Thursday, April 09, 2009

Pay No Attention to the VC Behind the Curtains: Focus on the Emerging Technologies Fund Instead

What with all the twit-slapping and bloggering that’s been going on in the last week, I’ve ducked my head and avoided any discussion of venture capital here in Canada. If I had time, I’d probably point to the email I received from a US investor saying “THIS is why I don’t like having local VC partners” and note that the dialogue generally has not been that productive from a marketing perspective. I may even suggest that this is no time to man up, but a perfect time to man DOWN.

But I figure, my job is to sort out what’s relevant for my clients, who are mostly entrepreneurs. So I ask you now to turn away from the carnage and pay attention:

Here’s what you need to focus on: the as-yet unpublished guidelines for getting matching investment money from Ontario’s Emerging Technology Funds (“ETF”). The guidelines, which the Minister of Research and Innovation (the MRI) says will be available in June, will tell us what kind of investment will qualify for additional funds from the ETF.

Since the ETF was announced March 18, little has been made known beyond the fact that the fund would invest $50 million a year for the next 5 years alongside “qualified venture capital funds and private sector investors”. You should care, and care strongly about how John Wilkinson and his team decide to define these terms in the next few weeks.

Why? On the one hand, if the MRI decides that “qualified private sector investors” means any investor who is considered “accredited” under Ontario securities laws, then the availability of this matching funding becomes a meaningful thing for many Ontario companies.

If, however, ETF funds are available only to a smaller group –perhaps only investments made by VCs, and/or angel groups, then that’s another matter altogether. It’s great news for those portfolio companies who have been stranded by their current VC backers’ low cash reserves(although, note to VCs: what are the guidelines going to say about the terms of the follow-on financings you want to put into your current portfolio? I’d watch closely). But it would have catastrophic consequences for those who’ve managed to bootstrap, create jobs, and innovate outside of the venture capital model of investment. Need some examples?

Example 1: Company A is a digital media tech business which has been in existence for two years. It has managed to build product, file patent applications, create jobs for 20 employees and attract its first set of paying customers, all based on the bootstrapping and personal funding of its own founders. In order to ramp up operations and continue development, its owners need additional money. It can raise some from a local angel, and the founders may put more of their own money in, but there will still be a shortfall in the amount needed to truly expand operations. If ETF money matched both angel and founder money, then the Company could continue growth without cutbacks.

Example 2: Company B is an IT solutions company that has been around for two years and has hit every development and revenue milestone its investors (angels, friends and family) have set. Some local VCs have suggested investment to further growth, but on terms that would effectively wipe out the stake of their current backers. Instead, the Company is electing to raise part funds from its current team of angels and founders on terms that preserve the upside for its original backers,and possibly take the business to break even. Should a company which has proven innovation be forced to accept onerous financing terms in order to qualify for matching funds?

Now, there is an argument that ETF should not hand out its money unless it is on market terms, or it will create a portfolio of government investments that have issues with later-stage investment. But that’s NOT the announced purpose of the ETF: job retention and job creation are. Here’s what John Wilkinson said:

The Emerging Technologies Fund supports the kind of investment that drives innovation, secures jobs today, and creates jobs tomorrow. We’re committed to supporting clean tech and other emerging technology companies in Ontario.”

I don’t see anything in here that suggests the purpose of the ETF is to create only good candidates for venture capital investment in the future. No question, there are some that will emerge as a result of this initiative, but they are not the ETF's sole raison d’etre.

Nor should there be. Ontario’s innovation economy is not made up of businesses that will ultimately be attractive to VCs. Venture capital invests in disruptive innovation (high risk, high reward). Incremental innovations, innovations that will create companies of $30 million or less in revenues – those are generally outside the VC model, and they form the majority of emerging high tech and clean tech businesses in this province. In fact, in the last two years, most of the province’s most promising entrepreneurs have designed and built emerging businesses specifically so they will not need to access venture capital that has not been there. If the provincial government is serious about preserving the current generation of entrepreneurs, then it needs to make sure that those who are in the market today can access ETF funds.

So what do you need to do? This is an entrepreneur’s issue, not a CVCA, MARs or anyone else's issue. You need to advocate yourselves, and to do it now. Go to the MRI website and send an email (there’s a handy contact form) that gives your thoughts. Ask for more insight (and an opportunity to comment) on the guidelines before they are put into place. Send your lawyers flowers and chocolates and get them to do it for you, if you haven’t the time (although really, it’s something you should do yourself.

You've bootstrapped yourselves this far - don't let your company get locked out of this lifeline.

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