By
Michael Volker
A New “Old” Funding Idea
It
drives me nuts! Almost daily I get a call from someone with another great idea
looking for a little cash to get the idea materialized. The reason that these
calls are frustrating is because of the great enthusiasm and energy behind these
ideas that might just warrant support – support that’s just not there.
You
never know which of these ideas might just be the next big thing. It seems that
there’s no shortage of people who are keen to pursue an entrepreneurial dream.
Access to capital, especially at the early stages of business development, is a
real problem. To advance Canada’s innovation agenda, the Prime Minister’s
Advisory Council on Science and Technology (PACST), is challenged with
figuring out how to better commercialize research. This resulted in a proposal
calling for a Government investment of $305 million in a public/private
partnership with VC funds.
The
Ontario government recently announced that, as part of its commercialization
strategy, it will invest $63 million, a large part of which will be used by
institutions to establish pools of seed capital.
Here
in B.C. we have an excellent, albeit very limited, venture capital tax credit
program that encourages investors to stick their necks out a little more in
support of emerging companies.
Several organizations across the country have made proposals involving grants or
tax credits to bolster capital formation at the nascent stages of business
development.
These
all seem to involve handouts of some form. We’re all good at coming up with
suggestions as to how to use grants more effectively. Are government subsidies
the only solution – for entrepreneurs and taxpayers?
I
really doubt that any of these proposals, if implemented, would actually
go so far as to invest in the pre-company “idea stage”.
Last
week, I heard an impressive speech by US Presidential candidate John Kerry
in which he talked about his government providing substantially increased
support to small business in the form of loans. This struck a cord.
Back
in the seventies when there was almost no venture capital, I recall that
Business Development Bank of Canada, (then called the Federal Business
Development Bank) played the role of “lender of last resort”. That’s how I first
accessed capital for my company. The terms “angel investor” and “venture
capitalist” had not been coined. If you need money, you go to the bank because
that’s where you’ll find it.
Perhaps we should re-invent debt financing through loans – not to the
entrepreneurial venture – but rather, to the entrepreneur herself. That’s not a
new idea. Even though a loan might be made to a business, the banks would
typically require the personal guarantees of the owners of the company. So, in
essence, they were effectively banking the individual and it was the individual
– not the bank or the company that was at risk.
Debt
financing has many attractive features: it defers the valuation question at
startup and putting in more than sweat equity bolsters any valuation
negotiation; it appeals to other investors because the entrepreneur also has
some cash at risk; it may foster a more frugal spending style but most
importantly, it demonstrates the entrepreneur’s commitment. Too often, I see
startups getting even modest sums from other people only to run out and buy
fancy furnishings or computers when egg crates and used equipment would still
get the job done.
I
recall one startup in which the founders had to meet some important clients in
their offices with hardly any chairs to sit on. They went out an bought some
from IKEA and after the meeting returned the goods!
Another benefit of government-backed debt financing is that governments are not
put in the position of picking winners, as one does when evaluating
“investments”. And, unlike other loans such as those made through programs such
as Technology Partnerships Canada(TPC), these personal loans should not
be forgivable – much better for taxpayers! In the case of the TPC program, more
than $2 billion has been invested and less than $100 million has been repaid!
For
budding venture starters, I would suggest a personal credit line (at prime
interest rate) up to $500K, secured by the entrepreneur’s assets (even if there
aren’t any), including his shares in the company with no “out” other than a
personal bankruptcy. The downside? In the event of a total failure, the
entrepreneur would be able to at least get some business loss write-offs against
future income.
How
to administer such a program? Why not let the banks handle it with appropriate
loan guarantees provided by government? That’s how BDC used to handle it. They
charged an extra point or two for providing the guarantee and for doing the
corporate due diligence. But since this is a personal loan, only the type of due
diligence that banks presently conduct on individuals would be necessary.
In
normal lending, only two conditions must be satisfied given that an individual
checks out (ie. no criminal record, etc): the borrower must have collateral to
cover a default and he must have the cash flow to service the interest cost.
That’s where the guarantee comes in with the government taking the risk by
collateralizing the loan. However, that’s still better for taxpayers than
outright subsidies and I suspect that the real costs through defaults will be
substantially less.
So,
what’s wrong with this idea? Well, there might be abuses. However, to a large
extent, it would be self-policing. If there is no forgiveness provision, most
individuals will not stick their necks out too far, i.e. now they can
stand in the cautious investor’s shoes! They might even conclude that their
great idea really isn’t that hot after all and not worth taking the risk.
Another problem could arise by providing cash to naïve entrepreneurs. This could
be the main challenge in formulating such a program. Perhaps a mandatory
bootcamp course, mentorship and a business plan review could mitigate this. This
would also address another commercialization impediment: the skills gap that’s
often mentioned as a commercialization impediment.
Entrepreneurs ought to know that debt financing, next to government handouts, is
the least expensive form of financing. Given a choice, it’s better to borrow a
half a million dollars at prime rather that give up a third of the company.
I
spent a fair amount of time in Taiwan in the mid-80’s doing some outsourcing
there. I was amazed at the number of small, young companies. When I asked how
they got their capital I was told about a practice (the name of which I can’t
recall) whereby successful business people -angels, I suppose - would provide
pools of capital and make loans to their proteges. These were simple debt deals
at rates a little higher than bank rates. Through mentoring and the “saving
face” culture, this seemed to work quite well.
The
bottom line: an innovative debt financing program could go a long way towards
addressing the “access to capital” problem by giving true entrepreneurs the
means to invest in themselves! If they’re not keen on this, how could they
expect someone else to be?
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. Due to the limitations on the
VCC program, WUTIF expects to use up the tax credits available to it by
mid-2004. So, 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
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