There was a flurry of debate and discussion recently as the various venture capital funds in Ontario and across the country went to the government to request for changes to be made to their particular model of "private venture capital" that would make it easier for them to raise sufficient capital to maintain Canada's competitiveness. I don’t begrudge these funds their sense of greatness, as an alumnus of one of the greatest of these funds, I have been accused once or twice of carrying such a sense of greatness myself! I have worked with and know many of the venture capitalists in this country and I can honestly say that most of them are talented and knowledgeable investors and in many of the ways that count, they truly are “great”. The private equity retail venture capital model as it currently exists needs to be overhauled however because the market has found an equilibrium in the financing of Canadian growth companies – and that equilibrium is via the public rather than the private equity markets. As a result, providing tax grants or subsidies to a select group of funds that would assist them in the diversion of capital and investors from the public venture model to the private equity model goes against the grain while having no public policy benefit.
Over the last twenty years the venture capital model in Canada has shifted dramatically from the private equity model that is more common in the US and Europe to a public markets model in which the financing of venture stage companies takes place in the public markets via institutional and retail investors in a quick, efficient and succesful model. By our estimates over the last five years more than three times the capital (and perhaps as much as ten times if we include venture stage resource and energy compaies into the mix) was invested in publicly listed venture stage companies than by the entire Canadian venture capital industry as a whole. The Ontario, BC and Alberta Securities Commissions have streamlined the process of fund raising by Canadian listed companies to reduce the more onerous trading restrictions that were once common for private placements, particularly for accredited investors, and with recent changes that allow for short form prospectus offerings this has further opened the kitty to all investors and funds (subjec to their risk tolerance). This capital raising process is one of the most efficient and streamlined equity financing models in the world and it applies not only to mature dividend paying companies – but to start-ups and pre-revenue ventures looking for their first round of capital. With the institutionalization of the reverse takeover via capital pool companies (“CPC”) the regime has established a model that can bring angel investors into the fold as well. In short, we have an excellent small business financing regime in Canada that is appealing to both investors and entrepreneurs, that is open to both funds and retail investors, that provides a measure of liquidity and that is more transparent than the private equity fund alternative.
The retail venture capital model as it currently stands flies in the face of these advancements in the public equity markets. It diverts money from the public markets into funds that are limited to focusing on the private equity markets. There is no legitimate public policy reason for this, particularly if there are already eligibility requirements in place as to the size of the target company by assets, number of employees and the use of funds. The lack of liquidity in the private equity markets brings less transperency in terms of valuations and net asset values which is not in the interest of the retail investor while the imposition of onerous unanimous shareholders agreements, board representation requirements and control provisions that are instituted by the funds to protect them from the lack of liquidity are not in the interests of the entrepreneur.
It doesn’t have to be this way, and in fact it wasn’t until the turn of the millenium when for whatever reason the Federal and Ontario governments decided to place restrictions on the retail venture capital industry that discouraged them from investing in publicly listed venture stage companies As an active participant in the public markets and as Head of the Public Markets Group at our fund, I could see that some of the best venture stage companies in the country were heading to the public markets and we were helping them by providing active due diligence in the process using our expertise as venture capitalists and our basic business knowledge. These factors made us the first call for investment bankers looking for a lead order and allowed us to have a say in the structuring and pricing of these transactions before they hit the broader market. In fact, Research in Motion Inc. – the most succesful venture capital backed Company in Canadian history -- was funded through this model, and as the lead investor on that issue we coordinated the transaction with investment bankers, the institutional public equity funds and the company directly. We took a company that at the time had less than $10MM in revenue and losses of over $8MM and we put together a $35MM financing via a “special warrant” financing that led to the initial public offering of the company less than one year later. This was in 1995 when $35MM really meant something! We did it with no shareholders agreement or board representation requirements and with a closing of less than four weeks from start-to-finish! With the restrictions that were subsequently placed on the public market activity of the retail venture funds, this transaction would not have qualified and certainly not on the terms and conditions that were agreed to by us at the time. It is in the truest sense ironic that the greatest success of the retail venture capital system would not be have taken place under the current regime. This is not in the best interest of any of the stakeholders in our economy.
The chasm that has developed between the notion of a purely private equity venture capital model in Canada and the reality of the public company nature of the venture capital industry as it actually exists needs to be addressed. As a matter of public policy, the various governments across the country need to remove restrictions on the eligibility of companies that have chosen to move to the public markets simply because there’s no need for these restrictions. I would further suggest that the governments should open up any tax credits or subsidies and make them more broadly available to pooled funds across all industries while eliminating industry specific tax credits (for example the flow through tax credits for energy and mining stocks or research tax credits for technology stocks) which serve to divert cash to to favoured groups rather than those that are the most competitive. In exchange a lower capital gains rate for venture stage companies would create incentives for investors looking to take on additional risk in their portfolios.
Unfortunately, there is typically a level of mistrust and misunderstanding between public equity and public market participants that leads them to believe that their interests are not aligned. This is not true, these groups should work more closely together using their specific strengths to the benefit of the other. The first step to this ooutcome should be the realization that “public vs private” should not be a government mandated investment criterion.
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