Ottawa has a reputation as a tech generating engine. But lately, it’s been said, the engine is throwing sparks and needs a major overhaul. Terry Matthews, instrumental in building much of the local tech scene, recently wondered aloud whether it will all be only a memory in a decade or so. Tech investment is drying up; the old wheels of funding are no longer spinning. Something needs to be done! is the cry being heard throughout the valley. But some folks are taking out their wrenches and rolling up their sleeves…
"The worst sin is that many (Ottawa) entrepreneurs and angels assume they understand venture capital. They do not."
The general partner of large US-based venture capital firm knowledgeable about Ottawa investment, has some choice words: “The sick adversarial nature between (Ottawa’s) VCs and angels is chasing money away…” It’s his contention that early-stage investors here are accepting evaluations that are too high, crippling later-stage investors who have been left with too small a slice of the pie.
“The worst sin is that many (Ottawa) entrepreneurs and angels assume they understand venture capital. They do not,” insists our VC, who wishes to remain anonymous… [Large VC firms] will not invest in locations that present ignorance issues like this… It’s hard to babysit a problem child with an attitude at a distance.”
Says venture capitalist Pat DiPietro, managing GM, Vengrowth Asset Management (vengrowth.com), “No one is making money. Companies are doing poorly compared to what investors expect, and investors are adopting a wait-and-see attitude. They want to see a glimpse of a turnaround before they are willing to invest further.” Apart from low returns, he points to three other major weaknesses that need to be addressed: taxes, costs, and a lack of initial round investors.
On the issue of taxes, he says that in order to motivate investors the tax structure needs to address the risk element of their investments appropriately. “People think this is resolved but its not, and government is not moving to solve the high tax rate on risk capital.”
On costs: “It used to be cheaper to hire people in Canada for R&D and for management. And with the government tax credits and the favourable exchange rate, Canadian R&D was half the cost of US R&D,” he points out. “But that isn’t the case anymore. So naturally an investor now looks to companies that are closer to home. A venture capitalist in Silicon Valley will invest in companies in Silicon Valley.”
On the need for early investment: “In Canada we don’t have many investors interested in A-round funding, and US investors won’t lead a ‘Canadian’ A- round. So we have a serious gap right at the start of the investment cycle,” according to Mr. DiPietro, who adds that Canadian investors need to fill that gap.
Mr. DiPietro has been beating the drum about these issues since 2003, trying to spur government to make the necessary changes, but with little success. “Natural resources are still considered the bread and butter of the country – oil is the big focus at the moment. Meanwhile intellectual property is being funded, developed and then sold too early.” He draws an analogy: “We are buying a gallon of paint, painting a wall and then trying to sell the house. But this might actually create a lower sale value because who wants to buy a half-painted house? So American companies are picking off good companies because we are not putting in the money to finish the job,” he laments. “These issues should have been solved years ago.”
"In Canada we don’t have many investors interested in A-round funding, and US investors won’t lead a ‘Canadian’ A-round."
Michelle Scarborough, VP of investment and commercialization at the Ottawa Centre for Research and Innovation (ocri.ca), agrees with Mr. DiPietro that the problem for Ottawa companies lies in the lack of investment for the full funding cycle. She sees a need to establish “the right economic conditions” to encourage local investment. To that end, she and OCRI are inviting people from outside the region to share their expertise and to invest, as well as showcasing the capital’s strengths to foreign investment communities. “OCRI is supporting the need and desire to create syndicates and co-investment deals in Ottawa,” says Ms. Scarborough.
Andrew Fisher, executive vice president at VC and business advisor Wesley Clover Corporation (wesleyclover.com), points out some of the fundamental weaknesses with Ottawa company business plans that he has seen over the years.
“In the nineties, it was the ‘hockey stick approach’ to growth – plans thrown together with a long-term investment requirement before any revenue potential. That just doesn’t play today,” he asserts. “Today the time to revenue has to be shorter, there has to be less upfront cash needed and yet I still see too many companies that want $2 million to $3 million without a line of sight to revenue or a customer.”
He says, however, that the problem isn’t the entrepreneur’s alone, and that VCs must take some of the rap.
“The VCs have done a poor job of adapting to the new business models. They used to be able to cherry-pick opportunities (those with high returns and low risk), and they expected high management fees. Now they need to get involved, they need to help companies grow,” Mr. Fisher insists.
He says that prior to 2000, investing was easier. Now “the ‘details’ must be there, the global focus and management track record must be there, and companies need proof points, goals that, when achieved, tell management and investors that the company is on the right path.”
For VCs, the new millennium brought new business models, like building a portfolio of companies that complement each other. “It’s all about ecosystems, gaining a critical mass of companies that can work together.” says Mr. Fisher. “The ecosystem idea is necessary in order to build critical mass and critical mass is necessary to have a portfolio. Once a portfolio is created, paths to the market are in place.”
But with new business models comes new problems. VCs embarking on a ‘complementary portfolio’ approach may be caught between using scarce cash to support their existing portfolio and trying to build a new one. Also, new portfolios require new strategic partners, often on a global scale, which brings us back to the tax issue.
“Section 116 of government legislation forced foreign VCs to report investments made in Canada to the tax department,” says Mr. Fisher. “Needless to say this has deterred many foreign VCs from investing here in Canada.”
Ending on a positive note, after all this slagging of the local investment climate: According to Mr. Fisher there are at least three new VC funds currently trying to get off the ground in Ottawa. One is looking opportunities in online social networking, another is focusing on defence/security and the third is hoping to invest in clean tech/clean energy.
James Bowen, PhD, PMP, CMC is an Ottawa technology entrepreneur and adjunct professor at uOttawa’s Telfer School of Management.
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