By Peter van der Velden, President & CEO of Lumira Capital

Lumira Capital, is Canadian-based life sciences venture capital company

“Liquidity Shrivels Up For VCs in First Quarter” was the banner screaming across the wire services earlier this week.  While true, what was lost in the subtext were a few important observations for Canadian VCs, particularly those focused on life sciences:

1.     That healthcare investments generally fared better than their counterparts in ALL other venture backed sectors with transaction value in the Q1, 2009 actually exceeding that in Q1, 2008, albeit on a smaller number of transactions (Dow Jones, PE Analyst) 

2.     There were “13 health care deals generating $1.31 billion in the first quarter of 2009”(Dow Jones, PE Analyst)  and Canadian VCs played significant roles in four  transactions that occurred during the quarter. Lumira Capital companies Ception, Alveolus and Guava all announced acquisitions by strategic buyers during the period as did Virochem which had enjoyed sponsorship from CDP Capital, Solidarity Fund QFL, and the BDC.

3.     Medtronic Inc., which has not been particularly acquisitive for some time, stepped up big during the quarter, making two North American acquisitions – CoreValve Inc. and Ablation Frontiers Inc – and also acquiring Israeli-based start-up Ventor.  Rather than being “Rock-Bottom Pricing” as was the theme of the press releases this week, the Ventor and CoreValve transactions were done at valuations that generated 10-15X returns for their investors despite being relatively early stage companies. The later two acquisitions in particular should also bode very well for other companies in the structured heart area, including Lumira Capital’s investee Cardiac Dimensions, as Medtronic’s key competitors address their own needs and desires to compete in this segment of the market.

Liquidity and realizations DO NOT HAPPEN by serendipity.  The story behind each of the recent realization transactions in our portfolio is different, but what I can say is they would not have happened without the management teams and investment partners having a clear set of realization objectives for their companies.  The shareholders of Ception were not looking to sell, (however we all sure understood the value proposition to an acquisitor, the key development objectives that needed to be fulfilled and what we would and would not consider for an exit), but when the opportunities for a high value exit started to emerge ahead of plan, the BOD and management team knew where they wanted to go and did a great job of securing a high value transaction.  The Guava and Alveolus deals emerged from very different circumstances in that the directors, management teams and shareholders of each of these companies concluded some time ago that they were more likely to thrive in the hands of strategic shareholders and therefore should be sold.  In both of these cases, the transactions completed were the product of a thought-out and managed process, with Guava being sold to a buyer with whom it had initiated a strategic partnership 9 months prior, and Alveolus being sold after a “fully marketed” process in conjunction with an investment banker.

Lately I have been thinking a lot about the issue of driving realizations, not because of the state of capital markets, but perhaps in spite of them.  More and more we are hearing of investors and BOD members who aren’t prepared to pursue a liquidity event because of the current state of the markets.  I think I understand this behavior for the top percentage of each VC’s portfolio of investments – those companies that truly are the cream of the crop and that will likely command exceptional multiples in a more buoyant market.  On the other hand I think there is little evidence to support the contention that average companies will suddenly become exceptional when markets improve (yeah we all can point to that mediocre company that suddenly improved or that crappy company that some strategic buyer just had to own, but those situations are truly exceptions and not something upon which fund performance can be managed or sustained). The simple reality is that sometimes we get it wrong (there I said it) – we misjudge management’s capabilities, the market size, the competitors, the IP risk, the product development risk, the clinical challenges, the regulatory environment, our ability to value add or any of the other myriad variables that affect the outcomes of our companies. Sometimes these misjudgments can be fixed (and I am sure all of us have lived through the process of trying), but more often than not they are fatal or semi-fatal. When this happens we don’t do the companies, ourselves or our investors any favours by diverting valuable human and capital resources to companies that are simply always going be average or worse.  Acknowledging this is tough.  It means acknowledging a fatal mistake to your partners, your peers and yes maybe even to your spouse sometimes. Failing to do so is however so much worse. 

So the point? The drop in liquidity this quarter is likely as much a function of unrealistic expectations on the part of the shareholders and management teams as it is a function of the market. Today’s market represents an outstanding time to cull the weak and underperforming from our herds so that there is lots of grass and water for those that are left (I am thinking in terms of western metaphors these days in anticipation of the CVCA’s up and coming conference in Calgary).  A 1x change in the revenue exit multiple makes a $50 million difference in exit value for that winner $50 million revenue company and only a $10 million difference for the underperformer doing $10 million in revenues.  I certainly know where our team wants to focus its energy and efforts as the markets improve (but we are of course also happy to take the big wins like Ception in this kind of a market).

