MONEY TALKS by Andrew Waitman

Canada lacks a sufficiently robust gene pool of venture investors who have consistently demonstrated that they are capable of sourcing, selecting, nurturing and then successfully selling early-stage companies.

WaitmanHighEdit-111X196.jpgDoubt disease leads to failure by instilling fear of the future
From SCAN's Print Edition

During a famine, there is no shortage of opinion by “experts” about who is to blame and how it might be solved. Those affected do their best to survive and those responsible to improve the situation do a great deal of hand wringing. Nature takes its time, but the suffering eventually ends either because there is no one or nothing left to evoke pity or the environmental circumstances change.
Is famine an appropriate metaphor for the current state of Canadian venture capital? I believe it is because it offers a model to discuss causality and consequences. As a result, it also offers an opportunity to consider survival adaptation. In our local Ottawa pond (puddle) the venture capital water has evaporated. This raises two important questions: Why has this happened? And how should people and companies adapt to survive? I will wade into this complex conundrum and offer some opinions and advice with specific examples of thriving species.
First the why. Investors invest into venture capital when they believe that the potential return of more money, in the future, exceeds the perceived risks of losing that money. Investors avoid investing in venture capital when they believe that they can earn more money with less risk in alternative places or at another time. To say this is to be accused of stating the obvious, but venture firms generally and those that have operated specifically in Ottawa have yet to demonstrate reasonable returns for the significant risks of investing in a long term and extremely illiquid asset class.

The dearth of Ottawa venture capital has unique regional reasons in addition to specifically Canadian dynamics. The Canadian venture ecosystem suffers from numerous structural deficiencies. Furthermore, the general venture environment stills suffers from the (1994-2000) boom ─bust (2001-2008) cycle. Exacerbating venture capital problems is an extremely pessimistic Wall Street, which is avoiding illiquid assets as a result of the sub-debt crisis and its depression-threatening fallout. This pessimistic preoccupation keeps the IPO market closed, while a skeptical and cautious corporate class steps only cautiously and conservatively into M&A transactions. As a result, few premium-priced venture-backed acquisitions occur and therefore exits for venture investors are limited, driving down IRRs and multiples.

People and companies in Ottawa can do little to change the macro economic malaise nor can they control the vicissitudes of Wall Street fears and phobias. However, they can and must adapt to the Canadian reality. Some of the Canadian venture capital structural issues will take time to resolve while others will never be resolved.
Canada lacks a sufficiently robust gene pool of venture investors who have consistently demonstrated that they are capable of sourcing, selecting, nurturing and then successfully selling early-stage companies. As a result of this lack of venture success, returns are low or negative and few Canadian institutional investors are interested in participating in the asset class. Among the many other variables that contribute to the returns problem is an over-investment in too many start-ups. There are now no venture firms in Ottawa with available capital so this problem will has reversed dramatically, with most Ottawa start-ups finding venture capital very difficult to secure.
So what should entrepreneurs and others do to adapt to the new funding famine?

First, recognize that a significant environmental change has occurred. Executives, boards and entrepreneurs must accept this environment and make different decisions as a result. Some are sourcing venture capital outside the city and country. In some cases they will be successful. Others are seeking capital from other non-traditional venture firms such as hedge funds, high net worth individuals or corporations.

I have been thinking about this on-coming famine of funds for some time. My new perspective is that we could learn a great deal from start-up companies and the entrepreneurs behind such companies as Fidus, Pythian, Macadamian, MXI and Fuel Industries. These are the models for the new reality in Ottawa. We should learn from these business models and embrace their insights about how great companies can be built in Ottawa without venture capital. What these very successful companies have in common is that they have grown organically with modest amounts of initial capital into world class competitors in their respective market spaces by providing great services to global customers. All of them began as service companies. Some developed products to enhance their services. Though service start-ups are often frowned upon by venture capitalists due to their lower leverage and longer growth time frames, they provide a much tighter feedback loop between customer need and revenue results.

There are more examples in Ottawa of great companies built without venture capital that compete successfully internationally. We need to understand and learn from these examples, and celebrate their success, because they show the way to the future for Ottawa’s next generation of high technology entrepreneurs in light of the new venture capital funding reality.

Andrew Waitman is managing partner of Blackswan Ventures Inc.

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