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
Keith:
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
Valerie:
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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