The New Funding Gap for Canadian Entrepreneurs

The newly-renamed National Angel Capital Association has announced its first Co-Investment Summit for November 19 (was there really any confusion about what the National Angel Organization did? I asked my brother the priest, and he said his people were clear on the matter). The event is designed "to bridge even more of the funding gap faced by seed- and early-stage enterprises in Canada."

Two points here: first, the NCAO is looking for some companies to pitch - go check the site if you are interested. Second - and I'm seguing away from the NCAO to another matter altogether - it's time we stopped attaching the phrase "funding gap" to early stage ventures.

In a relative world, the funding gap for research and commericalization is a teeny tiny little thing. Like the gap between Madonna's front teeth, it's not as charming as her publicists might want you to believe, but it's not as hideous as the gap you'll see in any hockey player's mouth, either.

It seems to me that, of the available government capital, most of it has been allocated to research and commercialization. If we're going to accurately speak of funding gaps and the need for urgent action, then public discourse in Canada needs to turn to later stage ventures.


We've all seen the "Valley of Death" charts that many advocates for government funding used to great effect 4 years ago. Now, however, those charts look much different. The new occupants of the Valley of Death are companies that angels and VCs have funded, that now find themselves with increasingly limited access to anything other than small bridge $$ from their current investors.


What's the likely size of this gap? According to the CVCA, in Canada 412 companies received VC funding in 2007. If you apply the "angels do 30-40% more deals than VCs" maxim, that means approximately 1200 received angel funding during the same period. Applying the 18-24 month cash runway rule of investing, that means that most of these are now seeking follow-on funding in a cash desert.

I wish Paul Kedrosky was here – he could draw me a nifty graph to illustrate the point.

Here are the questions we need to ask ourselves: Why is there no government policy that focuses on job retention/creation for this sector? What good is an innovation strategy that feeds academic researchers while it starves the current generation of entrepreneurs?

Disclaimer: Let's not get sidetracked by the debate over whether government support is the right way to foster innovation and entrepreneurship. The reality is that it is, in the near term, the predominant support available. Shouldn't some of that near-term support be directed to entrepreneurs who have proven they can commericalize a product and build a start-up?

Yaletown's New Fund: The New Kind of Closing

Vancouver's Yaletown Venture Partners made it official today, issuing a press release about a first closing on their $100 million fund. They have $65 million in committed capital for early stage clean tech and IT.

Today's release - aimed at both potential investees and potential limited partners - is an interesting reflection of the times. Three years ago, a VC generally woudln't announce that one could only raise 2/3 of the fund it marketed. Now, it's an achievement to be celebrated.

The fund is open for additional LP investmetns for another 12 months.

Looking for Something to Do Next Wednesday?

Pathways to Education is holding its annual Gala at Casa Loma. Pathways has been helping children in Regent Park stay in school through a variety of assistance and mentoring programs. This grass roots initiative has been so effective that the Ontario government has announced a $19 million grant to expand the program to other neighbourhoods. It's the poster child for how to build a successful not-for-profit startup.

Great food and great networking, and of course, the usual eye candy (CBC's Evan Solomon is returning as host) - contact dgomes@pathwayscanada.ca for details.

Trio Capital: Under Construction

Monitoring how VCs and private equity players are reinventing themselves to play in the current economic environment is fascinating. Compare the website for Vengrowth today and 3 years ago, and you'll get a sense of the ongoing evolution. Others are still playing their cards close to their chests, but merit watching.


One of the lesser known stories of the last two years is that of Trio Capital. Trio is staffed by a group of ex-telecom luminaries, including Microcell's Andre Tremblay and Nortel's Pascal Debon. Trio partnered with the Caisse in 2006 to launch the Telecom Media Fund, an investment vehicle seeded with $200 million for telecom investments. The amount seemed astonishingly large for a group of first time fund managers. Their first investment was $50 million into Cellfish Media, followed by one other publicly announced deal.

There have been rumours that the direction of the Trio/Caisse partnership has changed, and its current "under construction" note would bear that out. I'd never count out Andre Tremblay, and so I'll watch to see how he repositions Trio - this is a team with the skills to make buyouts in telecom.

Government Investment in Venture Capital: Should There Be Rules?

