The Future of Venture Capital in Canada
One of my favourite Sopranos characters once told Tony Soprano that he was at the "precipice of an enormous crossroads." It's beginning to feel like that in Canadian venture capital. The Canadian Venture Capital Association recently released 2009 data indicating that deal activity was at its lowest level since the mid-1990s. This is not a uniquely Canadian phenomenon, but the drought in new venture financing has seemed longer and drier in Canada than elsewhere. In some sectors, earlier-stage investors have become more visible, but what was once concern in the industry is now escalating to alarm, as more players ask what is to become of the Canadian innovation economy.
What's more, our neighbours to the south continue to lead the way in innovating venture finance. New models of technology incubation and seed finance seem to emerge in the United States every day, as those on the hunt for opportunity continue to explore how best to develop it. Indeed, there is now a move afoot in the U.S. to change immigration law to create a "Startup Visa" that would create new opportunity for immigrant entrepreneurs to remain in the U.S.
Where should entrepreneurs in Canada turn now? We have a national record of innovation that is unrivaled, and our universities are among the best in the world, but without a rich financial ecosystem to sponsor innovation, opportunity will certainly migrate elsewhere. Many Canadians involved in these areas believe we need to act now. In its recent budget, the Federal Government announced revisions to certain aspects of Canadian income tax law that many believe have impeded foreign investment in Canadian innovation. This is a welcome development, but arguably of little relevance to home-grown sources of innovation capital.
Today we turn to an exploration of these issues, and invite you to join with us. We've assembled a diverse group of talented and experienced entrepreneurs, investors, and strategists to give us their thoughts on the challenges we face in venture capital. We hope you'll take part.
Don’t Fear the Startup
- First Posted: Mar 16 2010 07:21 AM
- Updated: 3 months
We need venture capital funds willing to risk $100,000 on an idea.
When talking about venture capital, it's important to avoid generalizing the entire industry. There are many different segments to the VC world. Some of them work well. Others simply suck.
A business that has established itself and is generating some revenue will have little difficulty finding later stage funding in Canada. Most experienced venture capitalists, the people who have been doing this for 10 years now, are totally comfortable dealing with these kinds of businesses.
Companies just starting up, however, are having more pronounced problems. In looking for solutions, there are a number of things to keep in mind.
First, nobody knows a damn thing when they start something from scratch. A truly original idea comes straight from the founder's brain and it needs to be validated and refined before it can start to grow.
Having said that, a venture capitalist who demands 80 gigs of market data, 400 spreadsheets, and 10 years of projections before they think about investing, is in the wrong asset class. Too many funds demand too much from startups. This creates the perfect storm of founder frustration, analysis paralysis, and potentially great businesses leaving the country.
Make no mistake, if a seed stage entrepreneur is creating a three year model and 50 page business plan for $250,000 seed investment, they are on a collision course with a paper pushing analytic who has no business making "snap" calls on ideas. It's an unworkable combination of styles and talent.
The solution to this is to create funds that don't just target early stage companies, but are also run by people who understand that side of the business; those who have lived it or those who love it. The laughable “stage agnostic” label many Canadian firms use ought to be banned because it sends a seriously bad message about what the firm will or won't fund. Businesses looking for capital should simply look at the past deals on a particular VC's website and figure it out. And remember, one “seed” or “early stage” deal does not make a seed/early stage fund.
Second, Canada needs to put failure in perspective. Failure equals experience and if we treat it like that, we can grow talent in a way that makes both companies and investment opportunities better. Somebody who can blow it their first time at bat, and then come back stronger and wiser their next time up is exactly what the talent pool needs. Encouraging risk is just as important as managing for failure.
Third, we have to learn how to fail faster. When it comes to software, you can build, test, rework, and test again for under $100,000. We need a structure in place that allows that kind of money to be thrown at something to see if it works, and if it doesn't, kill it and try something different. Most firms don't have the infrastructure to do this without massive legal fees, overhead, etc.