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Source: The Canadian Press

Mar 31, 2009. updated April, 2009

By Julian Beltrame

OTTAWA  - The ability of Canada to develop the new technologies of the future is in jeopardy because entrepreneurs can’t get financing to see them through the recession, the Business Development Bank of Canada warns.

The Crown corporation which helps finance Canadian businesses says the disappearance of venture capital in the country will snuff out hundreds of innovative small companies in infancy and their technology with them.

“It breaks my heart because if we let go of these technology companies, once this recession is over you will have lost all this (new) technology, you will have lost a decade,” Edmee Metivier, the development bank’s executive vice president of financing, told a House of Commons subcommittee Tuesday.

Metivier said the BDC is a shareholder in about 150 technology firms, but in the future the corporation will only be able to help finance a much smaller portion of startups. 

But she says there are hundreds more such companies across the country that can’t find capital to fund research and get new products to the markets. And the BDC can only do so much because it needs partners to finance entrepreneurs.

“They are all at risk, there is no money for them on the marketplace at the moment,” she said.

In a later interview, Metivier said the focus of governments has been on the survival of mature companies, but in doing so they risk losing the companies that represent Canada’s technological future.

“Canada has to think through what it has to do with this sector,” she said.

Before the committee, Metivier and Benoit Daignault of Export Development Canada laid out the difficulties faced by Canada’s small and medium sized companies in obtaining sufficient credit to operate and grow during the recession.

While Canada enjoys a sound banking system, the collapse of many other non-bank lenders _ representing about 30 per cent of loans _ has created a tight market for credit in Canada.

As a result, many companies are being denied loans or are being charged exorbitant interest, they said.

”The difficulties facing Canadian businesses have increased in 2009, so it is difficult to find low-cost financing in these circumstances,” said Daignault.

The Business Development Bank has come under criticism from Liberal finance critic John McCallum in recent weeks for moving slowly in implementing several budget measures intended to free up credit for both businesses and consumers, particularly the auto leasing sector.

Metivier was not confronted by the charges in the subcommittee, but said she had been prepared to respond.

She said she expects the Crown corporation to double the rate of the annual increase in loans this year, and said $750 million had already gone out the door in the first three months.

Any delays on the $12 billion credit facility to increase credit in the auto leasing sector, and loan guarantees for companies were due to the fact the corporation, which operates on a commercial basis, had never engaged in either activity in the past and needed to do due diligence, she explained. 

The loan guarantee facility first announced in December will be in operation starting Wednesday, she said, whereas the measure on auto leasing will likely be up and running by the end of May.

“It would have been humanly impossible to kick start (either) any sooner,” she said. 

Copyright © 2009 The Canadian Press. All rights reserved.

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 March 16, 2009

Premier Dalton McGuinty

Government of Ontario

Legislative Building, Queen’s Park

Toronto, Ontario

M7A 1A1

Dear Mr. Premier,

On behalf of Canada’s Venture Capital and Private Equity Association (CVCA), I would like to draw your attention to the critical situation facing Ontario’s venture capital industry.  The current severe economic downturn is further exacerbating an already difficult fund raising and investing environment and risks compromising our collective ability to fund the industries of tomorrow.

Venture capital (VC) firms generally focus on entrepreneurial and fast growing small businesses in the technology arena, including information and communications technology, life sciences and biotechnology, alternative energy and clean tech.  Perhaps the best known Canadian VC success story is Research in Motion, which has fundamentally changed the way we work and communicate while at once creating tens of thousands of jobs and serving as an engine for Canada’s economy.

The CVCA has recently released a study on the economic impacts of venture capital.  This study has been led by the CVCA with the financial support of Ontario, several other provincial governments and the federal government.  This study clearly shows that venture capital in Canada has resulted in the creation of close to 150,000 jobs and an additional 1% to Canada’s GDP.  In addition, according to the Information Technology Association of Canada (ITAC), 700,000 Canadians work in the broader information technology and communications technology sectors.

This record reflects the specialized business-building skills that Canada’s venture capital firms bring to their portfolio companies.  It is also a measure of our long-term focus, astute risk management and strong sense of corporate responsibility and accountability to stakeholders.

