Welcome to the new job, Minister Murray

Welcome to the world of Ontario’s Innovation Economy, Glen Murray.

As you settle into your new cabinet role, the next couple of weeks will be consumed with the necessary ministry briefings. On behalf of the entrepreneurs and funders who make up your new official constituency in Ontario, welcome to the job! We are excited to have you.

Once you’ve had your fill of Powerpoints, we are looking forward to meeting you, and ensuring that you have the same sense of the state of the ecosystem that we do. As our third Minister in 14 months, we are hopeful we haven’t become the bastard child of Queen’s Park. Please prove it to us, and quickly. As a lifelong activist yourself, we know you’ll appreciate the frankness with which our industry is addressing the ongoing crisis in Ontario’s start-up and venture capital universe.

Think back just a few short years: Cognos, Delrina, Accellio, Hummingbird, ATI, Nortel, Newbridge…. All were important tech employers in their local markets. All of them are now gone to varying degrees. And all but one were acquired by international players.

Where’s the next generation?

Your job is, in part, to help the Ontario start-up and VC industry seed and grow the next generation of global corporate leaders. So far, things aren’t going so well. If, during your briefings, you’d like to ask your Deputy Minister some particularly insightful and perhaps prickly questions, feel free to crib from this post. He won’t mind a bit. 😉

To make it easy for you, I’ll try to tackle just the key / testy topics. But there’s a treasure trove of information available beyond your Ministerial briefing books. Lots of useful work has been done by groups such as the CVCA, the Toronto Board of Trade, OCRI, etc. And, make sure you look at the primary material, not the departmental summaries; no offense to your advisors, but the horse’s mouth is the way to go.

One quarter does not a trend make

The headline in your briefing book may well be “VC Industry Rebounding” or “Provincial Government Initiatives Stabilizing VC Industry”, and this just isn’t the case. The Q2 2010 national capital deployment statistics showed something of an uptick, with $643 million invested in the space during the first half, up 31% from a particularly brutal 2009. Since the benchmark being used was the year of the worst financial and economic crisis since the Great Depression, a 31% increase is not something to get excited about.

As the CVCA points out, the 13-ish year long negative trend hasn’t reversed. Not to mention the fact that the number of companies receiving funding actually slipped by one between Q2 2010 and 2009.

More dollars is good, of course, but the capital is largely going to follow-on rounds. Although the CVCA’s quarterly release didn’t break out Ontario’s specific allocation of the 2010 financings, Ontario-based fundings have fallen well behind Quebec over the past few years, despite having twice the population and multiple tech hubs (see prior post “Quebec’s VC world is rolling” Jan 28-10 and “Tories pounce on Grits over Ontario VC stats” March 2-10). There are several reasons why this is, and the two key ones are simply the strength of Quebec’s Labour-sponsored fund market (see representative prior post “Digging through the 2007 Venture stats” Feb 13-08) and the Quebec Provincial government’s overwhelming and effective direct support for local venture capital funds (see Private Capital Magazine article Summer 2009 pg. 28).

OVCF

When it was first announced in June 2007, I was skeptical that the Ontario Venture Capital Fund was the solution to anything (see prior post “$165MM MRI Fund: blessing or curse?” Dec 3-07). Sure, $205 million into funds was better than zero, but the OVCF only served to cannibalize the limited partnership universe, as I pointed out at the time. OMERS, TD, RBC and Manulife were all viable LP targets for several VC funds, and despite their corporate support for the government’s initiative, they were no longer going to be funding — on a direct basis — the likes of many of Canada’s best-known venture capital funds. Your department put up the first $90 million in the summer of 2007, and the corporate and Federal Crown Corp. LPs rounded out the additional $115 million in the months that followed.

The Province puts up all the money at the start (ie., the corporate LPs don’t cut a big cheque until the first $90 million is drawn by OVCF’s managers), and we taxpayers have agreed to take the first loss on the fund (so I’m told). If things go awry and the VC funds who tap the OVCF lose “only” 43% of their capital, Provincial taxpayers have essentially guaranteed big corporates that they probably wouldn’t lose money on their OVCF own commitment. And they did the Premier (he called some CEOs personally) a favour when they signed up at the outset.

