Monday, October 22, 2007

If Venture Capital is Dead, What's Next?

Sometime soon, pundits are going to officially declare that venture capital in Canada is dead. We’ve given it a good 15 years, they’ll say, but venture capital is not a sustainable business here.

They will point to the increasing number of defunct funds that no longer invest, keeping the doors open only to manage existing investments while the management fees last. Other VCs have either re-positioned themselves as asset managers or are in talks with their investors about returning to their origins as hedge funds.

The pundits will note the recent halting of efforts to raise new funds by prominent VCs. The root cause of this, they'll say, is the almost complete withdrawal of support by the pension funds and institutions that invest in venture capital funds. These backers have either: (a) gotten out of venture capital altogether, or (b) instead decided to invest their money in government initiatives, such as the new $90 million + seed fund that the Government of Ontario announced before the recent election.

All of these factors, the pundits will say, have led to a permanent sectoral decline. Venture capital in Canada is no longer an industry, but a financial product offered by only a handful of players.

When someone finally says this, I'll agree. But I'll also say that, as someone who advises entrepreneurs, I don't particularly care. All this tells me is that companies will now use different financial tools to feed growth, using business plans that are not shoehorned into the somewhat artificial venture capital model for growth - i.e., in and out in 3-7 years.

Here are the things to watch as we enter a new era of company creation:

1. The increase in advisors: there are many former VCs who are looking to stay in the game by providing advice and some modest seed capital out of their own pockets. They reckon that they can earn money in deal origination fees until they establish themselves and are able to raise a modest fund, much as Jeff Clavier has done. However, there are already many advisors who've been working in this space. Excess supply is always good news for the consumer - you, the entrepreneur. Tread carefully, though.

2. Increased government funding for seed investments and commercialization: the Ontario government has thrown almost unlimited amounts of money at a variety of initiatives to create public-sponsored infrastructure for startups. Which keeps the government agenda focused for the forseeable future on building an "innovation economy". Watch for additional funding options, managed by a new set of players. The federal government also is actively investing through EDC and Sustainable Technology Development Canada, among others. Can't attract money there? Consider moving part of your operations to Saskatchewan or New Brunswick.

3. New financial tools: there are a number of financial tools and structures that could attract a new kind of investor to early stage ventures. Look for a rise in the number of investments made through limited partnership structures and (for companies with some cash flow) capital pool companies. If venture capital funds are no longer part of your financing strategy, you are free to explore any model that meets the legitiamte needs of your backers.

4.Company creation through consolidation: Smart VCs will (and already are) looking for up-and-comers to bootstrap onto existing portfolio investments. There will be a near-term rise in the number of early acquisitions in some niches.

5. A return to seed investing by VCs:Venture Capital may no longer be an industry, but it's not extinct, either. There will still be funds, likely falling into two categories: (a) those who invest internationally, but retain local offices, and (b)those invest locally in emerging industries where Canada still could emerge as a world leader (clean tech, biotech and drug discovery/diagnostics). Ironically, local VCs ackowledge that they will have to play a greater role at seed stage or risk getting shut out by US VCs in later stage rounds, as was the case with iUpload.

6. Bootstrapping is the new black.Modifying business plans so that you grow only as funds allow is a return to basics, I know. But it works - ask RIM. There's also a number of creative models and ways to bootstrap, which we're seeing great examples here at our firm daily.

This is how I see the lay of the land, and it's all promising. Let's get cracking.

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