An idea for McKinsey & Co.

For fear that the Business Development Bank of Canada hasn’t tasked their management consulting team at McKinsey with stakeholder meetings in relation to the “BDC Venture Capital” strategic review currently underway (see prior post “Playing catch-up” July 7-10), David Crow asked me to share my simple suggestion with all of you.

I warn you: the idea isn’t all that novel. HSBC did it when they recenly spun out their six global private equity arms to the local management team. TD Bank did it when they handed TD Capital Private Equity Partners to the Toronto-based group that now goes by NorthLeaf Capital Partners. Quebec’s FTQ did it in 2008 with their 35 early stage venture capital investments. It’s not very complicated.

If BDC CEO Jean-Rene Halde is concerned about the 5% of his total assets (yes, sadly just 5%) that are tied up in money-losing VC deals, my suggestion is simple, and it works for everyone: Spin out the BDC Venture Capital arm to its management team.

Overnight, BDC VC would become Canada’s largest independent VC fund. The team would be elated, I’d hasten to guess. And the government could still say this is a new step they are taking to help Canada’s Innovation Economy recover.

Interestingly, the $13.2 million of 2009 G&A attributed to BDC’s VC arm may not even have to be cut, because with assets under management of $537 million, the new staff budget would be about $10.7 million based upon a “2 & 20” model.

Take the other $71.3 million of VC funds (at cost) within BDC’s VC Fund of Fund program, and assign those to an independent Fund-of-fund manager like Kensignton Capital or NorthLeaf, with a “1 & 10” budget. If there is still $40 million of fund-of-fund money assigned to SODA to deploy, tack that along to this package. For $1 million a year, one of the local pros will manage that for Industry Minister Tony Clement. Why replicate within government what the private sector is already succeeding at? Are we not in favour of the free market?

That puts G&A at $11.7 million, about $1.6 million less than the current model. As the LP, BDC’s got to be happy about that. More importantly, the investing team will have free reign to promote the good firms in their portfolio, and shut down the ones they know in their heart they’ve been funding for too long — but feared what political reaction they’d get if they let something go under (if such situations exist).

It seems so simple. The government, for an interim period of maybe 5 years, can be the sole limited partner. Then, 5 years from now, that $400 million will be up for grabs. If the BDC team did a good job with their portfolio, the government will likely re-up; maybe add $200 million to the pie. If performance was terrible, if a way that wasn’t market-related, the BDC VC team will lose the capital — as is the life and times of the private sector.

Industry Minister Tony Clement would then be free to put those $400 million of funds into a federal fund-of-fund program, satisfying the recommendations of the CVCA (albeit 7 years after the initial ask). If it works out, groups such as Teralys, OVCF, EDC, Northleaf, etc., can also become LPs of the independent BDC VC Fund II. Along with anyone else in the institutional world who have a venture allocation. Just as they’ve done with the Tandem Expansion Fund, for example. A government-created firm which operates outside the four walls of government.

It seems such an elegant solution for all concerned. Free the dedicated BDC VC team of their crown corp. chains. You have nothing to fear but success.

MRM