Without ambition, there can be no success

Does Canada have a start-up culture? Should governments be in the business of creating an environment of innovation and risk-taking? These were questions I was glad to see tackled by my morning newspaper over the weekend.

Does it deserve a “response” post? Normally; what with this being the backwater blog spot for all things VC in Canada over the past 6+ years.

Today was tough, however. I had a brief moment of perspective, viewing some of the work by the winners of the 2012 World Press Photo awards. It seems that girls as young as 5 and 6 years of age are still being sent off to amorous young husbands via arranged marriages. In terms of issues of global importance, I must admit to being a bit indifferent to the question of whether or not the Globe and Mail’s “Ambitious Turnaround” piece moved the topic forward one inch. At least in the wake of seeing the photos on display today at Toronto’s Brookfield Place.

But, as a slave to the popular demands of our modest but fervourent readership, I proffer an answer:

Not likely. But that’s not really the authour’s fault given all of the reporting that’s already been done here and elsewhere on the crisis (see representative prior posts “Canadian Business Magazine interview” May 21-11, “Venture Capital advances drop 33% at BDC in fiscal 2010 part 2” Sept. 27-10, “Bloomberg News coverage on Ottawa Technology scene” Apr 13-10 and “Reuters coverage on Section 116” Mar 11-10). I’m delighted that the paper decided to summarize the issues for the nation…even if it undercut the political case that Canada’s start-up ecosystem is worth saving/preserving/restarting. Here’s what the Globe told us:

1. Former PE boss Sam Duboc is busy helping Finance Minister Jim Flaherty as he attempts to restart Canada’s early stage ecosystem.

This is good, of course, and Minister Flaherty made an inspired choice (see prior post “Feds on right path with Innovation ecosystem consultations” July 2-12). He will be well-served by having an outsider balance the inertia that has long-since befallen the doves within Industry Canada and their puppet masters at the Business Development Bank of Canada. The fact that Mr. Duboc has enjoyed some wins and losses in his career gives him cred.

2. Investing in the VC asset class has generated poor returns:

“The last 10 years have been just a wasteland from a return point of view” in Canadian venture capital, said Leo de Bever, chief executive of Alberta Investment Management Corp., one of Canada’s largest fund managers. “We’d like to do more and we’re being pressured to do so” by governments. “But us stepping into that is a bit tricky because the failure rate is so high.”

The case of AIMCo is curious to reference, since they have never been known to have an allocation to Canadian venture capital funds. Like, ever. But the real question is the so-called investment “failure rate”. It isn’t a “wasteland”, Mr. de Bever: Edgestone’s two venture funds made folks money, for example, and Wellington Financial’s 5 year net return to investors is 10% on a GAAP basis (9.5% net cash IRR since inception in 2000). How have pension funds done with the capital they ostensibly pulled out of the risky venture asset class and redeployed into greener pastures??

That depends. CPP Investment Board is likely flat at best on its humongous private equity portfolio over the past 10 years, according to one former Toronto-based pension boss (see representative prior post “CPPIB’s $29 billion PE program largest naked currency bet in Canadian history” March 31-11). AIMCo isn’t following the same path in private equity landscape as the CPPIB (see prior post “AIMCo’s take on PE marks stark contrast to CPPIB” Aug 24-11), but that doesn’t mean its assets didn’t shrink over the past 2 fiscal years — they did.

Let’s look at AIMCo’s own investment thesis. 24% of its pension and endowment assets are in equities (according to the 2011/12 annual report). If you put $1 in the S&P 500 index five years ago, you’d have seen your capital shrink by 5.6%. Should you have had the good fortune to be in a surplus position and been able to reinvest the dividends you received, which was rare for most plans of late, you would have earned 4.8% in total during this period. AIMCo probably didn’t have that luxury, what with $16.2 billion of net cash outflows during the past three fiscal years alone. This is not to pick on AIMCo, but since they offered themselves to the Globe as careful stewards who wisely stayed away from the venture landscape, their own middling results are worth noting (in bold print).

In any event, when I did the math at various points in time over the past three years, VC returns surpassed the public markets (see prior posts “Canadian Venture Stats Top Dow Jones” Jan. 17-11 and “VC returns trump all” June 22-09) in each instance. That doesn’t mean that every VC fund made money over the past number of years. But guys like Edgestone Venture and ourselves have, not to mention several other Canadian firms.

Crikey, even the two old CPPIB 2002-vintage Canadian VC fund of funds are above par (see prior post “CPPIB Q2 2011 General Partner performance numbers” Dec. 20-11). I know this sounds a bit like “how could you be so thick?”, but I’m a stickler for facts.

3. U.S. VCs = smart, Canadian VCs = dumb

Where to begin?

It is true that some Canadian VCs circa 2000-2004 had the luxury of being generalists. Which is not to say that just because VenGrowth had biotech and information technology funds under management, that the same people were writing the cheques across the two domains. This was absolutely not the case. Whether or not it made sense for Ventures West to have a mutli-strategy fund, you can’t help but notice that they were on their 7th fund when the NASDAQ bubble finally burst; which tells you that something was working for their institutional investors during the prior 2+ decades.

Of the current 935 U.S. VC funds plying their stock and trade, industry rumours persist that over 400 will never raise another fund. Whether that’s due to poor returns, the Volker Rule, weak fundraising by funds-of-funds, or a rationalization of the GP universe at the behest of institutional LPs such as CalPERS, all is not rosy south of the border, either.

