Look at the Bright Side, R&D Downturn,
New Tax Credit Proposal, A "Junior Junior" Exchange?, Capital Pool
Corps Update, and Local Events
Look at the Bright Side
A recent Financial Post column on stock winners
and losers over the past year identified three technology companies from B.C. as
the biggest losers stock-price-wise. These included Sierra Wireless (TSX:SW)
down 96%, Burntsand Inc. (TSX:BRT) down 94.6% and Pivotal Corp (TSX:PVTL)
down 92.8% and covered the period from Sept, 2000 to July 2002. The biggest
loser was Nortel (TSX:NT) which lost 98.7% of its value!
When I look at my own portfolio, now so small I
can hardly see it, I realize that I'm one of the many people whose retirement
nest egg has been blown away.
As I looked at those 90% plus losses (I have a
some stock in all of these companies), I was wondering just how much worse
things can get. The answer is obvious: not much. Even if these companies all
fold, which I consider highly unlikely, I can't lose more than 100% of what I
risked in the first instance. Going back to basic principles, the whole reason
why I invested (i.e. speculate) in these technology (i.e. high risk) companies
was to take a chance on seeing a multiple return - not 20% or 30% - but perhaps
10X or 100X my investment.
The technology sector has been hit very hard.
Investors in this sector all have a little egg on their collective face. Just
two years ago, the aggregate value of B.C. tech companies (i.e. the public ones)
was approaching $100 billion. Now, that number is closer to $5 billion.
In 1998, when we created the T-Net index (set
at 1000 on January 1, 1998) to track the performance of the B.C. technology
sector, I was arrogantly predicting that we'll see the index hit 2000 by the
year 2000. It easily passed that goal and soared to 10,000! More recently it's
been hovering in the 1100 to 1400 range.
What's the lesson to be learned from this?
Unlike running your own business where you have a lot more control, you are at
the mercy of the economy, the stock market, and the integrity and ability of the
management in the companies you invest in. Furthermore, high technology
companies are inherently risky because of possible technology obsolescence,
market adoption and rapid growth. No matter how solid a prospect looks, it's a
gamble. And when you're gambling you can get wiped out if you have all your
capital at risk. So the lesson I've learned from this is that "money
management" is critical. By that I mean how much of one's "financial
pie" should be exposed at any given time?
As an example, suppose you had $1 million in
tech stocks (easy if you started with $100K in 1998 or earlier), you would have
- if you practiced prudent money management - converted some equity and held
about $200K in cash. Today, you could take half that cash (still being prudent)
and buy into some of the many "bargains" that are out there. Result:
your $1 million (reduced to $800K pre-tumble) would now be worth only around
$40K. Add that to your new $100K. A "modest" tech multiple of 10X will
get you up to $1.5 million (including your $100K cash reserve). I'm certain
this will happen. It's only a question of "when".
Regardless of the numbers and how crazy you
think a 10X or 100X return may be, the key point here is that by always holding
back some cash you can buy-in when others are forced into selling out (which I'm
sure has happened to many people lately).
These net worth declines remind me of one of
the "standards" applied by securities regulators to determine if an
investor is "sophisticated" or not - i.e. the $1 million test. If you
are an angel investor who had a portfolio of $1 million plus which is now under
$100K, are you still considered "sophisticated" enough to be able to
make an early-stage investment in a startup?
Although the shine is certainly off the tech
sector for the time being, I firmly believe it will rebound and when it does,
good old fear and greed will once again propel stock prices. Why? Because in
terms of investment options, there may be safer, lower-return, non-tech stocks
people can invest in, but it's in high tech that you can enjoy multiples and
it's the lure of that huge win that will get investors back in the game. But,
when it happens, remember to hold a little cash in reserve!
R&D Downturn
In July, Statistics Canada reported
that, for the first time in thirty years, Canadian companies plan to reduce
R&D spending in 2002 by 6.1% to $11.2 billion. Telecommunications equipment
companies are expected to reduce their R&D expenditures by 23% while
semiconductor firms forecast a decline of 12% this year. And, it could get much
worse, given the uncertainty as to corporate recovery especially in these
sectors.
