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

Something Ventured:
May 20th, 2005

By Brent Holliday
Greenstone Venture Partners


More And Less


"I'll give a little bit
I'll give a little bit of my life for you
Now's the time that we need to share,
So find yourself,
We're on our way back home" - Supertramp, Give A Little Bit

Rt. Hon. Paul Martin Hon. Gordon Campbell

Dear Mr. Prime Minister and Mr. Premier,

Congratulations to you both for recently scraping enough votes together to form governments for the next little while. It was certainly entertaining watching your "theatre" this week. I haven't had so much fun since Glen Clark. Whew! The Belinda-Peter thing… fantastic! It was so gripping I skipped all of the Stanley Cup playoff games on TV this week.

While you are busy congratulating yourselves on your "mandates", I wanted to write to you from a little corner of Canada to ask you to get your caucuses to help solve a little issue near and dear to my heart: early stage company formation. Now, perhaps I'm a little late for Mr. Martin's vote grabbing, mega-pork handout festival, but I'm not really asking for a cash handout per se. I'm asking for some real thinking about structural changes and perhaps some re-directing of funds already committed. By the way, I made a promise to my readers three years ago that I wouldn't write about government policies anymore, because, truth be told, you don't affect the individual successes of technology companies that much. But larger macro changes can help set a path for long term change that can be beneficial to BC and Canada. Let me explain (and perhaps my readers will forgive me):

First a little background for your minions to run around and check, confirm and write up thick documents of which you can read the first and last two sentences and then ask them what it all means, thereby wasting at least six months of taxpayer funded time to get to the same conclusion I will draw for you here:

Especially here in BC, but I suspect in Quebec and Ontario as well, we have an unhealthy distribution of technology companies by size and revenue. What I mean by that is that instead of a nice pyramid shape, where the lower part is early stage companies with no revenue and less than 25 employees, the middle is fewer later stage companies with small digit millions in revenue and 25-100 employees and the top where even fewer of the largest profitable companies with hundreds or thousands of employees exist, we have a large base and very skinny middle. This is unhealthy because it means that the vast number of employees in our technology industry work in small, bootstrapped or underfunded, risky ventures. It is unhealthy because we are not creating as many successful mid-stage companies that can become bigger companies that are profitable and pay tax (tax usually gets your attention… more revenues to be spent in key ridings!). As you will see, we have a problem with policies around early stage company formation in technology where we are rewarding the creation of too many underfunded companies.

Now there are a number for reasons for this distribution, I suspect and I also suspect that I have not thought of all of the reasons. But a short list of mine would include:

- We are selling companies at earlier stages than in the US, thus creating subsidiary companies (not bad at all for employees, but not good for investors, other stakeholders who lose business to the parent company infrastructure, etc.)
- We have too many companies being started that maybe shouldn't be started (more on this impact in a minute)
- We have not got enough access to later stage/growth capital necessary to grow middle stage companies

Here are some interesting facts to compare Canada with the US (from McDonald & Associates, Venture Economics, CVCA and others):

- Over the past 10 years, Canadian technology companies receive 60% of the total venture capital funding available at the earliest stages (product still not commercialized, management team incomplete, no revenue for the foreseeable future or minimal revenue from sampling/services) compared to less than 20% in the US.
- Canada's venture industry funds more technology companies per capita than in the US.
- Average Canadian venture investment deal size per investment round is 1/3 that of the US.
- As you would expect, US venture funds put significantly more of their allocation of funds into companies at the revenue stage and/or near or at profitability stages than we do in Canada.
- US venture money makes up 25% of the total investment in Canadian technology companies (since 1999) but disproportionately invests at the later stages here.
- These trends remain the same in Q1 2005

So, the fact that we are funding more companies at the early stage than in the US helps you understand why we have too many start-ups. Too many start-ups dilute the available talent so critical for being successful. And the lack of investment at later stages (despite the arrival of US funds for predominantly that stage) helps explain why a) Canadian start-ups sell out early (too hard to find resources to grow independently) and b) there simply aren't more middle stage companies… too many start-ups funded with too little money chasing too little later stage capital, so many just fail. If we had more middle stage companies employing tech workers, we wouldn't have so many of them available for start-ups out of necessity for a job, rather than for a great opportunity!