Another election is over, which means the planning for the next federal budget has begun. Entrepreneurs should be taking this opportunity to place themselves at the forefront of the innovation debate, and grabbing some of the money that the government keeps allocating to research and venture capital.

Before we do that, however, we should ask ourselves whether current government initiatives can be shaped or adjusted to provide some near term relief. Take the money provided by government (through “fund of funds” programs) to venture capital funds to disburse to entrepreneurs: should there be some checks and balances on how it’s spent?

This is not an insignificant issue. Provincial “funds of funds” such as Ontario’s Technology Innovation Fund, Alberta’s Enterprise Corporation, and the like have been allocated hundreds of millions of taxpayer dollars in the aggregate to reinvest in venture capital funds. In addition, in February, the federal government also gave the BDC another $75 million in fresh capital to invest directly in high growth companies (those of you who missed that lifeline should be talking to them). Should government-provided venture capital be treated differently than money provided to VCs from private sources?

If the cycles of the last ten years have taught us anything, it’s that economic recession can lead to aggressive pricing and investing terms from venture capital investors. Down round valuations, ratchets and protective mechanisms – all the old standbys. I have even heard that the multiple liquidation preference (where an investor must get 3-4x his investment back before any other shareholder receives proceeds from a company sale) is back in town. Is it fair for those remaining angels and VCs to take advantage of market conditions? Of course. But is it appropriate to allow them to do so when the funds they are investing came from us, the taxpayers? I don’t think so.

How are Canadian entrepreneurs protected from being goudged? There needs to be some kind of oversight mechanism which will allow government to pressure VC recipients to behave in a reasonable fashion, above the market frenzy. To be specific: no multiple liquidation preferences. No usurious interest rates. And while we’re at it: if the purpose underlying these funds is to foster strong homegrown investment funds, why not insist that VCs who receive government funds embark on mandatory education, so that there is a minimum standard of financial, operational and governance competency? Surely the government entities disbursing money can insist on some strings attached to their commitments.

No question, these kinds of strings may impact the IRR of any VC who takes government money. But perhaps the best way for VCs to look at this funding is as a taxpayer bridge loan. We taxpayers don’t need to see a 30% IRR; we’re just trying to bridge VCs to the next phase in the cycle. If we get our money back, that will be perfectly fine. In the near term, however, we’ll also have kept current entrepreneurs who’ve already proven themselves in the game, with a meaningful stake in the businesses they’ve built.

Hacking hell

Some days, I want to second-guess this whole decision to stay a boutique-sized law firm. Like this morning, when I learned our firm web site has been hacked, or something. The site wasn't that great a visual experience to begin with, but this morning, anyone who typed in "venturelawassociates.com" landed on a page with a skull. Not the best branding for us.

Now, I have to take someone off other matters to try and fix this damn thing. We are a bunch of lawyers - how do you think this is going to end? It's only 11:00 am, and already today we are well on our way to becoming another "how many lawyers does it take...?" joke.

This is my life as a Covergirl.

After Venture Capital: Other Sources of Money

For the next 12 months at least in Canada, the largest pool of seed and growth capital that businesses can directly access is in the hands of the government. You already know about SRED, but have you considered how other government initiatives might be used to accelerate your business? Take a look at the following and consider how you might follow the example of other emerging businesses and partner with larger players (channel partners, customers, suppliers) to access some of the larger opportunities:

Second Career Program (Ontario): offers up to $28,000 to laid off workers for tuition, education and other training costs incurred in job retraining. A potentially great a venue for laid off high tech workers to upgrade skills or add new ones while forming a new business.

Next Generation of Jobs Fund (Ontario): Announced in 2007, the program has $1.15 billion earmarked for grants to businesses in bio-economy and clean tech, advanced health technologies and digital media and communications. The fund provides grants of up to 25% of the total eligible costs of projects of up to $25 million over 5 years, which means matching funds will be needed once the grant is approved. Those funds may be easier to get for later stage companies, given the size of the grant. For earlier stage businesses, creating an eligible project in tandem with a larger channel partner or strategic partner could be an effective channel to this cash.

Recipients: VC-backed 6N Silicon was recently granted $8 million as part of a proposed $50-million expansion that will see the company opening a new manufacturing plant in Vaughan and creating 84 new jobs over the next five years.

