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

Something Ventured:
June 4th, 2004

By Brent Holliday
Greenstone Venture Partners

"I stretched back and I hiccupped
And looked back on my busy day
Eleven hours in the Tin Pan
God, there's got to be another way
Who are you?" - The Who, Who Are You

Despite obvious ill will to the city of Calgary and its hockey team around the 19th of April for ending our Canuck's season, it's hard not to pull for the underdog team of the century in hockey now. Especially when you see the way the city has embraced and celebrated its puck heroes. There is no one off the bandwagon in Calgary and last week, the Canadian Venture Capital Association fortuitously held its annual gathering in the city during Games 1 and 2 of the Stanley Cup Final. Seeing the bedlam of 17th Ave. first hand was an experience I won't forget.

There was no such bedlam in the halls of the VC gathering as our bandwagon has gotten somewhat smaller in the first few years of this century. Think little red wagon... with wobbly wheels. Seriously, we had a somewhat upbeat meeting as the broader "private equity" industry, of which venture capital is a sub-set, is doing much better after three disastrous years.

After this pow-wow in Calgary, I thought that it might be useful to do a column on our industry within Canada a little to help shed light for most readers on what our motivations are and who we have to be held accountable to. It's pretty boring stuff, but I'll try and make it somewhat interesting. If you already know all of this about VCs, then get back to FlamesGirls.com and enjoy the Stanley Cup.

Angel investors are easy to understand. They have lots of money. They have little time. They dribble a few hundred thousand out to you to get started and then you have to come and meet the Venture groups. As for angels, it's their money. Easy to comprehend their motivations, right?

For most of you, we VCs are the necessary evil of start-ups in technology. We must look like Monty Burns to many of you, folding our long, bony fingers and looking bored as you sweat through a presentation to sway us to invest. It's not our money. We manage the money. So, what exactly is our motivation? Depends on who you are as a VC...

Vancouver is the only place in the world where there seem to be a lot of venture capitalists that do very different things. Because of the Venture Exchange and junior capital public markets (see Mike Volker's columns) in this town, some people call themselves venture capitalists that do very different things than I do. Everywhere else, it is understood that a VC is someone who raises a pool of money (committed capital) and invests it over a time frame (3-4 years) and returns the capital and profit within 10 years from the "close" of the fund-raising process. That is what we do (Greenstone, Chrysalix, Banyan, Yaletown and Ventures West are this traditional VC type). Other "venture capitalists" in this town raise money for public companies on a deal by deal basis. It's more like investment banking where the person is an intermediary between investors and companies.

We traditional VCs make up 85% of the venture capital in the US and about 40% of the $22B under management in Canada. We raise our pools of capital (called funds) from pension funds, insurance companies, endowments and other institutions with billions of idle capital available. Essentially, we have to pry the millions that we invest from our funds from managers of massive amounts of money. The legal entity that we use to manage the pool of money is a Limited Partnership (LP) and the partners are these institutions (whom we confusingly call LPs as well). Here's some perspective for you regarding pensions: My wife is a teacher in BC. A very small part of her pension has been entrusted to me to make money so that she can retire comfortably. I have to remind her that it is a very small portion...

In a nutshell, we have to impress quantitative financial people that our experience (track record) and plan (strategy for investing) will generate better than average returns for their money over time. These LPs see hundreds of private fund managers a year. They invest in a handful. Most get rejected. Sound familiar? This market system has evolved to weed out inefficient managers of money because if the track record stinks, they won't raise more. It is the VC comeuppance writ large. We feel your pain, Mr. Entrepreneur, because we have to go sell ourselves with PowerPoint and a business plan, just like you do to us. And if we don't execute on our plan, we will fail. So, we have a group that we are accountable to, which may help you understand our motivation.

But the real motivational kicker is in the terms of our relationship with the LP. We must invest our own money alongside of them. My investment in Greenstone is approaching the value of my mortgage. You could say I have skin in the game… We get a salary and expenses to run the fund through an annual fee. That fee is around 2% of the total capital, on average. But that is not why we are here. Traditional VCs get a share of the profit of the fund, called the "carried interest". Once the capital is returned by selling companies or having them go public after a few years, the VC manager can start to see some real upside. Now, that 2% annual fee for salaries... it gets paid back as well. It's as if we borrowed the money to pay our expenses and we pay it all back before we share in the profits.

So we VCs see none of the real green until long after the companies are sold or go public and our LPs get paid. This is truly a patient game.

We traditional VCs need to be entrepreneurial ourselves. We have to have naiveté and confidence to raise the first fund when there is no track record. Greenstone had evolved from BDC's Venture Capital division, so we had some experience at investing. But it was a tough go. Yaletown just accomplished the near impossible feat of raising their first money in the past two years, without any direct VC experience. At the CVCA conference in Calgary, one of the Yaletown partners said to me that he was glad he never came to CVCA prior to raising the money, because he may have never bothered after listening to the LPs say how difficult it is for them to bet on new managers.

Our motivation as stewards of the LPs money (which includes our own), is to make money for our investors. We don't raise more if we can't do that. Very simple. Very Darwinian. Very American. Very entrepreneurial.

