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

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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