Automotive Innovation Fund (Canada):Announced as part of the last federal budget, this program earmarks $250 million over five years to support strategic, large-scale research and development projects in the automotive sector in developing innovative, greener and more fuel-efficient vehicles. The first investment, announced last month, puts $80 million in Ford's Renaissance Project for Windsor, Ontario. The Renaissance Project will include the establishment of a new flexible engine assembly plant in Windsor, as well as the creation of a new North America Centre for Diesel and Advanced Powertrain Research and Innovation, which will perform research into engine efficiency and new fuel technologies. Is there an opportunity for emerging companies to participate in eligible projects put forth by Ford or others?
Sustainable Technology Development Canada: Still the granddaddy of grant programs for new and emerging technologies in the area.

Garage Canada: Failed Experiment?

Two years ago, much was made of the lunch of a Canadian affiliate of Guy Kawasaki's Garage Technology Ventures. Tom Sweeney (formerly of Bluetooth start-up Classwave Wireless) and Louis Desmarais(ex-Skypoint Capital) tagged to lead the fund, and spent the next 12 months or so marketing the heck out of the brand. A few investments were made - Group IV in Ottawa, Thermoceramix, Inscape, Lure Media. Then, about six months or so passed with a continuing silence.

Now, the Garage Canada web site is down, there is no reference to the affiliate on Garage's US site (although Tom used to be listed as an advisor) and there comes news that some of the former fund staffers are forming a new entity St Lawrence Capital(no website yet). What happened to the portfolio, and the undeployed capital contributed by Quebec LPs like Caisse and Soldiarity Fund QFL?

Indemnification Agreements: When Trouble Hits, Who Picks up the Tab?

(Warning: Technical post about to unfold here. Why wade through it? you may well ask. One answer: I’ve been slaving over a hot printout of the decision all day; would it kill you to show some appreciation and take a look at what I think about it? Another thought: you should make sure that you understand when your company needs to pay any director’s fees and expenses, and when you may be able to switch tactics to lessen the cost to your company.)

What happens when your board is threatened with a lawsuit? Does the company pick up the tab, or is each director on his own? The answer used to be clear, but now, thanks to a recent Delaware court decisions, waters are being muddied.

There are multiple layers of paper that protect VCs (or any private equity investor, for that matter) from any liability as a director of a portfolio company. First, there is the indemnity provided by the portfolio company to the VC-director. This can reside in a shareholders agreement or, as I suggested in a previous post, it will now increasingly be part of a separate indemnification agreement between a company and each individual director.

VCs also will have received similar protection from their own fund, in the form of yet another indemnity agreement. How do these various indemnities work together when trouble strikes? VC funds often assume that they would be liable for the legal costs of their director nominees only if the portfolio company was unable to pay. However, in the Levy v. HLI Operating Company, Inc., the Delaware Chancery court established that, unless otherwise agreed, liability should be shared between the portfolio company and the fund.

In Levy, the directors had entered into indemnification agreements with the company (HLI), containing the usual broad indemnification covenants by HLI. The indemnification agreements provided that HLI would advance expenses in connection with any indemnity claim, regardless of whether the directors prevailed in such litigation. Directors on the HLI board who were serving as nominees of the private equity fund that had invested in HLI had separate indemnification agreements with the fund as well.

The board was hit with a securities fraud lawsuit. The private equity fund had its nominee directors settle claims against them for $4.8 million, which amount was paid by the fund. The directors then tried to recover the amount paid by the fund from HLI, relying on the provisions of the indemnification agreement each had signed with HLI. HLI refused to reimburse them, and the directors (and their fund) sued.

The court sided with HLI, saying that there was no indemnifiable loss to the directors; their obligations had been paid in full by the private equity fund. Further, the fund was not entitled to be fully reimbursed by HLI; the court held that the fund only could seek reimbursement only for a portion share of the $4.8 million payment—a far cry from being made whole.

The takeaway? Companies need to think tactically before actually making indemnification payments on behalf of their directors who are fund representatives. It may not be your obligation alone. And, of course, the same applies to VCs.

Red Herring Top 50

Congratulations to Nulogy and our other clients (you know who you are) who have been selected as part of this year's Red Herring Top 50 in Canada. Nulogy is yet another example of the many great, solid high tech businesses that Toronto and southwestern Ontario have been producing in the last few years. Youo're going to be hearing a lot more about them.