I couldn’t help but notice that Toronto’s FixMo was cited as an example of a local company that had attracted a star U.S. VC investor (Kleiner Perkins). As even semi-regular readers of this site will know, I believe the government must understand that If it’s not built, they can’t come (my post from March 6-10). As much as things like the removal of Section 116 from the Income Tax Act are important (as it applied to foreign VCs), Globe readers must appreciate that FixMo’s first three or four rounds of funding came from local Angels (like me), Extreme Venture Partners (Amar Varma, who started investing back in the Common), RHO Canada (Jeff Grammer, came in to lead the Series A pref), and Inovia (Chris Arsenault, who joined the team on the Series A1) (see prior post “Fixmo lands US$23.4M from Kleiner Perkins, Paladin and Horizons” Nov 27-11).

That takes nothing away from the importance of FixMo’s Silicon Valley-based investors Panorama and Kleiner, or Hong Kong’s Horizons and D.C.-based Paladin for that matter. The simple point is that names like Achievers, Beyond The Rack, QuickPlay, Airborne, BTI, Vantrix, Bluestreak, and OZ (to cite a few examples) all attracted local venture capital and built a good business long before the foreign guys joined the syndicate.

4. In Silicon Valley “people want to fund things like behaviour change, changing how people think about things like cars. In Canada, there isn’t investor appetite for that.”

The Globe cites an example of a former Ottawa-based entrepreneur who set-off for the land of milk and honey when he hit a brick wall with Canadian VCs:

Sam Zaid, who started two firms in Ottawa, reached when he set out to launch his third, Getaround. His idea – allowing car owners to rent out their vehicles online – was too “aggressive” for Canada, he decided. So he moved to Silicon Valley in 2011, launched his business and has rolled out in a handful of U.S. cities. Mr. Zaid has no idea if it will catch on or if it can even make money. Canadian VCs have told him, “prove to us you have a business model and can get revenues.” Mr. Zaid instead raised more than $17-million (U.S.) from such U.S. high-tech luminaries as Yahoo CEO Marissa Mayer and Google’s Eric Schmidt.

I can’t speak for the Canadian VC community, and Ms. Mayer and Mr. Schmidt are far more successful in business than I, but can you blame anyone who passed on a deal that arranged for people to rent their own cars to strangers? I wouldn’t want to take on Zipcar (or Autoshare), either, if it were only that simple. And the PR disaster of that infamous condo-sharing site that became prey to Californian vandals comes to mind.

There are two things that the economic crisis and the new reality of venture-land have brought to bear on almost every VC firm in North America. First, post-crisis, VCs such as DFJ’s Tim Draper admit to looking at firms that are just a bit later stage than they had spent time with prior to 2009. That doesn’t ignore the social media start-up frenzy that infected a few players, but by and large, VCs that were once pre-revenue concept-types now look for a product if not revenue; and the folks who wanted a product prior to cutting a cheque now want customer validation in the form of a first client sale.

The “new reality” is that exits are taking longer, between a tough IPO market and the set-back of 2008-10 that continues to bedevil the world economy. So VC Limited Partners are subtlely encouraging their General Partners to do more later-stage deals than might have made sense in the past; play for a few doubles or triples with firms in the $10 million and up revenue category, rather than merely looking for the pre-revenue 20-bagger opportunity hiding deep in the haystack.

You see that in spades with OMERS Ventures, for example, which was launched at the 2009 CVCA conference in Calgary as a Pan-Atlantic, early stage “life-cycle” investor. The original idea was that only a pension plan could do a $500k seed deal, and then follow along with $20 million of additional capital over the next few years…with no pressure on the entrepreneur/founder for an exit to satisfy the investors ultimately in behind the fund; ever. “Just build the business, and we’ll take care of the capital.” Over the last few months, OMERS has committed about $76 million of its $180 million fund to what might be considered as four late stage deals: Hootsuite, BuildDirect, VisionCritical and Desire2Learn. Some star companies there, but the same barbell approach that traditional VC firms have been doing as they de-risk their traditional swing-for-the-fences investment philosophies.

The point is simply that Canadian VC folks have learned from the past 15 years, many have positive returns, and pension plans such as AIMCo shouldn’t be throwing stones from within their taxpayer-funded glass towers. The OMERS Board of Directors have put their money where their mouths are, even as so many others of their ilk have pulled back from the Innovation Economy; which had the byproduct of pushing it further zone of death as I highlighted in my presentation to the Cantor Fitzgerald tech conference late last month (see prior post “Cantor Fitzgerald Tech Conference” Sept. 27-12).

As Mr. Duboc will tell you, there are dozens of great ideas that might solve the trials of Canada’s early stage ecosystem. I offered up a few myself via an op-ed column in Canadian Business Magazine back in April. I don’t envy Minister Flaherty’s task. But the entrepreneurs and funders within the Innovation Economy are delighted that he and his team are tackling the problem personally.

As will be every Canadian who knows the jobs of the future won’t look much like the jobs of the past.

MRM
(disclosure: Airborne, Bluestreak, BTI, OZ, Vantrix, and VisionCritical are all portfolio companies of Wellington Financial Funds II or III; bad fact alert: there are four funds that can do growth capital in excess of $10 million per deal: Tandem, OMERS, Difference and Wellington Financial Fund IV; the article missed the last two)