A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry. Something Ventured By Brent Holliday Greenstone Venture Partners How To Fix Venture Capital in Canada, Part 2   “But when the wrong antidote Is like a bulge on the throat, You run for cover in the heat. Why don't they, Do what they say, Say what they mean, One thing leads to another.” – The Fixx, One Thing Leads To Another Last time, I talked about the background of Canadian venture capital (VC) and how it emerged.  I did this as groundwork for this week’s column where I describe my thoughts and ideas on how to fix VC in Canada.  This all emanated from a new company in town called Boot Up Labs, run by Boris Mann and Danny Robinson.  Danny posted a call to arms a couple of weeks ago that has generated some interesting discussion.  I started to reply and found that my column was headed for 3000 words, so I decided to break it up into two columns.  For those that read the post last time, sorry for the suspense.  For those that did not, go back and read it first.  Thanks.  In a very interesting response to my “history” column last week, Jim Fletcher, one of the original Canadian VCs with Ventures West (raising $78M in 2 funds in the 80’s), well before it was an established industry, added a few salient points to the discussion: ·         The US VC industry original VCs were operators for the most part, with experience in “anchor” companies like Intel, Apple, Honeywell etc.  The original CDN VCs were, by and large, bankers and lawyers. ·         Without the “anchor” companies in existence already, such as they were in the Silicon Valley, it was very hard to find talent at every level in Canada ·         Without sizable funds in the 80’s and 90’s, the good ideas funded in Canada were quickly caught and passed by the US companies that could get more capital from the more established and larger US VCs. ·         For some reason, the angel/VC relationship in Canada was always poor from the beginning, according to Jim.  This was the opposite in the US and still is today.  That strain meant that good companies were underfunded, as the angels typically don’t have deep pockets.   ·         Structural issues in federal tax policy (including the arcane Section 116) have un-necessarily hindered foreign investment in VC funds and in the companies themselves. So add those points to mine last week and you have a variety of historical reasons (dare I say excuses?) that we are where we are today. How do we fix VC in Canada?  In a word, returns.  You have to have good returns from companies growing tremendously on the back of global market dominance in their space, or from companies making solid returns in small niches.  You have to create incentives that are returns based, not tax based.  You have to remove any red tape or policy that hinders those returns leaving the country back to foreign investors.  Basically, get returns and get out of the way of returns. It’s not like we weren’t trying to get great returns. All of us tried hard. But the answer to how to fix things lies in a distinctly Canadian approach, not a copy of the Silicon Valley approach.  We have to recognize where the strengths are here and capitalize on them.  We also have to remove the barriers that are artificial.  Cripes, it’s hard enough without barriers! And we have to cooperate.  All parts of the technology start-up ecosystem have to work together, not as independent solutions. For Canadian VCs to emerge from a tough adolescent stage into proven managers, the proof must be in the amount of money they make for the LPs.  One of the issues managers face in getting returns in Canada is geography.  A Canadian VC needs to have access to deals in Vancouver, Calgary/Edmonton, Toronto/Waterloo and Ottawa/Montreal in order to have enough great companies to invest in and make great returns.  The problem is that you can’t have VC partners with every expertise in all of these areas.  One suggestion is sector focused funds that have partners in many of the locations that know biotech or software or telecom equipment.  But is there enough of any one sector across Canada to support a fund big enough to support 6 or 7 partners? Perhaps the returns can come from smaller regional funds that co-invest with angels in smaller bootstrapped opportunities and balance their risk with larger investments in later stage companies seeking B or C rounds in their region.  Call these the regional generalist funds that fill the barrier between angels and larger VCs (like BC Advantage and Discovery do here) but also take less risk by filling the gap for later stage funding for companies with a few million in revenue. These are my opinions and there are many smarter people out there that have their opinions... but everyone needs to frame the debate about what type of VC fund can generate great returns by considering a Canadian approach.  Learn from our constraints and craft a new way forward. Whatever format the funds take to generate better returns, the fact is that they need more capital.  We need to incent our institutional sources of this capital, not apply a stick to them.  The pension funds in Canada have shown that they can’t consistently be coerced into investment in Canadian managers.  They had restrictions lifted on where they could invest their money (it used to be similar to your RRSP limits on foreign investment).  Now they can choose to invest anywhere.  If US VC is making good money, why not put their dollars there?  The best way to get investors to pile into the Canadian VC market is to show them existing returns on invested dollars and to show them a path to preferential returns.  The Renaissance Fund in BC is a good start.  Tax-driven strategies to incent major investors don’t work.  Many of them don’t even pay tax (pension funds, for instance).   A huge source of capital is from outside of Canada for VC funds or for direct investment. As Jim mentioned, the barriers to foreign investment in funds or companies MUST disappear.  These tax policies take away the returns or delay the returns with un-necessary red tape. Some changes have been made recently, but the problem remains.  This is something that can be addressed NOW. Last time, I talked about how many successes exist in technology without VC investment.  There are two things that need to improve for VCs to see more of these deals and make investments in them: 1) better relations with angels, as Jim pointed out and 2) a new approach to early stage investment structures.  VCs will miss successful companies if they appear to have a skewed “value-add to pain of term sheet” ratio.  Many of the VC-less successes did approach VCs and got more favourable terms from elsewhere. Taking a lesson from my bellicose entrepreneur, VC managers need to re-think their approach to early stage investment.  They need to adapt to the needs and stage of the investment vis a vis their terms and class of shares. The standard way of thinking has been that VCs need to add terms that manage downside risk concomitant with that risk. What is needed is exactly the opposite.  Smaller, earlier stage investments with ½ page term sheets.  A little less paper and a lot quicker access to capital.  VCs, in other words, must compete and cooperate with angels for a broader portfolio of riskier deals.  More risk at the earliest stages, but many investments to draw from.  If I was to do Greenstone again with $40M today, I would invest in 20 companies, not 12 and I would make the investments earlier with larger amounts to follow-on in later rounds.  I also would balance the risk with a few later stage investments. In summary, Canada is not and never will be the Silicon Valley.  We need to emulate the entrepreneurs and the strategies for market entry and growth that the Silicon Valley has employed.  We need to emulate their energy and work ethic.  But we don’t need to copy their exact methods for investing.  Their world is different.  Fixing VC in Canada requires a bit of policy work, a lot of new thinking on the part of the VC fund managers and a lot more cooperation at the earliest stages of company development. We are in the throes of adolescence in the Canadian VC industry.  In order to mature to adulthood, we need returns. Good luck to everyone. What Do You Think? Talk Back To Brent Holliday Something Ventured is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks). Something Ventured Archive Printable edition