Something
Ventured:
September 9th, 2005
By Brent
Holliday
Greenstone
Venture Partners
A House Of Cards
“And now the end has come,
You're feeling really dumb,
But you deserve it,
You had no choice.
It falls apart,
In little pieces on the floor…” – Odds, It Falls Apart
Tongues are wagging across Canada in the venture capital
business. In fact, the tongues have never had more to
wag about…
Exhibit A - An earthquake hit the LSIFs (labour-sponsored
investment funds) in Ontario on August 29th,
when Greg Sorbara, finance minister of Ontario, sent out
a quiet press release that said that there would be no
more provincial tax credit after February 2006. The
aftershocks are still being felt in Quebec, Manitoba and
BC, where great gobs of early stage capital rely on the
provincial and federal tax credit equally to offer to
investors (15% each for a total of 30%). No one saw
this coming and no one knows what happens next, but it
is safe to say some in the business are in complete
shock.
Exhibit B – MDS Capital, the nation’s largest biotech
investor by a country mile, released its top staff and
instructed a new President to re-structure and sell the
investment company with cash and assets of roughly $1B
as soon as possible.
This
one-two punch happened within three days of one another,
leaving the venture capital industry out of breath. The
change in the scenery will be dramatic, especially if
the Ontario move is the first domino in the end of
tax-assisted venture capital among the other provinces.
The key to that set of dominoes is the Federal
government’s response. Will they pull the tax credit
for all provinces as well?
There
is a mess in Manitoba that raised an ugly stench for
LSIFs. The Crocus fund’s management company is facing
lawsuits and jail time for fraudulently reporting the
asset value of their companies and for ridiculous
expenses amassed by overpaid investment managers. This
embarrassment for the industry was just leaving the page
of the business sections when the new news hit. The
Crocus mess didn’t figure into Ontario’s decision, but
the timing is amazing.
More
importantly, for the first time in a long time, LSIFs
did not raise their total allotments in the winter of
2005, including BC’s Working Opportunity Fund.
Consolidation was happening across Ontario where too
many small funds had raised too little money to play the
VC game effectively. All of this is further ammunition
that the tax credits have run their course of
usefulness. And Ontario was the first to pull the
trigger while others had been merely musing about how to
end the dependency on tax-assisted investment.
In Quebec, they are re-evaluating the original LSIF
programs and looking at new ways to stimulate investment
at the early stage. In some ways, insiders tell me, this
is where the Feds will watch for guidance on their
portion of the tax credit for LSIFs. If Quebec screams
for it to remain, the political card of appeasing Quebec
in a minority government might mean that the federal
portion remains and Ontario investors get 15% tax
credit, while BC remains at 30%. If Quebec is looking
at other stimulative measures for investment capital and
they don’t raise hell, the Feds may pull the plug
completely.
Let’s
say for a minute, that the federal tax credit is gone.
Then assume that BC decides it is not footing the tax
credit by itself and stops its multiple programs of LSIF
credits, VCC (venture capital company) fund credits and
ECP (equity capital program) credits for angels. What
would happen here?
Well,
Growthworks would still have lots of money and assets
and would have to go to the institutions (pension funds
etc.) to try and raise more money based largely on track
record, just like the rest of us in the VC community.
Smaller VCC funds raised in the past few years would
have less resources, a shorter, unrealized (haven’t
exited the invested companies) track record and be in a
worse position to raise money from similar sources.
However, the angel community would likely be
unaffected. The angel market is booming now in BC and
more and more companies are getting funded at later and
later stages and at larger amounts by angels. The ECP
program has something to do with that, but the reality
is that the BC economy is on a roll and everyone from
the cranberry farmer to the dentist to the commodity
(mining, lumber, oil & gas) executive is looking to
place risk capital. Examples of successes for angels
like Flickr, ID Biomedical and Schemasoft are the
cocktail party talk of the town. Even without the tax
credit, the angel market is healthy and will be for the
near future.
But
the fallout would be felt at the later stage, where the
venture industry is needed. The down side of a tax
credit wipeout and a subsequent struggle to raise money
by the affected parties means tougher times for local
companies to get the larger (>$3-5M) rounds together.
This would be bad for the entrepreneurs. Hopefully the
frothy US venture industry would pick up some of the
slack, but early stage VC is a local business and the
“touch” aspect of investing and growing a technology
company is important. Losing the LSIF component would
be a huge blow to the industry if it happened in an
instant.
The
amplification of problems in the life sciences sector
would be if MDS Capital moves to the US and pays less
attention to the Canadian market. This would further
dampen the later stage for this sector, even though
money travels further for research stage life sciences
companies than it does for pre-revenue IT companies. By
the way, the largest part of MDS Capital’s pool of money
and assets comes from its tax-assisted LSIFs based in
Ontario. And a lot of tax assisted dollars fund biotech
coast to coast.
These
are nervous days for the LSIFs, without a doubt. But
the complete removal of tax assisted venture capital in
Canada overnight is unlikely. It is more likely that
Mr. Sorbara and the crew in Ontario have started a
period of introspection for the venture industry. As I
have said in this space before, the technology formation
and commercialization business in Canada is in
adolescence compared to our brothers down south. The
feds and provinces now have to sit and think how best to
grow and support a knowledge based economy in Canada as
it takes the next step. It will be interesting times
for the next few months and years.
In
the meantime, while tongues wag among the VCs,
entrepreneurs need to look at all sources of investment
dollars in their plans for growth. If the current status
quo in Canada gets shifted and dollars dry up for some
period, the smart companies will have a back-up plan.
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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