Canadian Start-UPs: Where's Our Bailout?

This week, the Canadian Venture Capital Association issued a call to federal political parties to support technology commercialization programs. I don’t know exactly what “issuing a call” entails, but it seems to me that the entrepreneurial community had better get on board with its own call right away, and that call should be: “We’d like a piece of that action, too, please.”

Although Canadian entrepreneurs have built a grassroots community that other regions can only dream about, we’ve overlooked bringing into the fold those best-equipped to provide relief from the current venture capital drought – federal policy makers. We complain, but we don't necessarily engage. And this oversight has allowed the venture capital community to co-opt the current funding crisis as exclusively theirs. The result? Government initiatives that, for the most part, propose to stimulate innovation by propping up the venture capital community first, leaving entrepreneurs to rely on trickle down benefits when those funds invest. This needs to change.

To be clear, I agree with the CVCA’s proposals for shoring up venture capital. There is no question that the venture capital industry needs help; we will not succeed as an innovation nation unless we have a strong venture capital class. I agree that the government must create a federal fund of funds to subsidize the venture capital industry. But this alone won’t bail out my clients - high tech companies that have hired, have built product, and are now starved for growth capital.

Trickle-down economics take time to have an effect, and it’s no different here. It will take time for any government money that is earmarked today for a fund of funds investing to churn through the economy to businesses. Before an entrepreneur can see relief, that money has to: (a) churn from the government to a fund of funds that the government forms, then staffs with a team (in Ontario, this took nearly 8 months from announcement to closing); (b) be deployed by the fund of funds to one or more VCs (think another 6-18 months); and (c) be invested by the VC in a company (think another 6-12 months). In other words, any money earmarked for the venture capital community today is perhaps 1.5 to 2 years from making its way into the hands of an entrepreneur.

Entrepreneurs need a near-term bailout now. I can hear the groans from Bay Street at the idea of any initiative that would create a government portfolio of venture-capital like investments, and I don’t disagree with the sentiment. But this seems to me the lesser of all evils, given the opportunity cost of waiting for trickle-down relief. Can we afford to lose another innovation cycle by starving the entrepreneurs out there today?

So, grass-roots community: it’s time to find our government voice. Let’s say something, and say it soon. If there are initiatives afoot, let’s be afoot more loudly. Maybe it’s even time we asked for our own government funding, like the National Angel Association and others have received from the MRI, to create our own policy watchdog network.

But what we cannot do is rely on organizations for other industries to carry the day for us. Drafting only works if: (a) you're on a bicycle, and (b) the rider in front of you is headed in the same direction.

Who Really Controls Start-Up Funding in Canada?

You'll notice that Ian Carew of TD Capital Private Equity Partners will be speaking this week at Ottawa's Venture Capital Fair. The topic? The role of government led fund-of-funds in Canada's innovation and risk capital communities. I recommend that any of you nearby drop in and snuggle up as close as you can to Ian, because as far as I can determine, he and his group at TD Capital control the lion's share of the money (outside of Quebec) that is available in the near term for start-up growth in Canada.

How did this happen? In 2005, the CPP Investment Board gave TD $400 million to manage. $250 million was to be invested to a Canadian small and middle market buyout fund of funds and the remaining $150 million was to be invested in Canadian venture capital funds. Then this June, TD was selected by the Ontario government to manage its $205 million Innovation Fund.

The result? TD Capital holds the keys to the kingdom for any Canadian venture fund looking for money to invest. Of course, there other institutions that invest in venture funds as limited partners; however, many of those limited partenrs are waiting out the currrent market and allowing government money to lead.

Who TD backs will in many ways determine the course of high tech innovation locally for the next few years. Will money be directed to cleantech and healthcare -focused funds only? Or will there still be funds made available for VCs who want to invest in other high tech spaces? Stay tuned.

"The Age of the Angel" - A read from the other side

Want to get a sense of the investment philosophies driving our regional angel groups? Take a look at the first draft "Best Practices" published by the National Angel Association, available here.

Angel groups are one part of the angel ecosystem, historically the least active in terms of capital deployment but the most active in terms of cultivating deal flow. In the current environment, there is a movement within some of these groups to expand their reach, even cross-investing in the portfolio of another angel network.

