A monthly column focusing on new and emerging BC publicly listed technology companies     Technology Futures:     January 10, 2005 By Michael Volker In this month's column, I'll explain why I'm still very bullish on the B.C. tech scene by reference to three key success factors: People, IP, and Money. Tech Outlook 2005: Prognosis Good for Investors and Companies There’s never been a better time in British Columbia for technology ventures - especially startups - and for technology investors than right now. For tech investors, the past year has been pretty boring. In 2003 the NASDAQ index advanced almost 50% to close at 2003.37. But in 2004, it closed at  2175.44, a gain of less than 9%. The S&P IT index advanced only 2% in the year, but Telecomms was more exciting at 16% (Compare that to humdrum utilities at 20%!). The TSX Venture Index closed 2004 at 1825.47, up only 4% on the year as compared to a 63% gain in 2003. [However, those meager gains have almost disappeared in the first few trading days of 2005! Let’s hope that doesn’t continue.] So, why should 2005 be any different? Aside from a generally favorable economic climate, there are a number of factors that impact new venture creation in the technology sector. Building a successful technology venture requires three forms of capital: human capital (the people), intellectual capital (the ideas and the intellectual property) and plain old cash capital. And, all three are showing signs of strength and growth. First, let’s look at what’s happening on the people front. Over the past few years, the supply of talent has increased substantially at all levels. Universities are upping enrollments and graduate outputs. The brain drain has turned into a brain gain (eg the Canada Research Chair Initiative - a $900 million initiative to establish 2,000 new research professorships at universities across the country. The program was started in 2000 and has been extremely successful.) Academics and entrepreneurs are coming back as are new immigrants. After more than a decade of strong growth, Canada’s pool of technical and management talent has grown markedly. I still hear about the need for management skills but if you compare what we have today with where we were five years ago, there’s a huge difference. I frequently get inquiries from qualified people looking for exciting opportunities, especially in startups. More and more technical people have taken courses in entrepreneurship (many technical schools make it a requirement) and there’s no shortage of Masters programs in technology management. According to Arthur Carty, the Prime Minister’s Science Advisor, the migration of researchers from Canada to the U.S. does not constitute a problem. “Canada brings in about 10,000 new immigrants a year who could be classified as highly qualified people in science & technology, and we lose about a thousand a year. The international brain drain actually works dramatically in favor of Canada. Over the last year we have experienced an increase of 20 percent in the number of foreign students in Canada; that’s partly spillover from the U.S. because of their increased security concerns. On top of that, a lot has improved in Canada for younger researchers: there are a lot more funding opportunities these days. It’s a pretty attractive place for young people to start a career.” I’ve been watching startups for over two decades. There’s no question that new companies being formed today possess a level of sophistication that we’ve not seen before. No longer are the entrepreneurs winging it like they did in the 80’s or 90’s. They understand not only the science but also the business challenges. They are surrounding themselves with experienced boards, mentors and investors.    Second, with respect to intellectual capital, R&D spending has more than doubled in the past five years. In 2003, Canada’s total expenditure on R&D was close to C$23 billion—that means that Canada’s R&D investment as a percentage of the nation's GDP is around 1.9%. The Canadian government’s goal is to at least double its R&D spending by 2010, in order to reach its 3 percent target. Of the $23 billion, industry accounts for $10B. The establishment of new foundations such as the Canada Foundation for Innovation (CFI) and Genome Canada coupled with the healthy increases in the budgets of the existing granting councils has already resulted in the creation of more intellectual property (IP) as measured in patent filings, for example. CFI is an independent corporation established in 1997. Its base budget of C$3.65 billion to 2010 allows it to fund up to 40 percent of a research project’s infrastructure costs. The almost-a-year-old federal budget of March, 2004 gave a big boost to innovation in Canada. It added $90 million annually to the budgets of Canadian Institutes of Health Research (CIHR), Natural Sciences and Engineering Research Council (NSERC), and Social Sciences and Humanities Research Council (SSHRC). Before that top-up, SSHRC’s budget for 2004-05 was C$230 million, NSERC’s budget for 2003-2004 was C$760 million and CIHR, created in 2000, was to distribute C$662 million for health research in 2004/05. The budget added $60 million to the $375 million already received by Genome Canada. It also allocated $80 million towards commercialization at universities, hospitals, etc. Plus, $270 million was set aside for new investments in venture capital financing by the Business Development Bank of Canada (BDC) and the Farm Credit Corp (FCC).  