Sunday, February 10, 2008

Did You Miss Me?

Of course you didn’t. You’ve all been off creating all kinds of value and otherwise capitalizing on the interesting times the current markets are creating. I should know; I’ve been chained to my desk since November, barreling through the landslide of transactions many of you have generated.

Here are some of the things we’re watching at my firm, and that I’ll be blogging about this quarter:

1. The New VCs. Start-ups outside of Silicon Valley have always operated on the assumption that venture capital is a funding trend, rather than an industry. And in 2008, venture capital will remain relegated to the back of your closet, much like those pinwale corduroy pants you claim you threw out in 1992. Which means that until Dolce & Gabbana brings one of them back, you need to understand your options.

A few efforts are afoot to replicate the micro-VC models espoused by Y Combinator and a few other players who loosely coined the term “crowdsourcing” venture capital. Y Combinator is a great way to sell a book and brand a startup camp, but a lousy way to make money, and it won’t replace the growth or volume venture capital can generate. While we applaud and will support all those trying to fill this role (in fact, if you need something and haven’t already asked us, just drop us a line), here’s where we’re seeing the major money for start-up funding coming from in 2008: (a) the government, (b) angels, and (c) public venture capital.

We’ve seen unprecedented growth in the number of angel deals done in the last two quarters. It’s important to note that the most active investing angels are not the noisiest. In our experience, it’s strategic corporate and individual angels who are writing the cheques, and lots of them. Circumstances also are driving local VCs to become born-again angels as well. What terms should stay in a VC angel deal, and what should wait until a later round? What degree of control is acceptable in an angel deal? How much paper and due diligence is enough? What securities law restrictions are there on the issuance of warrants to “managing” angels? More on all that later.

There is a corresponding rise in pre-angel advisors and funding schemes that also bear discussion. When is it appropriate to hire an advisor to help raise funds? What are acceptable terms for engagement letter?

2. Increased Scrutiny of Canadian Business in the US: It’s no secret that the IRS and Canada’s Revenue Agency exchange information. US advisors warn that that same information is in turn being shared by the IRS with Homeland Security, and being used by border guards to scrutinize entrants to the US. “Have you filed your US tax returns?” is a question some are warning Canadians who spend extended periods of time in the US to expect. We think there are a number of dynamics at play that may result in Canadian businesses facing this same scrutiny soon, particularly as their employees cross the border to provide post sales support. Take, for example, state retail sales taxes. Many states impose sales tax on maintenance services provided by non-residents. While many larger Canadian software companies register and remit, this is not always the case in the startup world. A growing number of state and federal initiatives also may apply to Canadian companies providing services from Canada to the US. Did you try and save data costs by using a server farm located in the US? Are you a white label provider of services for US businesses? Make sure you’ve structured your contracts and operations so that you aren’t inadvertently falling under the long arm of certain US laws. We’ll be taking some more time blogging about how to evaluate the manner in which you do business with (and expand into) the US.

3. Mainstreaming Micro-Entrepreneurialism:
We are fortunate to work with clients who are part of the international economic aid community. Using international aid money, they’ve put their technological expertise to work to help develop sustainable, competitive business clusters in other parts of the world. The result? A broad portfolio of applications that do everything from integrating the smallest SME to larger supply chains, to operating as a platform for administering community-based lending programs. In the current North American environment, where gaining incremental and niche markets is a near term imperative for many technology startups, commercializing these by-products of “competitiveness” could be an interesting trend.

4. Management Buyouts of VC-Backed Companies: The fund-raising challenges many funds face have left many VC-backed ventures in an interesting situation, particularly here in Canada. It is generally more difficult to raise growth capital when your backers have reached the limits of their financial support for you in their current fund, and/or– if your VCs include labour-sponsored funds – are facing a potentially huge redemption by unit holders of the fund in the next 1- 2 years. Over the years we have worked with a number of later stage start-ups on a buyout of the business from their current backers. We think the current market dynamics offer another window for some start-up management teams to buy back some of their investors’ stake.

Interesting times ahead. I hope you’ll stay tuned. And as Valentine’s Day approaches, remember: a Bird of Paradise isn’t a flower. It's a plant. It doesn’t count. A dozen of them will just make matters worse.

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