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

Something Ventured:
May 18th, 2007

By Brent Holliday
Greenstone Venture Partners

Lack Of Funds


“No time,
Always runnin’ here and there
Chasin’ the money…
Where are we runnin
We need some time to clear our heads
Where are we runnin
Keep on working ‘til we’re dead”
– Lenny Kravitz, Where Are We Runnin


My profession is getting a big butt-kicking this week.  In 1999, when we raised Greenstone’s funds, it was soooo cool to be a venture capitalist.  Of course, when we raised money, it was top of the technology market.  Everyone wanted in.  First time fund managers like us were not only able to get funds, some of our sources (the so-called Limited Partners or LPs that are made up of mainly pension funds) even bragged about doing first time funds.  It’s easy to see why.  Returns were jaw dropping in early stage investing.  Average returns were good, not just the top performing funds.  As it turned out, those returns were short lived (1997 to 2000).  Now, being a VC in Canada is as popular as a Microsoft Zune player…

So what happened this week?  My Canadian fraternity has seen their available capital to invest in venture-type deals dwindle for six years in a row as less capital gets raised every year (2006 was the lowest amount raised for venture capital in 10 years!).  April was one of the lowest months of investment in early stage, following a meek first quarter.  Also this week the CD Howe institute releases a scathing report of the tax-credit based investment vehicle also known as the labour funds or LSVCCs.  The authour reveals, among other things, that if you leave in the cost of the annual management fees, it appears that none of Canada’s 125 labour funds has a positive rate of return to this point.  Yikes.  The investors have appeared to figure this out as the amount raised by LSVCCs in 2006 was down 25% from 2005.

It’s easy to take potshots at the LSVCCs because their data is public.  But the decline in new funds is prevalent across the private funds as well.  First and second time managers are finding it nearly impossible to raise new money in Canada because their returns are poor and, like Greenstone, have no previous success to show during the boom times.  Returns are not published, but data I have seen shows that the aggregate private funds return over the last 15 years is only marginally better than the LSVCCs.  It gets much better if you only include the top five funds, however.

The other huge trend that has venture investing in the dumps is that there is an alternative investment for LPs that is making them money right now: Private Equity.  Of course, venture capital is a subset of private equity, but VCs reliance on early stage technology as a source of returns is what defines it.  Technology markets have been steadily improving since 2004.  The NASDAQ is at or near 5 year highs.  Profits are large and growing.  Employment is nearly full in the technology centres.  New technology markets like Web 2.0, digital media and old ones like wireless are very hot.  So why is early stage out of favour?  The answer is that it isn’t out of favour, just in Canada.  US early stage investing is up and access to capital is not a problem for managers in the US (which declined by half since 2000, leaving better odds of getting money for the remaining managers).  Even the US early stage technology funding is hot, don’t count on them to save our bacon.  They will continue to do later stage investing in Canada, but very rarely come in for the Series A rounds.

The funny thing about capital, especially institutionally managed capital, is that it is usually smart and follows the returns.  So, the main culprit in the dearth of capital for investing in Canada is that the returns aren’t here.  There have been no blockbuster exits in Canada for a while.  The last really good pop was probably Aspreva Pharmaceuticals given the amount of time from investment to IPO and subsequent solid share performance.  One good exit does not draw the capital.  A trend has to develop.  

The decline in available VC in Canada is directly tied to the absence of consistent returns and the availability of those returns in other investment vehicles (private equity, the stock market, etc.).  But isn’t this a death spiral for innovation in technology in Canada?  If there aren’t meaningful returns, the VCs don’t get funds.  If the VCs don’t get funds, they don’t fund innovation and the returns get even worse…

I have talked in this space before about the smaller average exit price for Canadian M&A as compared to the US.  Brightside is a recent example of a company exiting early to the benefit of its angel investors, but not generating breathtaking returns that make institutional people take notice.  The institutions have tons of money to invest and need it to help create some very large companies like RIM, MDA and PMC-Sierra in order for their invested dollars to get a return.

So who’s at fault for the poor returns in Canada then? More importantly, is there a fix?

Is it the entrepreneurs?  Are they not thinking big enough?  Are they selling out too early?  Are they not stepping out a second or third time to try and make money again?  Are they inexperienced in growing large companies (the perception from the US investors)?

Is it the investors?  Are they making bad investments at bad valuations?  Are they starving the oxygen from some of these companies by turning off the taps as soon as the CEO stumbles once?  Are they themselves too small and too conservative to fund big ideas?

Is it the US investment market and its preponderance to assume all Canadian companies are not worth investing in? Is it too tough for Canadian companies to compete against their better funded US brethren?