The CATAAlliance is pushing the Department
of Finance to revise the SR&ED (Scientific Research and
Experimental Development) Tax Credit Program so that it can stimulate industrial
R&D especially when times are tough.
Even as it is, I'm convinced that the SR&ED
program is underutilized and that many companies are leaving money on the table. It
always amazes me at how few people know about it, how it works, and how easy it
is to access it.
Here's a quick reminder of how it works: For
every dollar that companies spend on "eligible R&D", they can
recover up to 68 cents in cash. That's the best case scenario and it applies to
CCPCs - Canadian Controlled Private Companies. Canada Customs and Revenue
Agency (CCRA) offers a refundable tax credit of 35% on R&D
expenditures while the B.C. Government offers an additional 10%. However,
these percentages are applied to a grossed-up amount of expenditure (taking into
account an "overhead proxy" of 65%). Example: $100 spent on R&D
salaries works out to $165, including the overhead allowance. B.C. offers 10%,
i.e. $16.50 while Canada offers 35% of (165.00-16.50=) $51.98 for a total of
$68.48 in tax credits. In the case of a CCPC, the tax credits are refundable
- which means that CCRA will send you a cheque!
There's no competition involved. As long as the
rules are followed, you can claim this very attractive credit. Some $1.5 billion
annually is provided to companies under this program - another under-publicized
reason from locating in Canada (and B.C.). Even individuals (start-up
entrepreneurs take note) can take advantage of this (although the percentage is
less). The Vancouver
Enterprise Forum web site (under "resources") lists many experts
on this program.
However, for non-CCPCs such as public companies
or foreign-controlled entities, the Federal incentive percentage is reduced
(e.g. from 35% to 20%). Furthermore, the tax credit is not, alas, refundable.
In these difficult times, the SR&ED credit
is of little value to unprofitable companies (which most are - note that of the
top 20 B.C. public companies, less than one-quarter are reporting any profits!).
CATAAlliance has recommended that the
government revise the SR&ED rules to let public companies use the tax
credits they earn whether they are profitable or not - during extreme downturns,
like now. As for the percentages, I've never really understood the rationale for
a reduction just because a company has many (rather than a handful) of
shareholders.
I suspect that the original proponents of the
SR&ED program viewed public companies as "big, strong, and
well-funded" and not in need of the extra support. They likely had a myopic
view of public companies as being of the TSE or Nasdaq caliber. They
disregarded, and hence treated unfairly, those companies that opted to go public
early on a junior stock exchange such as the TSX-Venture in order to raise their
equity capital.
It's sacreligious for technology companies to
cut R&D spending in difficult times. It may help prolong their life slightly
but it won't ensure their future competitiveness. That's why an SR&ED policy
update is needed right now.
New
Tax Credit Incentive Program
This
is hot off the press - "The B.C. Ministry of Competition, Science &
Enterprise is developing a new tax credit incentive program to assist small
businesses to raise private sector investment capital.
Small businesses often have difficulty finding the capital they need to
start up and expand. The new
program, if implemented, would provide a 30% tax credit to BC investors to
stimulate investment into early stage BC companies."
"The
tax credit program would be governed by existing legislation called the Small
Business Venture Capital Act. The
Act currently provides tax credits to investors who invest in small businesses
through registered venture capital corporations.
A venture capital corporation (“VCC”) is a holding company that
raises money from investors and makes investments in qualifying small
businesses."
"In
response to demands from program users to reduce red tape and regulatory burden,
the Ministry is considering amendments to remove the holding company
requirement. This change would
allow the province to provide tax credits for direct investments in qualifying
small businesses (i.e. a “direct investment model”).
The direct investment model will be in addition to the current VCC model.
The VCC structure will be retained for fund managers wishing to establish
a holding company to invest in a variety of different small businesses."
This sounds promising. The current requirement to have a holding company only
adds an unnecessary corporate layer. For more information and or to comment,
contact Ms. Hilary Vance via email at hilary.vance@gems5.gov.bc.ca.
A Junior Junior Exchange?
