By KRYSTLE CHOW
Published in the Ottawa Business Journal newspaper and website.
Dec. 31, 2007 (Jan. 2, 2008 on OttawaBusinessJournal.com)

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While there’s an oft-stated fear that venture capital is dwindling in Ottawa and across the province, it seemed this year that local companies were able to find plenty of financing alternatives if they looked hard enough.

Ottawa companies have raised more than $1 billion through investment other than venture capital deals (see sidebar) this year alone, whether through private placements, venture debt deals, public offerings or grants, and it looks like this could become a bigger trend with lower levels of venture capital and as the startups that survived the tech crash mature.

One financing method that popped up in several local transactions this year was the venture debt deal, along with other types of loans. These venture debt financing rounds are much easier and cheaper to work with than equity financing rounds and help young companies avoid equity dilution, while giving them more time to raise other kinds of capital.

“As companies are getting a bit more mature, it means they’ve got sales and they’re able to leverage themselves a little bit by taking on some debt,” said Pat DiPietro of VenGrowth Asset Management. “And as you know, VC has been declining significantly over the past five years, falling by almost 93 per cent in Ontario in the last five years, and there’s a lack of VC for later-stage deals which are closer to an exit … so the gap is being filled a little bit by debt players.”

Mr. DiPietro said while later-stage companies are getting most of the venture capital funding as it is, with the younger startups starving for cash, there is still a large gap in the financing needs of intermediate-level companies, which is where the debt component comes in.

He noted that almost all recent later-stage deals seen in Ottawa have involved some sort of debt financing, and estimates that debt makes up approximately 30 per cent of those deals.

“(Venture debt players) are helping companies bridge between the hard-to-obtain equity rounds, and in some cases are helping companies avoid the need to raise equity at all,” said PricewaterhouseCoopers Ottawa tax partner Lois McCarron-McGuire in an e-mail.

This is good news for the “teenaged” companies in Ottawa that started up after the tech bubble and are growing, but are not quite self-sufficient yet, Mr. DiPietro said.

“There are a crop of these companies where their business prospects are quite good, and … they’re growing year-over-year but they are still not out of the house just yet,” he said. “But if they’re appropriately funded for just a bit longer, they have the chance to become worldwide success stories. If for the next couple of years they can attract enough capital to keep them from starving to death, a few have the potential to become an anchor tenant like Cognos and generate spinoff companies in the area. We’re just on the verge of that either happening in a positive way or a negative way (with companies collapsing).”

Meanwhile, although private equity investment hasn’t seen as much of an increase as venture debt financing, observers say there’s been more private equity firms investing in smaller and earlier-stage firms than previously seen.

“Typically, private equity firms are looking for larger companies to invest in, ones with very significant cash flows. What we are seeing now is that they are sometimes investing in smaller companies,” said Ms. McCarron-McGuire. “Some private equity firms tend to be experts in a specific sector, and if they see a company they like in a sector they really understand, they will get involved at an earlier stage.”

One example would be Plasco Energy Group, which has received more than $90 million in equity financing since August 2005, including a recent $54-million round which saw the green tech firm selling $35 million of its common shares to Connecticut-based private equity firm First Reserve Corp. and raising the balance through purchase warrant exercises and share buy-ins. This is despite the fact that PlascoEnergy is still testing out its plasma gasification technology at its Ottawa demonstration plant, although there is high interest in its system across the world.

PlascoEnergy CEO Rod Bryden said the world’s capital pools have been very responsive to good investments in Ottawa, and as a result, local companies have more financing choices than they did before if they do their research well and have a solid product.

“Private equity firms aren’t walking down the street with pockets bulging with money and knocking on doors saying, ‘Hi, I’m Joe from Boston and I’d like to invest in you,’ but there’s still lots of money if you look for it,” he said.

“The separation in the market areas for VC and private equity has blurred a bit at their two edges; it was the case that VC was for earlier-stage companies, and hedge funds and private equity tended to be available almost exclusively for established companies with good reported earnings. But I think venture funds have moved up in the food chain and are investing in more established companies than they used to, while some hedge and private equity funds have established groups dealing with smaller companies, and there’s a group of companies that have the choice that wouldn’t have had the choice before.”

However, it seems as if most of the money for Ottawa’s tech companies is still coming from outside Canada’s borders – especially from the United States – with Mr. Bryden speculating that it’s because Canadian investors are not as comfortable with high tech firms.

“Canada’s a huge pool which exports more than it imports capital, but my impression is that the Canadian VC and fund management markets are more comfortable in oil and gas, forestry and the automotive sector where Canada is strong,” he said, noting that PlascoEnergy would probably be more likely to look at San Francisco and New York than at Toronto for funding.

“This points out how poor the Canadian financing situation is; there’s a lack of belief that Canadian companies can become worldwide success stories, an inferiority complex,” said Mr. DiPietro.

He said that it isn’t necessarily a bad thing, though, as long as the money’s coming in, and it’s especially good in the case of venture debt and private equity financing deals where companies aren’t giving up as much control to their investors.

“The pools of capital do not influence your business and they want you to do your business where you can succeed, so there’s no threat to growing in Canada,” added Mr. Bryden. “At the end of the day, they’re just interested in whether you’re profitable or not.”