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Canada, the VC ghost town

Posted by Amie @ MaRS, October 16th, 2008

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The tumbleweed

Once upon a time, all I wanted to do with myself was work in VC. After spending time in Ottawa last week at the Ottawa Venture Technology Summit, in the midst of our current financial state, I am glad that I chose a different path.

First off, thanks to OCRI for arranging some great panels, and letting us in to Stephen Poloz’s candid world of economics. It’s not easy being in venture capital these days, especially here in Canada, and while many of these issues are directly influenced by what’s happening in the market now, they have been brewing for quite some time.

Here are just a few reasons why VC in Canada is not too fun right now:

The public markets stink – The climate for exits is poor and the IPO pipeline is frozen. As far as acquisitions go, cash remains king. Acquiring companies are watching their cash due to their own share price and uncertainty. These companies will just wait till you burn all of your cash so that they can scoop you up for a deal. There might be more share exchanges as a result, but these will be challenging to peg due to market uncertainty.
Our VC’s have no money (right now) – Cash left in current funds will be reserved to support the existing portfolio rather than create a new one. As far as fundraising goes, one VC commented that “2008 might be the worst fundraising year.” A fund can’t demonstrate returns on their existing portfolio because of the lack of exits, and the Canadian tax environment (the dreaded Section 116) is a deterrent for global partners that might be looking to invest.
Nobody else has any money for you (right now) – We are in a credit crunch, folks – the banks won’t give it to you either. And don’t think a US VC is going to save you, as they will be staying close to home (also because of Section 116 above). They won’t lead an A-round here, and since our community isn’t investing at that stage either, we have a severe gap.

If you are a technology entrepreneur out there trying to raise money right now or in the next year, I sincerely hope that none of this is news to you. But wait, don’t slit your wrists yet, just have a better understanding of what you are up against as a new company. Here are the trends that I saw in the tech companies that were pitching:

Low-risk innovation – Now I did see some cool companies with some pretty neat stuff, like Magenn, eSight, Quadra Solar, DISTIL Interactive and Youi Labs, but for the most part, the companies I saw were quite conservative. That big, audacious, disruptive, idea was not there, but rather, we mainly saw technology-enabled products for a pretty well-defined customer base, or that are right on resilient trends.
Low cost – Cross-sector, these companies are light on cost and infrastructure. This probably isn’t the best time to build your biodiesel plant, or to get that semiconductor company off the ground.
Gone are the days of the hockey stick – Here, we see companies that will be generating revenues in a shorter amount of time, and will be (or have been) growing their company through sales – yes, that’s right sales… of products … that exist. These companies either have customers already, or will very soon. Even the biotech company I saw took the more conservative approach of producing antibodies and vaccines vs. small molecule compounds, and generics vs. novel, in order to address a larger market and cut time to market in half

Even if this profile might not describe your company, keep in mind that these are the types of companies that you will be competing against for a limited pool of funds.

The silver lining:
All this aside, it is a good time to start something new. Challenging times sparks innovation, and bright people will not sit idly by, especially if they have just been laid off. If your product is truly disruptive and revolutionary, and is a great business opportunity, someone will put money into it – there are still some people out there with money. Entrepreneurs are just going to have to be smarter with their business rather than their technology alone. If you and your business can make it through the next few years, then there’s a good chance that you will be in great shape when markets improve – and they will, just pay attention and watch the cycle.

But this is all easy for me to say, as I watch on the sidelines, not having made the leap myself… yet.

Discussion

Ken

I've said this elsewhere, but it's worth saying again. The reason that Canadian entrepreneurs are making incremental innovations versus audacious bets is that they aren't getting any support from investors. Entrepreneurs will build whatever business is doable with the resources at hand. If VC's want a return they have to stop being afraid of making real bets.

Greg Boutin

Very nice post Amie. I'm certainly biased given my work as management consulting, but it pains me to see all those technology-enabled businesses, as you put it, suffer because they haven't invested soon enough in getting to revenues sooner. Figuring out a business model should be the first thing founders do, instead of toying around with DIY marketing in a "build it and they will come" mentality. I feel their pain but at least the crisis is going to force many of the techies to figure out market realities and get some pro on board. Marketing is just like mechanical engineering, if you've never done it before, stop wasting your time and get specialists to the rescue.

Randall Howard

Amie,
Thanks for bravely posting this. Finding ways to capitalize innovative knowledge-based startups is a key ingredient to an bright future for the Canadian economy, so this topic needs to interest many more people than just founders.

At Verdexus, we're huge proponents of the Venture 2.0 model of building companies for less capital, having shifted to this playbook long before our current credit crunch. Now, that model has moved from merely compelling to absolutely essential.

That being said, new startups which, by running on fumes, do manage to survive these dire economic times often find that small, selective growth investments can lead to huge returns. Fewer competitors mean that being counter-cyclical can sometimes be a plus.

Randall

Josh

Hi Amie,

It is certainly an interesting and difficult climate for entrepreneurs right now. You are also correct - cash is tight for existing businesses and for VCs. Many VCs are saving money to support existing investments and ensuring that they remain flush with cash. It's survival mode right now. If you didn't read Sequoia's "R.I.P. Good Times" presentation, I suggest you have a read ... granted it's a few months old now.

All Canadian VCs are not dry, however. If there are any businesses developing software applications for financial services or mobile (smartphones), try approaching our funds: RBC Venture Partners and the BlackBerry Partners Fund. We have cash and are always looking for good investment opportunities.

Good luck and all the best to all you entrepreneurs in 2009!

Josh

Yoram

Hi Amie,
Good article and I am glad that MARS included it in a recent email.
As a Toronto based start up, we share the pain.

Josh - if you are reading the comments, please check AskKinjo.com. We are in the mobile space and certainly interested to find more about RBC Venture and Blackberry Partners fund.

Overall, I think that the Canadian government could and should be much more active and generous in promoting entrepreneurship and innovation. The Canadian government has to realize that investing in start-ups is not wasteful. The money is spent on R&D in Canada, promotion in Canada, developing skills in Canada. In short, the money stays and every dollar moves several times through the industry, generate IP and skills. The talent which is retained in Canada and evolve will create wealth of knowledge and a feeling that "yes, we can" to be shared by all. And most of all, a sense that Canadian can innovate and develop start-ups into viable business. For example, when Nortel was growing (the good old days) they evolved fantastic R&D skills and huge engineering community. Same for RIM and few others, but it may be easier to build 100 smaller success story than the mega-success story.
Best of luck to all,
Yoram

Philip De Groot

Securing venture capital for anything other than extraction (mining) operations has always been more challenging in Canada than the US. Differences in bankruptcy laws; however, make it easier for small Canadian firms to incur bank debt. Outside recessionary periods it is easier to raise equity in the US and easier to raise debt in Canada. Debt involves banks and banks lend against assets and revenue streams. The Canadian ethos definitely favours startups that can generate some revenue from their inception. Thus the Canadian technology entrepreneur is under much more pressure to develop commercial applications driven by the needs of specific market segments or customers. Some of your earliest research needs to be market research. Luckily the world is full of technical problems that need solving. The advantage of a startup business model that includes some revenue generation is that you have some control over the length of your runway. I expect 2009 to be the year that a lot of good but small public US biotech firms will be purchased for a song by cash rich, pipeline poor Big Pharma when the little firm's runways have run out.

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Amie manages programs for the Business Mentorship and Entrepreneurship Program, a component in the Ministry of Research and Innovation’s Market Readiness Program.