While the venture capital industry has been a key driver of Ontario’s prosperity, our members are currently facing significant challenges that we believe require government action.  At a time when our economy urgently needs new success stories like RIM, ATI, Open Text, Cognos and Corel, we believe that it is vital for the government to address the: 

● Current lack of funding available to bridge the gap between research and development and the commercialization of promising technologies;

● Existing obstacles to foreign investment

Each of these challenges is presented below along with a proposed approach to form the basis for a more detailed discussion.

Access to Funding

Given the current economic environment, fundraising in our sector reached new lows in 2008.  The ability of funds to raise new capital impacts their capacity as financial intermediaries to make investments into promising companies.  Because of the increasing difficulties in fundraising, between 2003 and 2008, venture capital investment in Ontario dropped to $99 million in Q 4, 2008, down precipitously from $177 million in Q 3, 2008 and from $217 million in Q 4, 2007.

The lack of capital available to venture capital investors reflects the broader market volatility and the new market realities.  Institutional investors such as pension funds have incurred considerable losses in their public equity portfolios, which in turn has resulted in a corresponding lower allocation to venture capital and private equity.  Additionally, individual investors are increasingly reticent to invest in publicly-traded vehicles such as Labour-Sponsored Venture Capital Corporations, for a variety of reasons, including the gradual withdrawal of tax incentives for investing in the asset class.

Simply, the lack of capital is putting Ontario’s innovation at risk.  Without funding, there is an increasing and very real risk that Ontario will not be able to fully capitalize on and benefit from its multi-billion dollar investment in research and development.

We note that the federal government has already taken significant steps towards improving SMEs’ access to credit.  However, the fastest-growing, most export intensive Canadian SMEs are disproportionately backed by equity infusions from venture capital funds.  The current economic environment is depriving venture capital funds of their ability to raise capital, thereby robbing our most promising SMEs of the opportunity to grow.

A practical commercialization support program will ensure that more of Ontario’s enterprising companies are able to realize their full potential, which will help to strengthen Ontario’s competitiveness in the global, knowledge-based economy of the 21^st century.  The CVCA recommends the following initiatives: 

• Setting up a federal $300-million, third-party managed fund of funds similar to the fund recently-established by Ontario to help fuel the growth of vibrant, leading-edge companies;
• Doubling the size of the Ontario venture fund through a direct injection of $200 million in government funding;
• Improving the federal Scientific Research and Experimental Development program (SR&ED) so that for every $1 of approved claims,$1.50 is returned to the company, thereby stimulating its growth and development; Ontario’s support on this score would be welcome;
• Enabling greater use of government procurement/offsets to encourage domestic as well as foreign multinational investment in domestic venture capital funds; and
• Creating an incentive for large Ontario corporations to invest in domestic VC funds, where an investment in a VC fund would receive the same tax treatment that is currently available for in-house research and development.

 These measures would benefit Ontario’s technology firms as well as its venture capital funds in both the short and medium term and would improve our collective ability to achieve the longer-term innovation and productivity goals that are necessary to maintain the province’s competitiveness in the global economy.

Removing Remaining Obstacles to Foreign Investment

Foreign venture capital investment has historically been an important contributor to the success of emerging Canadian companies.   However, at the end of the fourth quarter of 2008, foreign venture capital investment in Canada fell 56% in 2008 relative to 2007, the lowest level in five years.  Moreover, this trend appears to be accelerating.

We encourage the government to examine ways to improve Ontario’s and Canada’s investment appeal.  The CVCA shares the analysis of the situation put forth by the recently-released federal Advisory Panel on Canada’s System of International Taxation, namely that the current Section 116 process “may negatively affect Canada’s ability to access foreign capital, particularly by private companies.” (p.91). The Advisory Panel’s Recommendation 7.4 that deals with this matter is, regrettably, insufficient to deal with the problems encountered by our members and by the foreign investors with whom they deal.

Canada currently defines taxable Canadian property to include shares of a private corporation resident in Canada.  At the same time, Canada’s tax treaties cede taxing jurisdiction to the country where the non-resident vendor is resident, provided the shares do not derive their value principally from real property.  Based on the large number of tax treaties Canada has concluded, it appears that Canada is prepared to exempt from taxation all gains realized by non-residents, other than the gains from the disposition of real property.