In Canada, there is a unique form of venture capital, the labour-sponsored fund (Growthworks' Working Opportunity Fund in BC). Most of you are familiar with how they raise money, from retail channels that lead to you and me, Joe and Jane RRSP. Their attractiveness initially is the 30% tax credit which is necessary to defray the patience needed for returns. If the redemption lock up is 7 or 8 years, then the normally impatient retail investor needs a reason not to flip Nortel shares instead… or buy public equity mutual funds. The LSVCC and newer PVCC (Private Venture Capital Corporation) tax credit vehicles make up almost 50% of the $22B of venture funds in Canada. It is a huge business in Canada and exactly 0% of the US venture market. It is uniquely Canadian because of the reluctance of pension funds in Canada to embrace venture funds in the 80's and mid 90's. The US system had evolved by that time and many pension funds were already investing.

These funds, like mutual funds, never end. Their investors pile in and can sell (after the redemption period) out. Any gains made by the investments being sold or going public, raise the Net Asset Value Per Share allowing Joe and Jane RRSP to sell their shares for a profit sometime down the road. Their managers are not a big part of the fund raising machine that is largely driven by RRSP season every year. They have varying bonus structures based on performance, like the traditional VCs, but the upside is not as lucrative on a dollar for dollar basis. Don't cry for these managers however, because they do also get expenses and salaries paid by a management fee. Unlike traditional VCs, this fee is never paid back to the investors. It just melts away as the cost of putting your money into a vehicle like this. They are accountable to a Board and, of course, the shareholders who could put them out of business by redeeming their shares en masse. It is not easy street being a labour fund, especially in the beginning when capital is low (ask Altura, for instance).

So the managers of labour funds are motivated by success, just like the traditional VCs. They do not typically have their own money in the labour funds. So the traditional VC has more upside, but also more downside if they lose money for their investors.

The last major source of venture capital in Canada is the quasi-government source, which, outside of Quebec, is BDC. BDC Venture Capital is a large and growing fund with no definitive end (an evergreen fund). All profits are plowed back into the fund for future investments, minus the bonuses and expenses of carrying the investment professionals. The investment teams are salaried employees of the Bank and many of the processes (that we fought when we were there!) are very bank-like. But the group does a good job of addressing the needs of venture investing and acting like a traditional venture investor to the companies they invest in. The managers at BDC have the least upside in relative bonuses, but they don't have to plow in their own money either. When things are going well for the entire team, the managers are quite happy. And I'm not aware of any other VC firm that has as good a pension!

All of us that invest in early stage in Canada are accountable to others who either a) employ us and or/ b) give us our funding. It is not all our money, like the angels. This complicates things because human nature is such that you spend your own money differently than you spend other people's money. We worry, like you do, whether there is more money down the road, and how much. And last week in Calgary, we got together and worried a little more. But like the underdog Flames, with gritty determination and a little luck, success is likely to come our way. I hope this helps you see us across the table in a somewhat different light. If not, I can still do my Monty Burns impressions for you.

Letters From Last Time –

Hi Brent

I liked your piece on leadership and what it takes to make a success. I think you are mostly right in your thinking on this one.

I would go further and say that it takes very different people to be successful across a range of business situations. In fact, I think every CEO has to be bloody minded about succeeding. Beyond that, he has to be superior in some skills. Intuition and leadership are good. Decision-making and inspiration are also good.

But there are also some characteristics that are deadly. Like being excessively self-focused to the exclusion of giving any credit to the people really getting the work done. Being excessively concerned about data (or quality or image or ...) can be a problem too.

If we look at the big successes, they are driven to excess (Gates, Pattison, Trump) while generally being damned good at making key decisions.

Regards, Keith Cowan


I agree. Inspiration and motivation are key. As someone told me, the leader can be a nasty S.O.B., but he/she better be able to inspire us by their work ethic, knowledge and/or conviction that we will win. Think of a drill sergeant in the army...

I enjoyed your article this week. We've met several times at tech functions. To refresh your memory, I act as an out-sourced VP HR for dozens of Vancouver hi-tech early and mid-stage start-ups and know many of the VCs.

I've been asked by boards to go in and assess the senior management of companies and what I've feedback to Boards is similar to your article. Leaders can be given training and can make some changes, but the changes are usually to their behaviours, unfortunately not to the core of who they are. While they may be able to change their style for a while, when the stress comes and the going gets tough, the core comes back out.

You're right that it takes time for someone's true character to come out, however Boards' biggest fault is that they do not act quickly enough and allow the bad leaders to stay too long. If we go with the premise Leaders are born not made, then I think Boards would work more quickly to make changes before there is too much negative impact.

Regards, Valerie Henderson


We have a saying at Greenstone: When you as a Board member think that the CEO is not doing a good job, it's already way past the time to make a change. CEOs are human and will get defensive when attacked for performance or style. It is natural. You cannot be cowed by how the person will react or feel. A good Board will treat the CEO with dignity, but will move decisively and quickly, as you say. A mediocre Board might avoid confrontation and let the negative cancer spread in the organization. Thanks for the input.

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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