By
Michael Volker
Angel
investing 101
My
passion is startups. The thrill and challenge of creating a new technology
venture is a most gratifying experience. Successful entrepreneurs – those that
have built and sold their companies – can rarely resist the lure of a new
startup.
While
some like to run and build their next venture, i.e. being serial
entrepreneurs, others prefer the vicarious route by becoming angel investors.
Armed with plenty of experience and hopefully tons of cash, they play a major
role in new company formation.
And
here, in British Columbia, new angels are being born with increasing frequency
and numbers as their companies are being acquired.
One
of the recurring themes in my columns has been the early stage funding gap that
exists. Commercializing the research conducted in taxpayers’ institutions,
e.g. our universities, requires risk-taking. This is what angel investing is all
about and it is an essential ingredient in the development of an advanced
technology industry.
The
growth of the technology sector in B.C. was largely aided by the provincial
government’s funding of various organizations such as the Innovation and
Science Council of B.C. and the B.C. Advanced Systems Institute (BC/ASI).
They supplied relatively small, yet critically needed, capital in the form of
commercialization grants to the likes of well-known companies such as Sierra
Wireless, Ballard Power, PMC Sierra, QLT Inc., Angiotech,
Macdonald Dettwiler, Creo Inc., and Westport Innovations to name just
a few. Of course, they also supported many that failed. But, that goes with the
turf.
The
Science Council invested $68 million in hundreds of companies since 1991 through
its TechBC program. For every dollar invested, these companies generated
$18 in revenue. Since 1989, BC/ASI invested some $12 million in 77 companies,
yet it only started out with $2 million. A private seed fund started with $10
million in 1995 and turned it into almost $40 million in 7 years. Indeed, the
returns are there!
Instead
of leaving government to the task of trying to pick the winners, the trend as
demonstrated by the B.C. government, is now towards letting the private sector
(read as "us" - you and me) do this job. And to encourage us to do it,
the government has created a very attractive incentive.
The
recently revamped B.C. Small Business Venture Capital Act (SBVCA) provides
investors with a refundable tax credit of 30% on investments made in eligible
small businesses. When combined with investments made through RRSPs and a target
company’s use of the Scientific Research and Experimental Development (SRED)
tax credits, a few hundred thousand bucks invested by angels can go a long way.
By
stacking the SBVCA credits and RRSP deductions, top marginal taxpayers enjoy
great leverage - almost 4:1. For every dollar invested, the taxpayer gets back
74 cents immediately. If this doesn't increase one's propensity towards taking
more risk, I don't know what will.
Private,
individual investors differ from institutional investors in one very important
aspect. Angels think of the reasons why they should invest in a deal unlike
traditional venture capitalists whose job it is to come up with reasons why not
to invest. It is these angels that help in grooming companies to the point where
they are less risky and ready for serious venture capital investors.
While
this sounds good in theory, it doesn’t always work that well in practice. In
reality most technology communities do not have a large number of well-heeled
angels that can make dozens of investments. Typically, a few angels will cough
up one or two hundred thousand dollars when double or triple that amount is
actually required. Regrettably,
too many angels are starting to think like VCs and VCs are starting to think
like bankers.
Anyone
who has played the angel investor role knows that the odds of picking a winner
are slim. We’ve all heard that only one in ten investments will produce a
greater than ten-fold return. Using this logic, ten investments should produce a
positive return. However, I’ve heard that to get one out of ten you have to be
in at least sixteen deals! If that’s true, it’s going to be very difficult
to find enough individuals willing to cast their nets this widely.
Another
problem is that of insufficient funding for a company. If a business plan calls
for $500k and a few angels manage to come up with only $200k, where's the rest
going to come from? This is also exacerbated by the fact that the recent trend
by angels has been to invest much smaller amounts and to spread the investment
among a larger number of angels.
These
are some of the reasons why new “angel funds” such as the Western
Universities Technology Innovation Fund (WUTIF) and the B.C.
Advantage Funds will – and must - grow in popularity. WUTIF is a
pooled fund that is managed by angels and co-invests with hands-on angels that
work closely with their companies. These funds can provide funding top-up and at
the same time reduce individual angels’ exposure. By investing in dozens of
deals, the likelihood of overall returns is improved.
According
to Venture Economics reports, Early stage funds generate the best overall
returns, averaging better than 20% compounded annual returns over the long term.
They tend to outperform stock indices and later stage venture funds.
These
funds are an excellent way for investors to play the angel game with smaller
amounts of capital at risk.
Assisted
by the afore-mentioned tax credits, angels
and other investors ought to be attracted to such funds. For this to really
work, it will take some visionary angels who understand that, aside from great
technology and exemplary entrepreneurs, successful investing in the tech sector
is nothing more than a numbers game.
Angels,
as a group, do well financially. Individually, it's often a different story. I
know some angels who have invested in only a few deals and have had humungous
payouts. Then there are those that have invested in many deals but have yet to
savor a juicy return - another good reason to consider pooling.
Speaking
of winners, I note that there are a number of M&A deals that tend to go
unnoticed because they may be smaller and involve less well known firms. These
are good examples of companies that needed - and received - the startup
funding support that angels and startup funds can provide. Recently, I commented
that the first two companies that presented to the Angel Network back in 1999,
i.e. ActiveState Corp. and qImaging Technologies, were both
recently sold for US$23 million and US$12 million respectively. And
angel-supported Westbay
Semiconductor was acquired by Intel for US$22 million.
