Friday, July 23, 2010

Mediazoic streams cash

Congratulations to our client Greg Nisbet at Mediazoic, who yesterday announced an investment from Slaight Communications Inc. in Mediazoic's personal broadcasting software business.

I checked the calendar and it's been 8 years since I started representing start-ups in online music and entertainment, beginning with the launch of Puretracks, Canada's first music download store. It's practically a mature industry. You can read about Mediazoic, and Greg's unique take on the future of the music industry, at the company site.

Tuesday, July 20, 2010

Ontario's Investment Accelerator Fund: Phase 2 Begins

For the last four years, Ontario's Investment Accelerator Fund has been a lifeline for many high- growth, early stage companies, providing convertible debenture financing of up to $500k per business. With the movement of the fund's management over to MARs, and the appointment of a new Managing Director (Barry Gekiere), it appears that the IAF may be laying the groundwork for an expanded mandate.

The IAF was formed in 2006, when the Ontario Government annonunced a "Market Readiness Program" to provide early-stage tech companies with "financial support and management expertise". The premise was that this combination would allow promising companies to accelerate growth and attract investment from VCs.

Despite receiving only $29 million to invest(a surprisingly large $17 million was allocated to a "Mentorship and Entrepreneurship Program"), the IAF produced. They get full credit in my books for adjusting to the market realities and assessing investments not only on the basis of whether the business would meet venture capital requirements for later investment.

Now, however, the fund finds itself in a unique position. With sources of follow-on capital low, what approach should it take to its current investments? Should it risk destabilizing businesses by forcing repayment of debentures? Or should it convert its stake and become a shareholder, and (if so) what kind of role should it take as an investor?

And what about future investments? Here, the IAF has always had a tricky path to walk. In an era where many companies build business plans on the assumption that there will be no venture capital, should the IAF assess investment-worthiness based on venture capital metrics, or should it focus more on the ability of a potential investee to create a sustainable, innovative business , i.e., one that may never be sold for millions of dollars and generate a capital gain? (A business that creates innovation economy jobs and is simply profitable is a policy maker's dream, but a VC's nightmare.) Does IAF's investment committee have the right blend of advisors to ensure that decisions reflect both equations, or is it too heavily populated with VCs?

Stay tuned.

Monday, July 19, 2010

Is Canada the Worst Consumer of its Own Innovation?

According to Techcrunch, a whopping $69 billion was spent on tech mergers and acquisitions in 2009. For me, the most interesting part of this data is the almost complete absence of Canadian acquirers.

If there is one common element in recent press about successful start-up exits, it’s this: the acquirer's residence is almost always anywhere but Canada. Large Canadian companies don't share the same appetite for Canada's start-ups as their foreign counterparts. Bumptop's patents? You can visit them at Google. 6N Silicon's silicon purification technology? Send your royalty payments to California. For all the tax dollars we allocate to fostering new discoveries and patents, it would seem that we rarely retain any ability to reap long-term rewards. This doesn’t make a lot of sense to me: when I pay for a facial, for example, I don’t expect to see the blackheads disappear from my neighbour’s face. Which leads me to ask, is Canada the worst consumer of its own innovation?

A long-standing complaint of many in the venture capital sector is that the corporate culture at Canada’s leading tech companies is too conservative to successfully implement a growth strategy based on M&A. Their engineering departments remain dominated by developers who swear by the “not invented here” school of thinking. The result? Often, it’s a deal focussed on acquiring patent rights, together with some transitional services from the inventors. Not surprisingly, this kind of deal: (a) is lower-priced, and (b) tends to drive deal flow away from the acquirer into the arms of a competitor with a more entrepreneurial corporate culture – usually, someone outside of Canada.

This mindset is also often reflected in corporate structure: because some Canadian tech stars do not view M&A as a cornerstone of their growth strategy, they have no real infrastructure to get deals done, or to properly integrate acquired staff into their businesses. In an environment where Google, Cisco and other competitors have entire departments focussed on mergers and acquisitions, this kind of ad hoc approach is a competitive disadvantage. And it shows: a US VC (and client) recently told me that he strongly discourages any of his portfolio companies from speaking about acquisitions with one Canadian tech giant, because it is a well-known “price bottom-feeder” who cannot complete a deal.

Conservatism is hardly a flaw, but is it an approach that Canada’s tech leaders can afford in the current climate, where tech M&A is at an all-time high? As any VC knows, future growth and profit is all about the quality of investment opportunities, or deal flow, that one can generate. I worry that poor access to great acquisition targets will be the long term price to be paid for the current approach to M&A that many Canadian tech companies take.

Beyond that, I worry about the return on my investment as a taxpayer. When we sell a start-up that turns out to have the next billion dollar discovery to a US acquiror, we lose the tax we could have collected from that business. Tax that could have paid for funding for more discoveries.

A common question in the world of Canadian innovation is: when? When will we see the next Nortel? With all the money being deployed (and tax credits awarded) for research and innovation over the last 12 years, why aren't there more emerging tech/biotech/clean tech giants? If we do not focus on improving the more mature parts of the value chain, then Canada’s innovation economy may well become an export industry. This would be wrong. Innovation is not like oil; there isn’t an infinite supply which can be extracted and shipped offshore for profit. How can we incent more Canadian acquisitions of Canadian tech? And beyond this, how do we create tech acquisition leaders?