Which investor wouldn’t love that?

As for getting money out the door into needy VC hands, that has proven to be even more difficult than raising the original OVCF fund three years ago (see prior post “UAE’s Sheikh Khalifa Fund vs. Ontario’s OVCF” Jan 10-10).

Although commitments have been made to four or maybe five funds (rumoured to be Mayfield, Georgian Partners, Edgestone Partners, XPV Water and Lumira), we’ve only seen formal closings for XPV and Georgian. A few months ago, OVCF had both Edgestone and Lumira on their website as “investments“, but those are no longer posted. One must assume that someone tipped the webmaster to the fact that a fund commitment isn’t the same thing as a fund close.

Lumira’s fund marketing is going well, and Bridgescale will almost certainly pick up Edgestone’s $20 million commitment, so it only a matter of time before those dollars make their way back into the “committed” column.

In the interim, that means about $30-40 million of the $205 million has closed since the government first launched OVCF in the summer of 2007 (see prior post “$165MM MRI Fund: blessing or curse?” Dec 3-07). And closed doesn’t mean drawn for new investments. OVCF also did two small syndicate participations with I Love Rewards and Bluecat Networks; good VCs are involved there, but were small syndicate positions really the core purpose of the fund?

Three years into the fund, and less than $10 million of hard cash has actually gone into action, so far (ignoring fees to the manager, that is). Unless I had a really good excuse, I’d likely have been fired by my LPs if I was 5% out the door after year three.

Why has it been so slow you may ask? Minister, I can’t quite put my finger on it. Maybe not enough funds are closing, so OVCF hasn’t been able to do as much as they’d have liked. Maybe the OVCF process is as slow as molasses in January — in more than one case taking 8 months to get back to certain Ontario-based VCs about their fund presentations.

Perhaps there are just too many funds with poor returns knocking on their door, and the OVCF team is stuck with more money than there are funds to commit to.

Some may say that can’t be the case, as Montreal-based Teralys Capital has been able to commit more money than OVCF in one third the timeframe.

For me, the situation is just plain curious. OVCF should be working, but for some reason, it isn’t; at least not to expectations. As one of the marquee elements of Ontario’s IT regeneration effort, this is worth understanding better. Keep an open mind.

ETF

Although the concept was announced in the Provincial Budget with not a moment of industry consultation, the CVCA took it upon itself to provide some ideas in the days that followed in the hopes it could help design the Emerging Technologies Fund to achieve the maximum impact. The fact that the ETF has been used by VCs a dozen times so far is proof that collaboration is crucial to the success of any government program. An envelope of $50 million a year only replaces a fraction of the capital that used to flow to local entrepreneurs from the Labour-sponsored Fund industry, but we can’t blame you for that decision.

The summary to date on the ETF is this: it appears to be working as designed when it comes to the VCs. Hopefully, the Angels will soon begin to tap it as well.

LSIFs

I know, I know, this is the third rail within your department. Any entrepreneur or VC who publicly questions the government’s decision to kill the Labour-sponsored Fund program gets 30 months in the penalty box. I’ve been there forever it seems.

That need not be your concern, however, since you have the luxury of playing the “new guy”. Ignore what otherwise brilliant academics might tell you about LSIFs making universally poor investments (see prior post “LSIF funds see another win as Microsoft acquires Opalis” Dec 27-09). Toss out the self-interested advice of traditional VC GPs who would have you believe that LSIF funds crowded-out their traditional access to LP capital.

Is the program expensive? Not at all. When the Ontario government puts $30 million into a “Green V-8” engine plant near Windsor to preserve 300 jobs (see prior post “CVCA’s budget pitch to Ont. Premier McGuinty” March 17-09), the LSIF program is a steal.