An
example of one of the smaller deals is Richmond's Network Simplicity
Software Inc.. which was acquired by Forgent Networks, of Austin,
Texas for some US $3.5 million in cash. Network Simplicity, a 10 person firm
started by James Dean, CEO, in 1994 makes scheduling applications for
small- to mid-sized businesses. There are many deals like this. I don't know if
any angels where involved with this one, but you can imagine that the payout
multiple was likely much less than a ten-bagger.
Fact
is that the mega million outcomes are few and far between. Getting into a
company when it's valued at less than $2 million and getting out at $20 million
- not $200 million - is the more likely scenario.
The
bottom line - the time is right for taking a closer look at startup pools
- whether you are an investor who'd like to bet with others or an angel who
could use some good company. Either way, it's now time for the private sector to
show some leadership and take on this worthy challenge of giving budding
entrepreneurs the chance to build tomorrow's technology enterprises.
Footnotes
In
the "I-told-you so" category, I note that the latest issue of the Canadian
Tax Journal dedicated 90 pages to the topic of stock options and that they
are BAD for companies and shareholders. Many months ago, I suggested that
options were a headache no matter how you look at them and that a form of stock
ownership should be encouraged. The Canadian Tax Journal pooh-poohs the notion
that options make executives feel like stakeholders (how can they when they
didn't "invest"?). My prognosis: sooner or later, we're going to
figure out how to do without them.
Recently,
France's Business Objects SA. took over Vancouver-based Crystal
Decisions Inc. for a cool US$820 million. It's not the first time that it
was bought. Crystal Decisions was started here and was taken over by Silicon
Valley's Seagate Corp. At the time, there was the usual concern
that perhaps B.C. would lose the company. This just didn't happen. It was
subsequently taken private again and still remained here.
It's
not always B.C. firms that are being gobbled up either. Sometimes they are the
gobblers rather than the goblees. A good example of that is Victoria's Carmanah
Technologies Corp. (TSXV:CMH), a solar-powered LED lighting firm that bought
Calgary's AVVA Technologies Inc. in an all-share deal valued at some $3.9
million. Vancouver's SCS Solars Computing Systems Inc. (TSXV:SCS) a small
dot-com era startup producing software for travel agents, announced that it
bought Portland's Accovia USA for an undisclosed amount. And, a few
months earlier, Creation
Technologies bought Edper Industries of Milwaukee for approximately
US$13.
VEF
UPDATE
This
month's Vancouver
Enterprise Forum event - on Tuesday, November 25th will focus on
B.C.'s Wireless Industry. What's the next big wireless wave? How will this wave
revolutionize people's lives and change human behavior? What business
opportunities are emerging right now for entrepreneurs? At this VEF event, you
can network with and hear from executives in B.C.'s wireless industry as they
discuss business trends in the wireless industry - and the potential stakes for
B.C. companies and entrepreneurs. There will be presentations by Brad Lowe
of Nokia in Vancouver, and Anwar Sukkarié, CEO of WebTech
Wireless (TSX:WEW). Brad will speak to emerging technology that will allow
the cellular phone to join PCs, laptops and PDAs as platforms for applications
such as games and entertainment. Anwar will outline the entrepreneurial steps
WebTech used to develop its business opportunity in wireless fleet tracking (telematics)
and become an industry leader in just four short years. In addition, attendees
will be introduced to WINBC, the Wireless Innovation Network of British
Columbia, which is also launching The Wireless Innovation Contest for wireless
software developers in various categories including a separate student award.
The moderators for this event will be Jim Barron of Ernst & Young
and Taranjeet Athwal of Microsage Wireless.
A
complete calendar of local technology events can be found on T-Net's
Events page.
SFU's
TIME Centre
If
you're an entrepreneur looking for a place to get your company started; there's
some great space available at Harbour Centre downtown. SFU's TIME Centre
provides not only office space but also access to various resources, e.g. tech
advisors, access to capital, mentors, etc. Worried about the high cost of being
downtown? Well, not to worry - they'll even reduce the fees and take some
payment in the form of equity. Check www.sfu.ca/time
for contact info.
A
reminder: SFU's TIME Centre is open for business - business folks, that is. TIME
is an acronym for Technology, Innovation, Management, and Entrepreneurship.
TIME supports the growth and development of the tech industry in B.C. TIME
features a "Business Centre" (looks like an airport business lounge)
which is open to technology entrepreneurs and business people to use as a
drop-in downtown office facility. Need to plug-in? Make some calls? Do some
work? Hold a meeting? There are some great facilities for holding your company's
AGM. Why hang out at MacDonald's when you can work productively at the TIME
Centre? Drop by and check it out! It is located at SFU's downtown campus at 515
West Hastings St.
Michael Volker,
a technology entrepreneur, is Director of the University/Industry Liaison
Office at Simon Fraser University, Chair of the B.C. Advanced Systems
Institute, Chair of the Vancouver
Angel Network and past Chair of the Vancouver
Enterprise Forum. He owns shares in many of the companies he writes about. Copyright,
2003.
What
Do You Think? Talk Back To Mike Volker
Tech Futures is
a bi-weekly column that focuses attention on new and emerging BC publicly listed
technology companies.
Contact: risktaker@volker.org
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