What is the role of public policy for funding entrepreneurs?

I’m at the annual Quebec City Conference where I’m attending the Public Policy Forum on Venture Capital and Innovation. I understand that last year’s conference concerned itself with what to do about the turmoil experienced throughout the financial sector. A year later, “the returns [of venture capital] are disappointing even against reasonable benchmarks” as understatedly observed by Prof. Thomas Hellmann of the University of British Columbia who is one of the conference organizers and speakers.

Against this backdrop where the venture capital industry appears to be shrinking, the spotlight was shone on the critical role of angel investors as important financiers of new businesses. A recent BC Angel Study confirms previous data that show angel investors bring not only capital to companies but also credibility, contacts and networks as well as their deep understanding of specific market segments gleaned from their own entrepreneurial experiences.

Angel investing is here to stay. Businesses have always benefited from personal monies. Most businesses become going concerns just from the investments they get from their own circle of friends and families - and only from the angel investors when that extra funding boost is required to lift the business to the next level.

The prominence of angel investors and venture capital (VC) firms is a fairly recent phenomenon as the role of technology became more central to the entrepreneurs' business models. After all, funding drug development from a university spin-out or developing an enterprise software business was obviously beyond the investing capabilities of most entrepreneurs' networks of friends and family.

No matter what the state of the economy, it is unlikely that angel investors - or any investor type - will disappear from the financing ecosystem entirely. Friends and family - and the occasional angel investor - will continue to be the first sources of funding for the entrepreneur. As technologies become less expensive and less central to the success of the underlying business models, there is less need for the entrepreneur to tap into larger investment sources such as offered by the VC firms. We're already witnessing this in social media applications. However, we will always have a need for the deep pockets of angel investors - and even deeper pockets of VC firms - for businesses that require such investments to grow and succeed.

The deliberations at the QCC are focusing on what role public policy should play to ameliorate the venture capital industry. I believe the role of governments should be minimal as to allow the market forces determine the financing models that will best serve the investment needs of early stage companies.

To be or not to be … a public company

“Should I take my company public?” is a question I often encounter. More dreadfully: “We’re vending our (early stage) company into a public vehicle” (shudder!).

Many entrepreneurs are cognizant of the desire for exits or some other liquidity event amongst angels and other early stage investors. These entrepreneurs feel that being a public company serves the purpose of liquidity (for the investors) and raising big sums of capital (for the entrepreneur). For early stage companies, going public may or may not be a good idea for the entrepreneurs or for the investors.

When does it make sense to be a public company?

• Strategic quality – The company has a clear strategic vision and the business plan to execute on that vision to make money. It has a demonstrable competitive advantage; and can sustain this competitive advantage into the future. The core business is capable of sustaining growth and shareholder value in the future. Its capital needs to meet its growth plans can best be satisfied by the public markets.

• Operational quality – The company should enjoy growing demand for its products. It should demonstrate the ability to keep growing its market share. Its infrastructure and operational processes should be aligned with its strategic direction.

• Reporting quality – The company must be able to predict and forecast based on good business planning. It must be credible in its message to financial audiences to ensure trading activity that warrants its corporate performance.

• Receptive public markets – Are the markets ready for your company to go public?

Too often, entrepreneurs only consider the receptiveness of the public markets without paying enough attention to the strategic, operational and reporting qualities of their company. Without these qualities to sustain its share price, the newly public company quickly languishes on the markets and has great difficulties in raising additional capital.

I can count the number of happy endings to early stage companies who went public before achieving any significant milestones on a single hand – and considering the number of early stage companies that have gone public since the late 1980’s when I started keeping track … well, you can do the math.

Believe it or not, the angel investors I hang out with are in this business of angel investing because they really, really (!) want to help the entrepreneur’s business to succeed. The thrill of helping to build and grow truly great companies may actually supersede their other investment priorities. Going public makes sense only if the benefits to the entrepreneurs and the investors are sustainable.

The Pitch IS the Packaging

It isn't fair but we all judge books by their covers. No matter who we are, what we do or what side of the bed we happened to awake from, we form our impressions within the first few seconds - and then spend the rest of the time either validating or refuting our initial impressions. Anecdotal evidence abounds about how investors - including the VANTEC angels - use their first impressions to decide whether they will listen to the rest of the entrepreneur's pitch, pursue the due diligence process, and then ultimately invest their funds in the entrepreneur's venture.

The Elevator Pitch is merely the packaging to the juicy contents inside; and it's also the first (and sometimes only) chance that an entrepreneur can interest a potential investor. It's not right but it's true that often the investors never go beyond this "packaging" if the first impressions don't entice them to pursue the venture further. Since we're not about to change human nature any time soon, let's just accept this as part of the fund raising terrain. So here's a quick guide to how entrepreneurs can pass through the "inner gatekeepers" in the investors' minds:

1. Why are you here? “We are here because ... [looking for CEO, looking for marketing planning help, looking for advisors, etc.]