Some of this ($100K) is supposed to be managed by VCs in new startup funds – heaven forbid (they don’t understand early stage investing). The National Research Council (NRC) continues to play a crucial role both in terms of conducting its own research as well as funding industry – notably young companies – through its popular IRAP  program. The National Research Council’s budget is approximately $800 million and funds 19 institutes covering physical sciences and engineering; life sciences and information technology; and technology and industry support across Canada through its staff of 4,000. There’s a new catch phrase going around in government known as the “Innovation Agenda”. This is being backed up by new budget appropriations to support the commercialisation of IP. Although they haven’t quite figured it out yet, we do know that by one mechanism or another, there’s likely to be more financial support for the early stage risky deals. It’s clear that more needs to be done to “mine the minds” that are creating the raw IP. It also means that technologies – not companies – can be incubated a little longer in the laboratories of their origin before they are kicked out into the harsh commercial world. This will reduce startup mortality rates. Canada’s National Innovation Strategy, a process that started in 2002, culminated in a roadmap to take us to the end of the decade. On the federal policy level, the Minister of Industry (a post now occupied by MP David Emerson of Vancouver) has traditionally been a key player. Most government agencies dealing with R&D report to Parliament through the Minister of Industry. In another speech, Carty emphasized that the commercialization of research results is the government’s top priority: “The Prime Minister has made it clear that commercialization of research is a priority issue that I should take on in my new role as National Science Advisor, and I intend to make it a focus of my first months in my new post.” And, indeed, even the Speech from the Throne expressed it in no uncertain terms: “Now we must do much more to ensure that our knowledge investment is converted to commercial success. We need to do more to get our ideas and innovations out of our minds and into the marketplace.” And finally, there’s more cash. Even traditional later-stage venture investors are starting to co-invest with angel investors. Angel investors are back in action after the dot-com fallout. Although the average investment size has decreased, more angels are pooling their capital and working together to provide seed financing. There are also new funds, for example the BC Advantage Fund and the Western Universities Technology Innovation Fund that focus specifically on these seed opportunities. The “public” VCC Funds (eg. BC Discovery, BC Advantage, and PenderGrowth) have no trouble selling out. They’ve done this now for two years in a row. Obviously, this demand from street investors provides an entirely untapped new source of capital. I’ve been running the Vancouver Angel Network for 6 years now. There are more than 300 angel investors who attend from time to time. Millions of dollars (the data are confidential) have been invested. Each and every month we see four or five deals of which one or two get funded. In addition to angels (aka financially successful entrepreneurs), there’s a growing number of boomers now in their late fifties and early sixties who are flush with cash with substantially improved cash flows as a result of paid-up mortgages, empty nests, investment and pension incomes (yes, I’m talking to you!). Many are co-investing alongside angels in early stage deals – not just for the upside potential but also for personal interest.  The National Angel Organization is lobbying the Federal Government to provide a tax credit to individual investors in order to increase the flow of capital from the private sector. In B.C., for example, the provincial 30% investment tax credit program has been so successful that the B.C. government oversold its allocations in 2003 – a nice problem to have! The objective is to have a national VCC program like the one here in B.C. Also, let’s not forget the Customs and Revenue Agency’s Scientific Research and Experimental Development (SRED) program – it provides up to 68 cents on the dollar (in B.C. to private companies) for performing R&D! A whopping $2 billion flows back to Canadian industry annually. In general, Small Business also got a boost in last year’s budget by an increase in the small business deduction limit to $300,000 by 2005 (below this, companies are only taxed at 12% federal income tax). And, for tech firms, the SRED program was improved to make it more accessible for some firms. For those companies that make it through their formative years, there’s an increasing abundance of traditional venture capital. According to Goodman & Carr’s Private Equity Canada report, some $50 billion (2003 data) in private equity capital is under management in Canada. More than 20% of this comes from well-heeled private individuals. Interestingly, slightly less than this percentage comes from retail investors who have supplied capital to the Labor-Sponsored (aka tax-assisted) Venture Capital Corporations (LSVCC). The balance is from corporations, pension funds, etc. Even so, there are many in government who still believe that the scarcity of venture capital is a real problem. No one seems to have the carrots that would make venture capitalists migrate to Canada in noticeable numbers. There are gaps in the process, e.g. financing proof of principle projects. The government will get more involved and assume more risk, because the risk is simply too high for private companies and VCs – hence the need for incentives for private investors. To learn more about the VC scene in B.C., the Vancouver Enterprise Forum’s January event (Jan 25), titled “Getting Yes from Dr. No”, will hear from David McIntyre of Ventures West and serial entrepreneurs Glen Brownlee of Tantalus Systems and Andrew Harries of Zeugma Systems as they discuss how B.C. technology entrepreneurs can get to ‘yes’ in the VC financing game. Let’s not overlook the TSX Venture Exchange (TSXV) (or maybe the new CNQ – Canadian National Quotation System) as a viable alternative for many companies. Many prefer this route – ie, getting many smaller investors over dealing with larger institutional investors. There are now almost 300 technology companies listed on the Venture Exchange. For the first three quarters of 2004, they raised $200 million from the public. As these companies mature, they often graduate to the TSX main board and/or to a US exchange. Last year, eight such companies made the transition including TIR Systems Ltd, RailPower Technologies Corp and Azure Dynamics Corp from B.C. On all three fronts – people, ideas, and capital – the outlook is bright, especially in comparison to where we stood five or ten years ago. So, are there any negatives in the British Columbia context? For starters, there’s little Science & Technology leadership. The Province is missing the boat on leveraging the huge federal investment in R&D.  