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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As a lawyer for entrepreneurs, I am often frustrated by my clients’ reluctance to seek local venture capital. There is a persistent view that Canadian venture capital is somehow second best to American or other foreign funds. This may or may not be true. (My own view is that having a rock star U.S. VC backing you won’t make a good business great; it may, however, help you fail more slowly.) What is clear is that there remains a growing divide between entrepreneurs and venture investors which needs to be addressed.

While this may seem to be about you, this post in fact is all about me. The continued health of my business depends on an expanding, sustainable base of good, well-fed entrepreneurs. I don’t believe this is achievable unless there is an alignment of startups and venture capital into one community. While there are many aspects to this issue, at its heart, it’s a question of marketing.

Is there any other industry that has so sharply felt the impact of negative publicity as has venture capital? Take a look south of the border: one day, everyone’s trading tips on the best place in Carmel to park your MIG. Then Blackstone files a prospectus disclosing private equity executive compensation and CEO Stephen Schwarzmann holds a few multi-million dollar parties. Next thing you know, Congress is overhauling its taxation of carried interests for everyone. Venture Capital may be the worst marketed industry out there.

Canadian private equity has been tarred with the same Blackstone feather in the public eyes, if only because it has not provided an alternate mission statement to the public at large and entrepreneurs in particular. I tip my hat to those labour-sponsored funds, who, in their heyday, tried to make the connection between job creation and local investing. Very few would argue, however, that the public right now sees much difference between venture capital and vulture capital.

If Canadian innovation is to scale, there needs to be a call to action for all participants in the ecosystem. This is a marketing exercise that needs to be led by you, the VCs. When was the last time you went to a bootcamp? Provided sponsorship dollars to entrepreneur-generated initiatives? Extended your channels in the US to provide a broader network for your portfolio? Many of these events are not immediately accretive to you, but they are vital to community creation. Let me re-phrase that; there has never been a more vital startup community, but it is one being fostered largely without VC involvement. This must not continue. The need to take a long-term approach to deal flow has never been greater.

Of course, it always helps to have a deep-seeded conviction that local partnering between VCs and startups matters. For me, this is the biggest missing piece: a mission statement that everyone can embrace. It’s also the easiest to solve. Think of the consequences of leakage (one of the most polarizing terms in the international development community). Every dollar of investment that comes from outside Canada ultimately leaks profit and wealth creation outside of Canada. There cannot be sustainable growth if the benefit of local innovation is reaped beyond our boundaries by private equity tourists. Every entrepreneur should feel a moral (if not economic) imperative to include Canadian VCs as part of its growth plans, and to serve as ambassadors for you abroad, directing deal flow from beyond your way (leak unto others as they leak unto you).

It’s time for you to make them believers.

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