2. Who are you? “We are [COMPANY NAME]. We make/provide/sell [COMPANY PRODUCTS/SERVICES] for [TARGET CUSTOMER] who need [SOLUTION] to solve [PROBLEM].”

These points should take no more than 20 seconds. One or the other (or sometimes both) is often enough to pique an investor's interest. If the entrepreneur is successful in eliciting a "tell me more" response, then continue with:

3. What is the market opportunity? Describe the problem that you are solving with your company products/services including size, why it hasn’t been solved yet, etc.

Pause for another "tell me more", then:

4. Why do you think you will win? “Unlike [COMPETITION], we [GIVE UNIQUE VALUE PROPOSITION].” Also, identify some management expertise you have or can access to deliver on your business model, identify your intellectual property strategy and other barriers to entry, etc.

Pause. Still interested? Then:

5. What do you want from us? Identify what your company needs in terms of “talent” (e.g. prototype development, marketing, finance, etc.) to get to the next level.

Pause. Did the above 2 to 3 minute exchange elicit even further interest? Congratulations on making a positive first impression. The entrepreneur's next meetings with the potential investors will go over the exact same 5 points - but in much further depth and details.

Good luck - may your audience be attracted enough by your "packaging" to delve into the content.

Future of angel investment

Last week the VANTEC angel investors relaxed over wine and hors d’oeuvres at the annual year-end Appreciation Reception at the Jericho Tennis Club for the sponsors and volunteers. We had seen presentations from 67 companies – prescreened from over three times that number – over a period of 11 months at the VANTEC meetings. If earlier reported investment patterns persist, then almost half of these companies will get funding through the VANTEC network; and some of these companies will eventually secure next-stage growth capital from venture capital firms.

All present agreed that the fund raising environment for entrepreneurs is very tough. While it’s generally acknowledged that the angel investment community in the province of British Columbia certainly stepped in to provide much needed capital for startups, the sources of capital are harder to come by – particularly for the beleaguered venture capital firms who have had a rough go of fund raising recently. Many wondered whether the local angel community can continue their level of capital infusion to the local startups. A lively discussion ensued about the future of investments amongst our local angels (in no particular order):

• NO EXITS! Lack of exits by current portfolio companies hamper the efforts of angel investors to “re-circulate” their investment winnings.

• No liquidity – Related to exits, this speaks more to the ability of the portfolio companies to pay back their earlier investors. One angel investor lamented that some of his investments are in their second decade and he has no way of liquidating his initial investments.

• Shrinking personal portfolios – Angel investors invest their personal monies in startups; unlike venture capital firms or other sources of institutional funding. This problem of smaller investment portfolios was particularly acute just after the economic meltdown in late 2008.

• Next generation of angel investors? Many of the VANTEC angels have been investing/mentoring local startups for a couple of decades.

What do you think? Please let me know your opinions about the future of angel investment in BC - and in general.

Basic Business Principles Knows No Boundaries

I've just returned from my semi-annual visit to California where I stayed with some close friends who reside in Orange County. The wife is a retired teacher so she and I can chat for a (very) long time about special education and learning disabilities (which is a deep-rooted interest of mine). The husband is a real estate developer (in which I have a side-line interest); and although he and I operate in different business spheres (he has no interest whatsoever in my "techie world"), I am always struck by how basic business practices and principles are ... well, "basic"!

Consider how he is starting up his latest new real estate venture: Purchasing distressed properties to renovate and then re-sell at below market prices. As he described his venture, I thought of my checklist for entrepreneurs:

(1) What is the problem? i.e. What is the market opportunity? Recent rough economic times have forced banks to foreclose on real estate properties; leaving them with large inventories of real estate that they have no desire to keep or manage. Despite the overall improving US economy, there are pockets of residential markets (my friend's specialty) where there is opportunity to buy, renovate and re-sell single family homes ... for the "right" financial terms.

(2) What is the solution? i.e. What is the value proposition? My friend has put together an attractive financing package to purchase single family homes from willing banks who hold the mortgages on these properties.

(3) Why do you think you would succeed? i.e. What is your competitive advantage? Recall I mentioned residential housing markets - particularly single family homes - are my friend's specialty? He's been in the real estate development business for over 35 years where he's experienced several up and down cycles in real estate markets all over North America. He's done this before with different real estate products and accompanying financing packages. He's well networked in both the buy-side and sell-side in his industry - and works with a few trusted partners to identify pockets where there is opportunity.

(4) How do you plan to succeed? i.e. What is your business model and how are you going to execute it? He's listened to the needs of the sell-side (in this case, the banks holding the mortgages) and developed a financing package accordingly. He's identified a real estate market where he's already has other real estate development projects; so he can be there "on the ground" (so to speak) to monitor his latest venture. He's using his own funds (no partners yet) to make a small investment in a few single family homes to "test" his venture. If this "prototype" works, then (and only then) will he ask his trusted partners to help him iterate the process. If it has potential for scale, then watch out for a mass marketing campaign for a real estate venture coming soon to your neighbourhood!

Investing in the life sciences ... PATIENCE!