I find it amusing that so many Nasdaq-listed
companies are finding themselves short of meeting the Nasdaq listing
requirements. The most senior companies trade on the so-called Nasdaq National
Market (NM) and are regarded as the jewels of the industry. The next rung of
companies trade on the Nasdaq Small Cap (SC) market - still part of the esteemed
Nasdaq club. Those companies that don't make the grade are relegated to the non-Nasdaq
Over-the-Counter Bulletin Board market (soon to become the BBX junior
market - see my comments in last
month's column).
There now appears to be an avalanche of
companies whose stock price (and hence value) and performance put them offside
with the Nasdaq standards. NM companies are turning into SC-designated entities
while many SC companies are facing a de-listing from the hallowed Nasdaq halls.
What's so amusing is that the Toronto Stock
Exchange (TSX) is thinking about launching a 'junior junior' exchange. This
will provide a home for those companies that no longer meet the listing
criteria for the TSX-Venture Exchange. Many of these companies got onto the TSX-V
with so-called "Tier-3" status. This was done to accommodate those
companies that moved over from the "unlisted" or Canadian OTC market,
previously referred to as the CDN. There are only about 230 such listings.
Interestingly, as an aside, a recent tax expert
noted that these companies were, according to CCRA, not considered to be
public companies because they do not trade on a recognized exchange (i.e.
CCRA regards them as large private companies, e.g. CCPCs) and hence investors in
such companies could benefit tax-wise from this status. For example, the $500K
life-time capital gains exemption for CCPC investments would apply - a real nice
deal! Similarly, the SR&ED program benefits referred to above would be
greater for such firms. Putting these companies on a "recognized"
exchange, however junior it may be, might remove that benefit.
[Note that pubco definitions vary depending on
who you speak to. Securities regulators and the Tax Department have inconsistent
definitions as to what constitutes a "public" company.]
An argument given by the TSX in favor of a new
exchange is that the current TSX-V will appear more credible with the riff-raff
gone.
Another possible explanation for the proposal
is that it might thwart the efforts of the new Canadian Trading and Quotation
System Inc. (www.cnq.ca),
an electronic market for some 1,000 "list-less" reporting issuers in
Canada.
Apparently, the TSX has also reportedly shown
an interest in purchasing the Cincinnati Exchange, an electronic trading system
based in Chicago. (I've been advocating a U.S. move by the TSX-V for many
years!).
Are we heading in the right direction? David
Raffa, writing in Business in Vancouver recently, hit the nail on the
head. He suggests that the TSX's time would be better spent in figuring out how
to make the TSX-V work more effectively for tech companies in raising equity
capital. Catering to the tech sector and promoting itself more - building on its
success instead of worrying about the black sheep is what's needed.
I agree that focusing on the opportunities in
the tech sector would be more productive than fussing around with an even more
junior market. Let's make the one that we've got work.
The proposed exchange has no name yet although
I expect it will be unique in that the TSX likely doesn't want to be seen as
playing in an arena of flaky companies that operate under minimal parental
guidance. Suggestion: let's call it the corporate leper colony. Nobody will want
to touch them!
Securities Regulators may have some
reservations about giving this proposal a green light in view of the U.S.
accounting scandals that have investors heading for the hills.
Tier 3 is the bottom rung of TSX Venture
Exchange listings. Most of the current Tier 3 TSX-V companies have a ticker
symbol that starts with the letter "Y". Wouldn't something like this
achieve the same purpose? That is, attach a highly visible label of some sort to
companies that are off-side. It eliminates the listing and de-listing to and fro
that could occur.
Such a categorization could also make it easier
for companies to go public earlier (yes, I know that's a contentious topic but
if that's what it takes to get capital, it should be an option to companies) and
then migrate to the higher ranks by removing the "Y" rather than going
through a more complicated process.
I
had to chuckle at a recent article in Red Herring about
a Vancouver-based software company, Imagis Corp (TSXV:NAB). It
refers to the TSX-V as the Vancouver “penny stock market—and the characters
who lurk there.” It goes on to say that “this isn't a market in which value,
like cream, rises to the top. It's a world where prices tend to go up because
someone is helping them up.”