Tuesday, July 06, 2010

Facebook Law: Beyond Privacy

There is a thin line between keeping a trade secret, well, secret and public disclosure, and that line is most narrowly drawn in the world of social networks. All of you who use your Facebook page and other networks as your own personal start-up sites, take heed:

Can postings, messages and/or emails that you send through social networking sites be used against you in contractual disputes? According to last month's ruling by the US District Court (Central California), the answer is maybe, probably, yes - perhaps. Would the same conclusion be reached in Canada? That also isn't clear.

Before the court was a request to subpoena all private messages, wall postings and comments posted by a litigant on his Facebook and MySpace pages. These items, it was argued, would support a defense in connection with a breach of contract/copyright infringement suit.

The court based its ruling on the antiquated Stored Communications Act, enacted by Congress in 1986 to protect emails and other private communications that individuals placed "in electronic storage" with "electronic communications service providers". The court went through a heavily-footnoted, elaborate analysis to conclude that yes indeed, direct messages sent via Facebook should be treated like emails sent via an ISP, and therefore protected from disclosure.

The court's findings did not extend to wall postings or comments, although the court hinted strongly that it would, if the facts indicated that the user had set his privacy settings to limited disclosure only.

Would the same reasoning apply here in Canada? It is difficult to see the line being so firmly drawn in many cases. Privacy settings allow for selective social networking, which is not the same thing as private, confidential or privileged communication. I can think of a number of situations where extending privacy to a user who has selected "friend only" access to his postings would be absurd.
What if the user granted all friend requests? What if the friends who could see the postings were, in fact, people with no relationship to the user? (One of my Facebook friends is, in fact, someone I've never met. He likes Farmville. A lot, according to my news feed.)

Until Facebook comes out with some kind of focussed business networks offering that manages these issues, you need to proceed with caution. Not a day goes by without a lawyer somewhere thanking the billing gods for the delivery of Facebook. For lo, unto us lawyers has been born an entirely new niche of legal practice: social networking, or "Facebook" law. Now that the body of Facebook law is expanding to deal with trade secret and copyrght disputes, and other commercial matters, the fun begins.

Monday, July 05, 2010

SRED Reform: Warning Signs Ahead

I've often worried that Canada does not have a organization that advocates exclusively for the start-up. After all, who has the time? Instead, we rely on organizations such as CATA and the CVCA to address issues on our behalf.

For the most part, this makes sense. But what happens when the interests of the start-up community diverge from those of other members of these associations?

SRED reform is one such area. The federal government currently is undertaking a review of the SRED program, and is soliciting active input from the private sector. CATA, ITAC and all these folk have opened their coffers and paid for handsome white papers, industry studies, advocacy programs and the like. But what they are advocating is not necessarily in the best interests of start-ups.

The SRED program, albeit full of warts, has been a valuable source of additional cash to Canadian start-ups. Under SRED, the federal government will refund up to 35%of the first $2 million spent on research and development each year to Canadian controlled private companies(CCPCs). For companies which do not meet the CCPC criteria (foreign-owned subsidiaries, publicly traded companies, start-ups backed by foreign venture capital), the cash refund is not available; instead, tax credits are awarded.

CATA and ITAC have quite rightly pointed out the many flaws inherent in the system. The process for claiming SRED refunds and credits is certainly no picnic, and has given birth to a lucrative cottage industry of specialists who will prepare the paperwork for you for the price of a small hybrid car. Audits of SRED claims are on the rise as well, making the time to refund, and the amount of any refund, uncertain in some instances.

But for many lobbying groups, addressing these flaws has taken a back seat to a different priority: getting cash refunds into the hands of later stage companies. Public companies, foreign-owned subsidiaries, profitable private companies - all of these folks should also, lobbyists argue, be eligible for SRED cash back.

Now, I know what you're thinking: if Canada provides direct cash government assistance to mature companies, will this turn SRED into an illegal trade subsidy that will cause all kinds of problems for Canadian companies in international trade? (Okay, I know you're not thinking that - it is Monday after the long weekend - but really, could someone explain to me how this would NOT cause problems? Has anyone been watching the increasing tech protectionist tendencies of Europe? Why not just paint a red target on the back of, say Opentext or RIM, and turn them towards the EU?)

What you are really thinking is, why do I care if there's more companies at the SRED refund party? The answer is simple: a tax base of 33 million people. The amount of federal money available is finite, which means that, should the federal government concede the point, the end result may well be less pie for everyone.

Unless advocates can explain where the extra cash to fund an expanded refund program will come from, we need to proceed with caution. Back in high school, I once shared a summer job with Tony Clement. I followed him around the Old City Hall courts for two months, doing furniture inventory for the Ministry of the Attorney General. Let me tell you: even as a university student, that boy could count. I would not bank on him advocating an unfunded policy.

There are valid reasons why CATA and others are advocating SRED cash for bigger industry players, but these needs should be balanced against those of the people currently benefiting from SRED. And you, entreprenuers, need to do the balancing. Agree that there should be cash made available to foreign-backed start-ups, as CATA recommends (although I will note that in my experience, while US VCs and angels have found SRED interesting, it hasn't been a key driver of investing in Canada. It's like leaving cookies out for Santa - sure, he might come, but I know that it's more likely I'll end up eating them)

SRED reform could enhance or further decimate the prospects of Canadian start-ups. Your participation is needed.