Recent conversations with companies and angel investors operating in the life sciences bring to mind ... PATIENCE! Each month I have the fun and privilege of working with entrepreneurs as they prepare their pitches to the local VANTEC angels. It is truly a lesson in patience for both sides - but it is particularly poignant for the angel investors and the entrepreneurs trying to grow (no pun intended!) life sciences businesses. Not only must life science entrepreneurs ensure their technology works as expected and that their business model will yield rewards for their customers and investors, life sciences companies must operate in strict regulatory environments. If all unfolds in the universe as we hope, the rewards to the patient entrepreneurs and investors can be great - as evidenced by local life sciences companies like QLT, Angiotech and Aspreva.

Here's an excerpt of an interview I did with Venture Hype a few weeks ago about backing companies in the life sciences. The complete interview can be found here.

VH: What are the unique characteristics of life sciences companies? For example, how are they different from technology ventures? What advice would you give to investors interested in backing life sciences companies?

TL: Life sciences encompasses many different types of products and services in the bio/health sectors – such as biopharmaceuticals, medical devices, bioinformatics, health IT – and bioenergy and other bioproducts in the environment, agriculture, marine and other resource sectors.

These companies operate in heavily regulated environments; and hence, investors in life science companies face longer timelines to exit than investors in not so regulated sectors such as social media and Internet companies.

The metrics for success are also different for life sciences. There’s a strong emphasis on proof-of-concept, which highlights the significance of the science behind the products and services.

The success of the life science company is tied to the achievement of the next regulatory hurdle, which is akin to receiving customer orders in businesses that don’t face the same types of regulatory controls.

Exit opportunities for investors in life science companies often occur when these companies reach a tolerable investment risk and valuation commensurate with their regulatory achievements – and often before revenues are generated.

My advice to investors interested in backing life science companies is to be

• confident in the management team’s ability to execute,
• very comfortable with the science underlying the business, and
• very, very patient for the exit opportunity to occur.

Entrepreneurs can achieve Olympian glory

The Great Olympic Party officially ended last night; capping 2 weeks that started with nervous anticipation and ended with a record Gold Medal haul for Canada. More importantly, it was our athletes who inspired all of us to believe it is possible to achieve greatness through the power of a dream.

In tandem with the Olympic festivities was the dosage of inspiration from entrepreneurs pursuing their dreams at the monthly VANTEC meetings of angel investors. Yes - I fully admit that I am under the Olympic spell. Nevertheless, here is my take on how entrepreneurs can achieve their Olympic moment to build a successful company:

1. Decide - and then go for broke. It seems so obvious but how many would-be entrepreneurs think up great ideas but never follow through? Or give up at the first sign of adversity? I'm thinking of Bronze medal winner Joannie Rochette - but can you imagine (insert your favorite athlete here) saying, "No, I'm not going to compete in this sport I love"?

2. Gather your forces - it's a team effort. Clearly Team Canada's Gold medal win was the result of many different players coming together and doing well as a team. However, one mustn't forget the "players" (coaches, trainers, etc.) behind the team that made the dream possible; nor the many people working with the athletes who compete in individual sports. Likewise, a successful entrepreneur does not go it alone; but recruits and retains people who have the skills and talents to realize the entrepreneur's dream - and who also believe in the dream.

3. Prepare. It's self-evident that athletes do this before they perform. The entrepreneur's equivalent is to understand the market first and foremost. What is the problem faced in the marketplace? Can you identify and fully understand the real customer pain? Why hasn't anyone else (aka the competition) solved this problem? Why do YOU think you can solve this customer pain? What steps (building market channel relationships, hiring talent, getting investments, etc.) are you taking to ensure the success of your company?

4. Train. Another self-evident part of the athlete's pre-performance regimen. The entrepreneur's equivalent is prototyping or continual iterations of the solution to the customer's pain. Just like how the athlete relies on the advice and support of trainers, physiotherapists, dietitians, coaches, etc. to help him/her to do better in practice sessions, the entrepreneur must also rely on others (e.g. beta customers, marketing, engineers/scientists, investors, advisers, etc.) to test out solutions to see if the identified customer pain can be solved.

5. Perform. All the preparation and training comes down to this event for the athlete. For the entrepreneur, it's often the first customer sale; a major milestone for the company. Like the athlete, can this company perform (e.g. make sales) repeatedly? Is there a management team in place that can execute on the business plan - and who can react effectively to market changes - time and time again? Is the company structured operationally and financially for the long-term?

6. Achieve the goal. For 6-time Olympic medalist Clara Hughes, her exit strategy was to perform her final sport on home ice in Vancouver. She did just that and she exited in style with a Bronze medal in the 5,000-metre race. Entrepreneurs - what is your exit strategy? How and when do you want to exit? What are you doing about executing on your exit strategy? I'm a huge believer in aligning the interests of the entrepreneur founders and the investors to give the best possible outcome for the company. Whether that means an early exit or hanging in a bit longer because you're convinced a home run is within grasp, you will get support for your exit strategy so long as the interests of all the stakeholders (see my point #2) are aligned.

Go forth ... and achieve!