The last time we had a senior political champion was when Pat McGeer was B.C.’s Science Minister in the 80’s. Last year, the Integrated Technology Initiative (ITI) was launched. That's positive. The ITI is an effort to create an integrated strategy for supporting highly competitive, functional technology clusters in British Columbia. (see the website at: http://www.techinit.ca).  It warms my heart to see so many people give their time towards improving the industry’s lot, but there’s an element of déjà vu in this. Will it lead to anything? More studies, maybe? One humongous committee is not a substitute for leadership. Not so much a negative as an area for improvement is B.C.’s VCC program. The 30% tax credit available to investors is capped at $20 million in credits thereby facilitating the formation of only $66 million in new capital. B.C. and Quebec both offer Provincial VCC programs. These add up to a half percent (around $500M) of total equity capital according to the Goodman and Carr report. With B.C. capped at $66 million, you can calculate Quebec’s share! BC’s public VCC funds have, for the past two years, easily sold out. Although we’ve seen lots of improvements made by the BC Securities Commission with respect to capital raising rules and regulations, there still remain far too many legal technicalities. These are largely due to our Provincial system of securities regulation. Increased pressure on regulators precipitated by fraud and scams only exacerbate this situation. The Sarbanes-Oxley Act in the US is being felt here and regulators in Canada are tightening up as well. This translates into substantially higher costs and more red tape for companies raising equity capital. Of course, it’s a bonus for the legal and accounting professions! Another area where I see a need for improvement is in the Angel-Venture Capitalist dynamic. There’s a lot of tension between these two groups. Much of this has arisen because of their different mind-sets. Angels empathize with entrepreneurs and give them the benefit of higher valuations. They think of the reasons why they should invest while VCs have a responsibility to their investors to think of all of the reasons why they should not invest. As a result, angels often get squeezed on subsequent financings. In the past year, I’ve seen lots of competition between them as angels get more involved in later rounds and VCs look at getting in earlier. Some local angels are working on a “Terms Sheet Initiative”. This was the subject of a December Angel get-together with a view to coming up with something that is good for a company’s founders, its early investors and something that will not cause structural problems later on. Bottom Line: we should see lots of exciting new companies get launched in 2005. I’m convinced that these will be quality deals with relatively low fallout. [In my last column, I was looking for a word describing an entrepreneurial that is the opposite of procrastination, i.e. an adjective to describe the trait of acting immediately without delay to accomplish a goal. I enticed readers with a bottle of Burrowing Owl to give me their ideas for the ideal word. Here are some of the responses: intensity or passion (Brian Dubberly), immediacy (Rodger Talstra), incisive (Neil Podmore), “sense-of-urgency” (Bob Stevens) and a couple of creative ones: Matt Ferguson’s TNT (for “today-not tomorrow”), and - one of my favorites – Rob Muir’s hodiate (from the Latin word hodie for today. Many thanks for these! Now about the wine…] Business Centre for non-downtowners If you don't have a Vancouver "office" but find yourself downtown occasionally without a "home", you are invited to use SFU's TIME Business Centre. TIME is an acronym for Technology, Innovation, Management, and Entrepreneurship. The Business Centre (looks like an airport business lounge) 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. You won't believe the price!  If you're an entrepreneur looking for a place to get your company started, there's some great office space available at the TIME Centre. There's also access to various resources, e.g. tech advisors, access to capital (e.g the VANTEC Angel Network), mentors, etc. Worried about the high cost of being downtown? Well, not to worry - some payments can be in the form of equity. Check www.sfu.ca/time for contact info. WUTIF...you wanted to invest in a tech startup? The Western Universities Technology Innovation Fund (WUTIF), is an "angel fund" catering to tech startups based in BC (not limited only to universities). WUTIF Capital is a VCC that offers investors a 30% BC refundable tax credit. If you're keen to co-invest with angels in up and coming companies, this is a good way to get started. Check www.wutif.ca for details. Pooling and risk-sharing is the way to go! Michael Volker, a technology entrepreneur, is Director of the University/Industry Liaison Office at Simon Fraser University, past Chair of the B.C. Advanced Systems Institute, Chair of the Vancouver Angel Network and past Chair of the Vancouver Enterprise Forum. He owns shares in many of the companies he writes about. Copyright, 2004. What Do You Think? Talk Back To Mike Volker Tech Futures is a bi-weekly column that focuses attention on new and emerging BC publicly listed technology companies.  Contact: risktaker@volker.org Tech Futures Archive B.C. High Tech Links