Against this backdrop, the guide makes for an interesting read. As someone on the investee side, I find parts of the guide out of touch, but other parts a compelling read. For example, wading through the recommended deal screening and due diligence practices helps one understand why angel groups can be very good at finding qualified deals, but very challenged at closing an investment. Here's hoping a final draft provides some tactical guidance.

More later.

Internet Accessibility for the Disabled: first Target, now iTunes

Web-site accessibility for the disabled has been a rich source of litigation for the last four years, and the bete noire for major on-line retailers. Yesterday's announcement by Massachusetts' Attorney- General that it had reached an agreement with Apple to make all iTunes stores accessible to the blind is the latest development in what appears to bean inevitable slide to making access to web sites mandatory.

Even though the blind can purchase software and keyboards that will convert website content into braille or speech, the technologies won't work unless web sites have been properly coded. Relying on federal civil rights and diabilities legislation, the National Federation of the Blind has been moving to make such coding mandatory. This August, the federation scored its first major victory when Target settled a class action lawsuit, agreeing to pay $6 million in damages to the Federation for failing to make its web store accessible to the blind. By contrast, Apple got off relatively lightly, agreeing to make a $250,000 donation to a Massachhusetts charity as well as agreeing to a timetable to implement accessibility over the next 9 months.

Canada does not have any similar examples, although similar legislation protecting the rights of the disabled exists. But stay tuned.

SPACs: Now, Public Venture Capital Is Even Prettier

(Warning: This post is going to talk about "public" venture capital, which means that somewhere in Montreal Mark McLeod is pulling out his hair and screaming.Fear not, my little coureur de bois: I will be speaking unfavourably about them.)

As you look for new sources of growth capital, here's a phrase you're going to hear a lot from Bay Street: roll-up. Instead of worrying about raising $4-5 million, they'll say, why not consolidate your current business with a few others through the public markets? And then they'll breathe a single acronym in your shell-like corporate ear: "SPAC."

Amid the chaos of this week, partners at Canada's largest law firms and investment banks have found a new life raft to cling to: the special purpose acquisition vehicle ("SPAC"). Long-banned from listing on the exchanges up here, a few weeks ago the comment period passed for a rule that would now permit trading of these vehicles, and the rule is in its final stage of adoption. A whole new investment vehicle: think what this means to us lawyers. Even if our mergers and acquisitions practice has gone south, even if our expertise lies outside of restructuring, we can still cling to the dream of the SPAC, which will allow us to continue to generate large fees on public market deals. Can I get an "amen", brothers and sisters?

What is the SPAC? Think of it as a capital pool company on steroids. It is a shell company listed on an exchange that has no operating business at the time of listing. The company has a management team of experienced management (think of those who would have appropriate experience for managing a publicly listed company) and sophisticated investors. Here's the key difference between an SPAC and a CPC: the SPAC must have a significant market capitalization - currently proposed in Canada to be $30 million. Once raised, the SPAC then has a similar period of time to find a qualifying transaction to roll into the shell.

I'm glossing over a number of technical details here to make a few practical points: SPACs have succeeded in the US as vehicles of hedge funds to park money. There are very few data points that would suggest SPACs succeed in attracting and acquiring solid businesses that in turn become solid public companies. Certainly, they will not be effective sources of capital for technology based companies in the United States. There are very few analysts covering technology sectors in the US anymore, thanks to the crackdown by Eliot Spitzer a few years (and young women) ago. How does a technology company create and engage an investor base without any star analysts? Or for that matter, how do you convince investors that there is still money to be made in tech stocks on NASDAQ?

The questions are not that different for SPACs here in Canada. Most of us in this space would agree that there is a strong base of pro-tech investors who are active on the TSX. And there is evidence that the CPC program is attracting more of them from abroad - take a look at Colorado-based ID Watchdog Inc ., which just announced a raise of some $10 million on the venture exchange. But what will SPACs do for the tech community, or any other Canadian industry?

In the near term, much of this won't matter up here. The professional fees that can be charged just to obtain the initial listing are impressive (just ask those who have been over-paying for years to achive the same listing as a CPC). Watch your in-box for breathless updates on the passage of the amended rules, but do it with a modicum of cynicism.

Drafting an IP Strategy: Checklist

Great checklist for creating an IP strategy in the "publications" section over here. While it's designed for a more mature, IP-heavy company, the steps are appropriate regardless of size or stage.