Without picking on any one firm, I'm pretty comfortable in saying that most funds in Canada who claim to be stage agnostic wouldn't do a $100,000 startup investment if you put a gun to their head. Their structure simply doesn't support it. Funds worth $100 million dollar or more just won't spend the time on such a small investment, not with their “move the needle” mentality. What we need are funds that are specifically set up to do investments of this size. Ones that will make twenty $100,000 deals, shoot the ones that don't pan out and make the money back on the winners, which can then move on to more established funds.
Canada is an amazing place to build a company. You can get funded in Canada. You can build a market in Canada.
Comments
Re:Marks
“ Its also good new that we are now seeing more and more entrepreneurs funding other entrepreneurs... As well as fund managers focused on the startup phase: BaseCamp; Founders Fuel; Extreme Ventures; MSBiV;
Chris Arsenault
“ Rick, Your column is full of practical and realistic tried-and-true advice. I wished we had more VCs like you "were", and more entrepreneurs like you "are". Also, I'm slightly disappointed that this series didn't include an entrepreneur (except your hybrid case) that's in the trenches, at the pre-funding levels which is where the pain points are. The reality is that entrepreneurs sit at the lowest end of the VC value chain, and they are the recipient of the pre-existing environment that's already in place. Your case for more aggressive & risk taking investments makes a lot of sense, but needs to be enacted upon.
William Mougayar
“ $100,000 bets sound great in sound bites, but rarely meet anyone's objective in practice. First of all, except in the case of Web 2.0 or mobile app companies who can build prototypes very cheaply, $100,000 isn't enough cash to achieve any tangible progress. In cleantech, biotech, materials science, system development, telecom equipment, and even old-fashioned software development, it costs $500,000 to $2M or $3M to fund any meaningful progress. With my colleagues at Ventures West I have funded a couple dozen seed stage companies. Even after a seed round of of $250k-$2.0M and months of work by founders, Board members & VCs, the conclusion for the overwhelming number of startups is still "it's too early to tell". Sure, there are a few that are obvious winners or obvious dogs after a seed round. But the vast majority show significant promise, but still can't get outside funding until they produce more milestones. And so begins the slippery slope of internal funding rounds and bridge loans.
Sam Znaimer
“ $100,000 bets sound great in sound bites but rarely work in practice. First of all except for Web 2.0 or mobile app companies, $100,000 doesn’t fund any tangible progress. In cleantech, biotech, materials science, telecom equipment, or even old-fashioned software development it takes $500,000 to $2M or $3M to fund the development of any significant milestones. Sure, after the seed round, there are some obvious winners or some obvious dogs. But for the overwhelming majority of seed stage companies, the conclusion after the initial funds are gone is “it’s too early to tell”. These companies have hit some of their milestones, and are a bit behind on others. They show significant promise, but aren’t near revenues and still can’t attract new outside financing. And so begins the slippery slope of bridge loans and internal financing rounds.
Sam Znaimer
“ @SamZ My scenario is precisely this example - as a founder with a truly original idea. I need software solutions, marketing, limited administration, website development, and a very small staff. All told, the $100,000 mark would prove immensely adequate to begin moving the needle on launch. The problem is, I haven't found a co-founder yet to help make my idea a reality: in theory, I have a very strong business idea, but I'm not certain if it makes sense to seek seed funding without having a prototype. Would that milestone prove 'still too early to tell'? I don't believe so. In my opinion, funding an idea such as mine would result not only in a realization of monetization, but also could scale rather quickly, given enough initial backing. Ideally, I would enter a vested agreement (based on the prototype, beta test, and gold release milestones) All three stages could be rather realistic achievements within 12 months, and even less with the right co-founder. I believe $250K would be far too much for my needs, unless there is a big media spend being considered: but again, I see the website coupled with social media largely being the branding and advertising strategy.
Quentin Karmark