Let’s
focus on making the current TSX-V really hum. A lot of work needs to be done in
the public education area. Rather than fighting the futile battle of trying to
operate a “clean” market, let’s be more pragmatic. There are always going
to be scams and cheats. As we’ve now seen, by several recent examples, the
junior markets aren’t the only places where you’ll find mis-dealings.
What’s been happening in the major U.S. markets makes the “characters” on
Vancouver look like kids caught dipping into the candy jar.
Capital Pool Corporation (CPC) Comments and
Update
In this column, I keep track of Capital
Pool Corporation ("CPC") companies as defined by the TSX Venture
Exchange (the former CDNX) because they may provide funding and management to,
and in the process acquire, technology companies. They provide companies with an
alternative to traditional venture capital financing. It lets the public
investor get into the game.
Check our Capital
Pool Corporation chart (in .pdf format) for a complete list of the CDNX's
CPC and VCP companies, thanks to David Ing of Pacific International
Securities. This list is updated on a regular, e.g. monthly basis. It is now
current to the end of July, 2002. (previous update was June, 2002).
There's only one new addition to the list since
the previous update last month. It is Sigma Ventures Inc., which is from
Quebec (even though it's contact phone number is from Alberta).
In the past month, the following CPC companies
have come to trade: Desco Exploration Ltd., Ergo Ventures Inc. and
Nutramed Capital Corp.
The following companies have been removed from
the list because they have completed their Qualifying Transactions and are no
longer considered to be CPC companies: E-amigos.com Inc., EREZ Inc., Silicon
Acquisition Inc., Sydenham Capital Inc. and Trioptimum Capital Corp.
An introductory
article explaining CPCs may be found at http://www.bctechnology.com
Local Events
Today, Allan Rock, Minister of Industry,
Herb Dhaliwal, Minister of Natural Resources Canada, and Stephen Owen,
Secretary of State (Western Economic Diversification)(Indian Affairs and
Northern Development) were on hand to open NewMIC's state-of-the-art Human
Computer Interaction (HCI) Lab. This facility, made possible through funding
from Western Economic Diversification Canada (WD), is the only one of its
kind in Western Canada. Funding was also announced for New Media BC,
which will is now collocated with NewMIC in downtown Vancouver.
Summertime is not usually a busy time for
networking and tech events. The BC TIA will hold its third annual BC
TIA Fall Golf Classic to be held on September 10, 2002. This is turning into
a key charity event for BC’s technology community.
Organized by the Technology Committee for
Children’s Hospital (TECCH) and the BC TIA, this year’s event has
already secured sponsorship from Telus, Nortel Networks, Cisco
and Digital Pioneer. The net proceeds will go towards much-needed
equipment, research and programs at BC’s Children’s Hospital. More info on
this can be found at www.tecch.com.
Another very worthwhile golf-fundraiser to
support Alzheimer's research takes place on August 16th at Pitt Meadows
Golf and Country Club. This is organized by the Aasen family (Greg Aasen
is a founder of PMC-Sierra). Check www.acegolfpro.com
for more information on how you can participate in this event.
A complete calendar of technology events can be
found on T-Net's
Events page.
Footnotes
If you're an entrepreneur looking for a place
to get your company started; there's some great space available at Harbour
Centre downtown. The New Media Innovation Centre (NewMIC) and SFU's
TIME Centre have teemed up to provide not only office space but also access
to various resources, e.g. tech advisors, access to capital, mentors, etc.
Worried about the high cost of being downtown? Well, not to worry - they'll even
reduce the fees and take some payment in the form of equity. Check www.sfu.ca/time
for contact info.
A reminder: SFU's TIME Centre is open for
business - business folks, that is. TIME is an acronym for Technology,
Innovation, Management, and Entrepreneurship. TIME supports the growth and
development of the tech industry in B.C. TIME features a "Business Centre"
(looks like an airport business lounge) which is open to technology
entrepreneurs and business people to use as a drop-in downtown office facility.
Need to plug-in? Make some calls? Do some work? Hold a meeting? There are some
great facilities for holding your company's AGM. Why hang out at MacDonald's
when you can work productively at the TIME Centre? Drop by and check it out! It
is located at SFU's downtown campus at 515 West Hastings St.
For a convenient printable, pdf version of this
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