to look at how it emerged here. I had
this exact conversation with a colleague from Ontario
two months ago. He had worked at a private fund, a
labour fund, an LP (institutions that fund the VCs) and
is now at a venture fund in Palo Alto, CA. You could
say, he’s seen it all and from all angles. For my part,
I have been a seed stage funder, worked for Canada’s
largest VC (BDC) and run a private VC fund. In a
nutshell, we posited that the main issue for Canadian VC
is that it grew up way too fast and is now suffering
because of it. Let me explain.
The US venture business started in the early 70’s when
pioneers like Arthur Rock (VenRock) and Eugene Kleiner (Kleiner
Perkins) tried to take the stuffy private equity
business, used to buying or investing in traditional
industrial companies, into the new world of technology.
By inventing a new asset class (venture capital) and
figuring out how to do it well, they suffered through
the mistakes and learned how to avoid them. But it took
time. And a whole bunch of lost money! But not a lot of
money... a big venture deal back then was $2M. As an
aside, one of the investors in Greenstone took $2M in
1976 for his company KLA Instruments and never required
another dime. He built the business on cash flow from
customers, capital equipment loans and eventually, his
IPO money. It is now the second largest semiconductor
capital equipment company in the world. Listening to
him talk about how the terms were structured (1/2 a page
of terms) and what he had to provide to the VC (2 page
business plan and a tour of his facility) makes me
laugh.
A venture fund in the US in the early 80s was made up of
money from university endowments and family trusts. The
largest players today in all private equity are pension
funds. Prior to 1992, a full twenty years into the VC
industry in the US, only CALpers participated in venture
funds. They were viewed as too risky and too immature
for the pension fund managers. In order to help the
pension funds get their significant capital into the
market, the US government instituted a program to help
fund managers raise bigger funds. They matched the
investment (over a certain threshold) of the pension
funds and limited the return. So an institutional
investor had the opportunity to make preferential
returns (a magical phrase to them as they are only
interested in returns, not tax, not patriotism and
certainly not to support certain industries. Just
returns). That program started in the early 90s and
drew the pension funds in through the late part of the
decade to the point where they are the main source of
funds in the US.
In Canada, we had a few pioneers as well. Haig Farris,
Mike Brown and Sam Znaimer at Ventures West, the
eclectic Ben Webster with Helix and Denzil Doyle, Terry
Matthews and others in Ottawa were all in the VC
business before it was the VC business. But it was a
dozen or so investors gathering the necessary
experience. Looking south in the early 90’s, it was
easy to think that we could emulate the US success in
raising money from pension funds. Managers sprung up
everywhere to raise money from institutions. The only
problem is that raising money requires a track record
of, you guessed it, returns. Instead of following the
US model which offered a chance at preferential returns,
the Canadian government elected to go a retail, tax
driven route to find capital when they created the
labour sponsored funds in Quebec, Ontario and BC. For a
decade or so, the labour funds raised lots of capital
and, in the opinion of my colleague and I, sprinted too
fast and too furiously into too many deals.
Meanwhile, funds like my own raised capital and assumed
that we knew the VC business. We also sprinted forward
and then lurched with everyone else in the downturn.
The main problem was that the Canadian VC industry
started growing like mad during the bull run of the late
90s. The labour funds and new funds like mine were just
that… new. The US guys making boatloads of money at
that time were established.
Fast forward to 2004. The US VC industry came out of
the downturn with a 30+ year track record and continued
to raise money. Canada’s VC industry started to sputter
with only a few funds having long enough track records
to raise money on proven success. Without the returns
over a long period of time, institutions turned away
from Canadian managers.
It was bad timing for Canadian VCs to just start raising
lots of dough just before everything went for a dump...
But were we ready, collectively, to understand how to
make money in VC? To really know how to invest the
money and not just where to invest it... Everyone with
an ounce of knowledge can see what looks like a good
deal: experienced team, huge market potential,
intellectual property and a head start over the
competition. That isn’t the hard part of being an
effective manager of funds. The hard part is knowing
what to pay (in amount and valuation), when to get
involved (can I sit this round out and get in when there
is less risk?), when to double down and when to exit.
The other important history lesson is that Canadian VCs
have not necessarily been involved in all of the biggest
successes in BC or Canada. We did a study in 2005,
later turned into a UBC/Leading Edge paper on what exits
had occurred in technology in Canada. To that point, no
one in Canada had bothered to measure what kinds of
successes we were having and, relatively speaking, how
that compared to other regions.
In BC, here are some prominent venture backed (Canadian
VCs) exits with their acquisition price or market value
at IPO:
Hothaus Technologies - $280M US
Octiga Bay - $115M US
MDI - $100M US
Telos - $48M US
Xantrex - $380M US
Creo - $1,200M US
Pivotal - $228M US
Sierra Wireless - $245M US
Here is a similar list of BC successes without Canadian
VCs in them at all:
Crystal Decisions - $1,200M US
Club Penguin - $350M US
Datum Telegraphic - $175M US
Workfire - $73M US
Xcert - $68M US
Absolute Software - $35M US (at IPO, now worth $500M)
Blast Radius - ~$65M US
The point here is that having VC investment is not a
direct correlation to success. There are other ways to
raise money, the most significant of which is to build
your business from cash flow. If you want to grow your
business faster, or you have a huge cash requirement to
get to a product (semiconductor, life sciences for
instance), then VC is almost necessary. But the answer
to funding all great technology ideas does not lay at
the feet of the Canadian VCs. There are stellar
examples of companies that raise money internationally
or from other sources, like angel investors only.
This column would be too long if I now started in on how
to fix VC in Canada. So instead, I have one more
background story to tell. Based on my history lessons
in this column, you may be able to guess where I am
headed next week…
As “new” VCs, Canadian fund managers copied a lot of the
rules of engagement on investing in start-ups from their
experienced US brethren. To be more accurate, we copied
them almost verbatim. Hey, it was working for them! We
would throw term sheets at entrepreneurs and tell them
(along with any advisors) that this was the way to get
it done and get the money. Entrepreneurs, in most
cases, rolled over and accepted many of the terms.
We had one experience that I thought was abnormal. When
presented with normal investor rights and preferred
share terms, one entrepreneur simply said no. He had no
other term sheets or offers for leverage, he simply said
no. He asked why we put in these investor “veto rights”
terms and reps and warranties. We answered it was
“standard VC terms”. He looked at us, folded his arms
and said, “well, I am not standard. I want my own deal.”
And he fought us on every term. He questioned every
motive. I have to tell you that I didn’t have an answer
for every motive. It was boilerplate stuff, I thought.
Now, with 7 more years of experience, I look at what his
objections were and I think that he was right to want
his own deal. If you are buying a car, do you just
accept all the terms, interest rates and extra costs,
because it’s normal business practice? Or do you fight
for a better deal. This entrepreneur pushed back where
many don’t because they are afraid that the investor
will walk away. We didn’t and it is one of the four
remaining, growing companies in our portfolio.
I didn’t intend to leave you hanging here for the
next column… but that’s the way it’s going to be. See
you again on 08-08-08.
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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