Same old story for venture capital in 2007: report

By KRYSTLE CHOW
Published in the Ottawa Business Journal newspaper.
Feb. 4, 2008

The value of venture capital investment in Ottawa fell by 31 per cent year-over-year in 2007, despite a pick-up in activity during the fourth quarter, according to a new report by the Ottawa Centre for Research and Innovation.

Disclosed venture capital investments in Ottawa-based businesses totalled $184.5 million for all of last year, down from the $266.1 million seen in 2006. The number of deals also fell to 14 from 19.

However, the fourth quarter of 2007 saw somewhat of a revival of VC investment compared to more sluggish activity earlier in the year, with five local deals worth a total of $84.4 million. Although the dollar figure was 2.3 per cent lower than the same quarter a year earlier, the fourth quarter of 2007 was the largest of the year and more than triple the $23.2-million investment seen in the third quarter.

“There was nothing new in 2007; it’s been more or less what we’ve been seeing since 2003, as venture capital investment hums along at around the $200-million level,” said Ottawa Capital Network manager Dave Scollon in an interview. “It was the same old story with investors fully invested in their portfolios and waiting for exits so they can raise new funds.”

Mr. Scollon said he expected to see more deals like the $54-million private equity financing of Plasco Energy Group, which was the largest funding deal seen since the second quarter of 2005.

Although not strictly a venture capital deal, Mr. Scollon said the deal did not count as a buyout fund financing or “special situations” investment, and was an investment in a growth company, making it fall under the general VC category.

“Entrepreneurs are looking at different avenues by necessity,” he said.

Despite the year-over-year decline, the report showed that the average amount of investment per deal has actually increased when compared to 2005, with the average investment value rising to $13.2 million per deal from an average of $12.5 million in 2005.

However, OCRI chief executive Jeffrey Dale cautioned that new VC funds would still be needed to catch and keep local talent and innovation.

“Last year we saw follow-on financings for our companies who are already up and running which is great news for them, but the new funds necessary for our startups are very limited. It’s critical that we establish and leverage other pools of risk capital in Ontario,” said Mr. Dale in a statement. “Ottawa is filled with talented entrepreneurs and if they don’t get the VC support they need here, then the best of our best are not only going to start looking elsewhere, they’ll pick up and move out of Ottawa and maybe even out of Canada.”

DILUTION DILEMMA

On top of that, Ottawa startups may often be caught between a rock and a hard place and have to choose between diminished funds and unpalatable term sheets, according to local entrepreneur Ross Norrie.

Mr. Norrie, whose company AssetMetrix raised its Series-A VC round in March 2005 and then was bought by Microsoft in April 2006, said startups may not be getting funded because venture capitalists are putting forward “ridiculous” agreements in exchange for the money.

“Typically in a startup, your Series-A will dilute all shareholders, specifically seed funding from your friends and family,” he said. “Some term sheets I’ve seen are just intolerable … and when there’s an exit all of the funds go to the VC, with the original investors left with less than their original investment. We saw those types of terms floating around, and we didn’t accept them.”

Mr. Norrie added that it’s often a “hurtful” situation since companies do need to expand and get financing to grow sales and marketing operations and so on, but one really needs to take into account what a VC deal is going to do to all the investors in the company.

Looking ahead to 2008, Mr. Scollon said he didn’t expect VC financing in 2008 to be radically different from last year, although it would depend on the state of the economy down south with the accompanying uncertainty of the stock markets and its effect on exit opportunities.

“Ottawa’s in a bit of a transition period, with VCs trying to restock their treasure chests. It will be interesting to see how VCs deploy their funds,” he said, adding that despite the troubles in the United States there should still be some opportunity for merger-and-acquisition-type exits.

“The subprime mortgage crunch might have an impact on other areas of private equity such as buyout funds which are dependent on loose credit, and it might cause a shift to venture capital but we don’t know for sure,” Mr. Scollon added.

Celtic House Venture Partners managing partner Andrew Waitman agreed with this assessment, noting, “The buyout world had a good last couple of years, but with the credit crunch that party’s over, and people are looking back at VC which doesn’t have the volatility connected with public markets. The VC market may come back into its own; the best vintage years for venture capital are sometimes in the beginning or middle of a recession.”

Meanwhile, Paul LaBarge of the LaBarge Weinstein law firm said it looked like investors who fled the Ottawa scene in 2001 after the big tech bust were slowly coming back into town.

BACK IN CIRCULATION

Mr. LaBarge, who called himself a “perpetual optimist,” said, “There have been a fair number of M & amp;A transactions lately; they’re not the home runs seen in 2000, but they’re quite respectable, and funds are coming back into circulation.”

He said his observation was that fund managers are realizing that they need to get back into investing or risk going out of business, and with more carefully focused technologies coming into the market, VCs are finding less risky investments in the local tech scene.

“Instead of using the field of dreams approach – if you build it, they will come – people are taking a very disciplined approach (to technology) and building it to meet a particular need,” he said. “So we’re starting to see cautious money coming back into the marketplace, with VCs looking for companies that have revenues today and are going to be cash flow positive within three to six months and profitable within 18 months.”

Nonetheless, Mr. Waitman cautioned that 2009 could be a difficult year for local companies in terms of exits, since a prolonged U.S. recession would likely lead to lower valualtions for companies seeking to be bought or to have an initial public offering.

“We tend to lag the U.S. by about a year, and though there’s a fair bit of optimism and things seem to be going fairly well, it depends on how serious and prolonged the U.S. recession will be as it will eventually affect local companies which sell to the U.S.,” he said. “I haven’t heard of any companies feeling the pinch but it’s something to put on the radar.”

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