In light of this treaty policy, we believe that Canada should adopt a broader exemption in its domestic law to exempt gains realized by non-residents other than those arising from the disposition of real property.

We see little benefit in providing the exemption only on a bilateral basis.  The benefit of a broader exemption is that it would make Canada a more attractive destination for equity investments by non-residents and, in particular, venture capital and private equity funds.  A broader exemption would also reduce a significant compliance burden that acts as an impediment to foreign direct investment in Canada.  Unfortunately, recently enacted changes regarding the Section 116 clearance certificate process did not address the issue and are unlikely to reduce the number of situations involving arm’s length transactions in which clearance certificates are obtained.  We recommend amending the definition of taxable Canadian property so as not to include the shares of a private corporation resident in Canada other than when such shares derive their value principally from real property in Canada.

This proposed solution would put an end to the onerous Section 116 compliance requirements (except for real property), should not result in any significant tax revenue loss and would mirror the practices of most leading international jurisdictions.

We would strongly urge Ontario to continue to press the federal government to remove the Section 116 obstacles to foreign investment.

Encouraging Angel Investing

Although it is not within the CVCA’s mandate, we recognize the important role that Angel Investors play in our ecosystem.  Although the CVCA has not taken a formal position on the topic, I will note that one half of U.S. State governments have adopted some sort of “Angel Tax Credit” to stimulate the creation of start-ups.

In closing, the strength of our venture capital industry has a direct impact on Canada’s economic health as well as the financial well-being of millions of Ontarians.  At the CVCA, we take this responsibility very seriously. 

We would welcome the opportunity to meet with you to further discuss the opportunities and challenges that are outlined in this letter. I can be reached at 416-607-5150 while the CVCA’s Executive Director, Richard Rémillard, can be contacted at 613-744-8969.

Yours sincerely,

Gregory Smith

President

CVCA

http://www.cvca.ca

cc. Dwight Duncan

      Minister of Finance

     John Wilkinson

     Minister of Research and Innovation

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Original post on 20 February, 2009

http://venturelaw.blogspot.com/2009/02/bridgewater-systems-challenges-of.html

By Suzanne Dingwall 

I’ve been fascinated by the recent press surrounding Ottawa-based Bridgewater Systems, whose current circumstances illustrate well the challenges of a public start-up. 

Bridgewater is one of the last Ottawa telecom start-ups to attract significant venture capital, from Vengrowth, EagleOne/Newbury, Terry Matthews’ Wesley Clover and even from strategic investor Alcatel-Lucent, among others. The company had been publicly contemplating an IPO since the early 2000s, before finally biting the bullet in 2007, driven in part by the desire of some of its VCs to generate some cash from their investment. 

Here’s where things get interesting. Despite becoming a public company, Bridgewater’s board post-IPO looks more like a private board – comprised of VC nominees, management and in one case a strategic consultant to the business. Great set of board members, but their strengths all appear to lie on the operational side. Which perhaps explains why the Company appears to have left itself without any defensive mechanisms to stave off the overtures of hedge funds such as Crescendo Partners.

Why is being a target an issue? It’s not, if you think your company’s stock is trading at a reasonable value. But whose is at the moment? Even in the best of cases, boards today who have received attractive offers from hedge funds find themselves unable to make a recommendation to their shareholders, due to the reluctance of advisors to give fairness opinions in support of that recommendation. 

Public company boards often have in place tools that allow them to slow down or discourage proxy fights to ensure that the best price is obtained in these kinds of circumstances. At our firm, we try to ensure that our public clients understand the kinds of shareholder defenses that can be put in place from day one following an IPO – from the simplest (staggered board terms, which make it hard to replace the entire board in a proxy fight) to a shareholder rights plan and beyond.

As more and more start-ups making the transition to the public markets to accommodate the liquidity needs of their VCs, shareholder defenses are becoming a start-up issue, too. Public company boards differ from those of private ones in that they must split their focus between (a) oversight of operations and (b) awareness of stock market dynamics and how they might affect shareholder value. It’s important to expand the skill set of any company as it transitions from private to public to include someone who understands proxy fights and market dynamics. 

The irony here is that companies like Bridgewater, who spent their formative years working towards an exit for their first backers, may well find themselves on the liquidity merry-go-round once more. Hedge Funds generally seek the same return on investment within the same time frame as VCs. Stay tuned.

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