One reason that the investment levels at the early stage are so dramatically different in Canada vs. the US is that our angels don't have as deep pockets as the US angels. On a comparative dollar basis (10:1 roughly) some new studies show that we are at about the same absolute levels of investment from angels. But, just like our venture funds comparatively to the US, our angels are puny and invest smaller amounts in more companies. More companies funded with less money per company! This brings the Canadian VCs in to companies at an earlier developmental stage than in the US. And the US does not have the BDC with its seed investment funds and tendency to fund to a quota. And the US does not have labour funds that also fund to a quota. If there aren't quality later stage deals for these VCs, they will fund earlier and voila, the cycle feeds on itself. More and more early stage companies. Quebec has a shining example of this phenomenon over the last 10 years.

In BC, Mr. Premier, you have been a bit luckier over the past decade. We do not have 30 labour funds chasing deals as they did in Ontario and Quebec helping create this bubble of early stage companies that have little later stage funding to grow. But, then again, your new angel tax credit created in 2003 had the unforeseen consequence of the creation of about 10 smaller tax credit funds. So as well as beefing up angels and their per company investment (a good thing!) they have created more VC investment in more companies at the earliest stages… Oh-oh.

In the US, the angels are supporting companies through to a later stage of development and the VCs come in with less risk, therefore committing more money (they also have waaaaaaay more money than Canadian VCs and can afford to place bigger bets). There are funds that invest only in mid-stage companies helping them attack markets with plenty of resources. This appears to be working better for the investors there than here.

Not all sectors in technology are the same. For instance, drug discovery, semiconductor design and telco grade networking devices are examples of sub-sectors that no angel has deep enough pockets to fund. At the earliest stages, these type of companies have no ability to bootstrap with customers and VCs are needed from the start. They simply require too much money to develop to revenue. So these sectors are unique and do not follow the trends I am discussing here. But then again, if these companies work, they become hypergrowth after years of losses and blow right through the middle stage of company size. So we will just leave them out of this discussion.

You can't blame the Canadian angels and VCs too much for their actions. They are acting within their constraints and quite properly not throwing way too much money at companies that have more risk. The effect is the drip feed, which any Canadian technology entrepreneur will tell you is torture. But it is equally torturous to give a huge amount of money to a company at the earliest stages of proof and no real market acceptance. We need to help the investors get over this through more of their own resources and more progress of the companies at the earliest stage.

While entrepreneurs sure don't want to hear this, the fact is that with our constraints in available capital and the current structure of our funding availability, we need to fund less companies with more money. This concentrates talent into the companies, giving them a better chance of success. We need less VC funds with more money and we need to encourage angels and government commercialization programs to put more money to work per early stage company. We also need a lot more available capital for the later stage. This can be from new VC funds focused on this stage in Canada or from foreign funds.

So, in conclusion, Mr. Premier and Mr. Prime Minister (and since this is the only part you will likely read), we need immediate action to look at ways the government might help us:

1) fatten angel investment but orient it to move fewer companies through riskier development periods with more money, thereby lessening the need for VCs to play at this stage
2) create a path for fewer and larger VC funds aimed at both early and later stages of investment
3) help create a culture of growing technology companies bigger in Canada through the previous two objectives and other programs that educate and promote "hitting a home run" around Canadian innovation

We have a flourishing and growing technology sector and the market conditions are improving, but there are some structural issues that could hold us back and this is certainly one of them. I urge you to help where you can. Maybe chewing on something like this will keep you from the politics part of being a politician. Just a thought. Ummm, and don't let Belinda work on this, please.


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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