Do one simple thing as you learn about your new role: hear out the remaining large LSIF funds yourself. Ask them to show you job creation stats. Have them account for the “tax room” that they consume via their program. Make them explain how some in their midst feel it is appropriate to raise $5,000 and then rebate investors 10% in cash on the following day as an incentive to invest in the first place.

Once you review the pros and cons of the industry, you’ll determine exactly what B.C., Quebec and others have come to realize. This program puts money directly into the jeans of innovation companies. Far more effectively than any government program ever could. Sure, the industry needs to fix what quantum of fees they charge investors and how they determine performance bonuses. But, the original decision to fire the sector was a classic case of throwing the baby out with the bath water.

Direct Corporate Investing / Lending (aka Corporate Welfare)

Every few months, we read about another “investment” by the Ontario government into a local tech company. Sandvine and Redline are just two examples of publicly-traded companies that have tapped the Provincial treasury for capital of late. These are public companies, with access to capital, who are at your doorstep. Huh?

In the case of Redline, some of your colleagues gave the company a $10 million interest free loan last year (see prior post “Why is Ontario getting into interest free corporate lending?” May 11-09). For a company that had burned $4.5 million in its previous fiscal quarter, and had just $4.4 million of cash on hand as at the prior quarter end (ie. one more quarter of burn). What were they thinking?

Sadly, revenue recognition issues have since arisen, and one can only imagine where that’ll go. The TSX cease trade order came soon after. The company hasn’t filed financial statements since November, and things look bleak to say the least. But the problems are about revenue recognition; this was a disaster-in-waiting the day Her Majesty cut the cheque. If bureaucrats can’t read financial statements before they put taxpayer capital at risk, perhaps such deals should be left for the private sector to arbitrate.

That’s what we are here for, after all. I’ll let you in on a little secret: not every tech or biotech firm deserves a cheque.

But that’s not the biggest gamble we’ve seen. The Samsung and Ubisoft deals take that prize. The Ubisoft one, in particular, seemed so disconnected from reality at the time it was announced. Sure, Vancouver and Montreal had created nice creative gaming software development hubs for themselves. The me-too strategy seemed almost natural. But was this the move to have made? $263 million in exchange for a loose promise to create 800 jobs over time (see prior post “Can Rainbow Six save Ontario’s economy?” July 6-09). To date, I’m told that the actual number of new jobs has reached 75. I guess that’s something, but it’s neither creative nor cost-effective, as I wrote last year:

Premier McGuinty’s $263 million swamps what the State of Michigan had to put up to attract General Electric’s Advanced R&D Centre just 10 days ago (see prior post “General Electric R&D Centre an idea to emulate” June 26-09). And it also exceeds all of the money that has been committed over the past three years to help secure the future of Ontario’s venture capital industry ($90MM for OVCF and $150MM for ETF). And Canada’s VC industry has created 147,000 jobs according to a recent independent study prepared for the CVCA.

In summary Minister, you’ve been given a tough job. But it’s a job that the Premier himself once wanted (and kept). Take that as an important sign — your Boss wants this portfolio to succeed in every possible way. No Premier in the nation appears to have a more inate interest in technology than our man in Ontario. Perhaps that’s why, like a frustrated major league baseball coach, he keeps changing his Pitchers at MRI.

The problems are clear. The current suite of solutions aren’t doing the job well enough. There’s lots of capital swirling around, but it is winding up in the wrong pockets. Success can be yours without new spending.

Rather than think big, or even long term, look for practical solutions that your allies in the ecosystem can put to use immediately. Ontario doesn’t have a shortfall in research dollars or on-campus activity, it has a paucity of recent commercialization successes. Not enough companies are being launched, and the VCs that do exist don’t have enough capital to fund the good ones. With few budding global tech champions lying in the weeds, awaiting their time in the sun, the byproduct of the past five years is clear.

Help us fix that, and they’ll name a University after you someday.

MRM
(disclosure – this post, like all blogs, represents a personal view and in no way reflects the official position of the CVCA, etc., etc.)