Is it regional, not a national problem?  Have poor returns in Quebec and way too many funds in Ontario dragged down the national average to the detriment of bright spots like BC and Kitchener-Waterloo?  {Our study from two years ago suggested that BC had better returns for the period of 1995-2004 overall than any other province and most US states.  But that was aggregate and included those companies that never received VC funding (some of the huge exits didn’t have BC VCs in them, so while the province did well, the VC returns might not have been as great vis a vis other provinces).}

All interesting questions… and all probably contributing to the problem.  I am telling you this in May 2007, but believe me, those in the VC industry in Canada have seen this train coming for a couple of years now.  With the release of the CD Howe report this week, some more interest from government in Ottawa will certainly be generated.  In BC, the BCTIA and the provincial government have been concentrating on this for some time.  The new Renaissance Fund is a positive step for getting some more capital into BC without offering any tax incentives.  It is a similar structure to that offered already in the US and Australia that concentrates on giving investors a chance at better returns, not a break on their invested capital (like tax credits).  The government can also look at capital gains taxation and red tape on cross border deals as ways to improve the situation in Canada.

But the government cannot fix everything.  Nor can they do anything that will impact the next couple of years.  Everything they should do will be long term and needs to be thought out well with input from all involved.  In BC, that process is working.

Some may argue that the lack of capital will help generate better returns as less companies get funded with more money giving them a better shot at being huge.  Q1 Capital Partners from Toronto thinks that there are only 5 or 6 active VCs doing new deals in Canada at the early stage right now.  That may be a bit low (I can count five in BC alone), but the point is that the pendulum of investment has swung too far to the side of a few VCs and will not help new companies get funded.  So our “return” eggs will be in a very small basket for the next few years.  The early stage industry and commercialized innovation in Canada will rest with a smaller number of companies for a while.  We all hope they do well.

While the LPs continue to ignore this class of investment in Canada and the LSVCCs continue to see less and less capital raised, we all need to hold our breath and hope the cycle breaks with some solid exits.  We can’t panic and institute quick fixes.  We just have to wait and see and plan for longer term capital solutions based on what the investors want: returns.  In the meantime, funding your new company will be an interesting experience.  If you are not yet cash flow positive, you would be best to focus on angels if you aren’t getting the immediate attention of local VC’s still actively investing.

Letters From Last Time:

My article last time generated a lot of responses, some very passionate.  As a follow up, the Shift Happens power point deck I referred you to was awarded World’s Best Presentation by Slideshare.net last week.  I include here a sample of what came back to me (some edited for brevity):

Hi Brent,

Here I am again. Thank you for yet another brilliant article.

As a db architect deeply involved in educational software I can only express my utter frustration with education in North America. It forces students to forget about everything else but GPA. So they burn their energy on what they are talented the least, just to get GPA right, hoping that eventually high GPA will give them the opportunity to do what they are talented for. For most, it’s a pipe dream. As a consequence all good positions are occupied by people that ere good at… well having high GPA.  They’ll make future curriculum and future criteria. Guess what is going to be high on their agenda? Political correctness regarding social and racial issues emphasises GPA even more.

On the other hand I have new comp science graduates that were thought that relational databases were matter of the past. They have to face harsh reality that they can’t use their university knowledge because the industry isn’t where they were told it would be. There is a risk in going ahead of curve as well.

Dragan Babovic 

Hi Brent, thanks for writing a very thought provoking article. Those of us in the late 30’s or early 40th age group have lots to think about in terms of preparing our children for the new demands in the world.

Also as a business owner, I certainly agree that we have to be much more nimble on our feet to bend and flex to what the market demands of our products and services. I worry personally that the decline in University enrollment in the math and sciences and engineering areas here in Canada is further going to hinder our ability to attract good talent and compete in the world marketplace.

I just picked up the World Is Flat and can’t wait to read it.

Appreciate your column.

Brenda Enegren

Thanks for your article on “Shift Happens”

I indeed found the presentation thought-provoking.  Your comments are dead on – my kids are older than yours (Grades 11 & 9), and I find it increasingly difficult to provide guidance as they approach university age, other than to “be adaptable as heck!”.  Hopefully, moving them and forcing them to deal with changes to their environment will have helped, but as for deciding what to study, where to study, even whether to study (just kidding?), it’s not as clear cut as it used to be.  I’ve forwarded the link to them – it will be interesting to see how they react!


Victor Holysh

You are quite right in noting the need for more education in business. Even in my own, mainly science based education, there was never any dealing with how science fits into the economic framework locally, nationally, or internationally. Our educational system could be much more integrative in its approach to producing a more well-rounded and informed individual capable of focused application when needed. I have met some young people who seem to have already gotten this, so it is possible.

More than anything, I guess, The Next Shift, due to its unpredictability, should, in my humble opinion, encourage an evaluative and flexible posture or , 'open preparedness', as I call it. Too often it seems time/money/effort is spent trying to predict and get ready for specific circumstance that either does not arrive or passes on all to soon, maybe a waste. Perhaps the most innovative idea we can learn from the last decades of transformation and proliferate towards the future is... 'Learn To Innovate'. I think if you look at China and India, industry and education, through that lens you will find they really are not doing much better, if at all, compared to us. They may think engineers and honour students are the thing to produce, but that might not be so in ten years and then what happens to all those people, hmmm... we have seen here in North America the horrors of down-sizing and multinational corporate migration. I think The Next Shift is going to see a lot more of that, making prediction at the very most, transient.

But, hey, at least we are out of the era of going down to the local sooth-sayer to get a prediction from mucking around in some animal's entrails! I don't think many want to go back to that, just like I don't meet many who want to go back to using a typewriter.



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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