Let the Sparks Fly!

What’s really up at Brightspark?

I have heard about five different rumours in the last few weeks about what Brightspark is up to (and not up to).

To quote Mark Twain in his famous 1897 quote “The reports of my death are greatly exaggerated”.

To be absolutely clear, Brightspark remains dedicated to the Canadian software and Internet startup market. The Brightspark team believes that there are many opportunities to create lucrative and successful Canadian Internet and software businesses.
Brightspark remains focused on running its VC Funds. Brightspark Fund 2 has made nine VC investments; is making a few new investments and the team continues to work closely with its portfolio companies.

At the same time, Brightspark has started a new business called Brightspark 3.0 Inc. Brightspark 3.0 is in the process of raising funds via private placement from accredited investors. (Due to the nature of the legals round private placements, we are not marketing the fundraising or soliciting public interest. If you would like information about the placement, please email me at marks@brightspark.com).

Brightspark 3.0 Inc is a corporation that will create and operate new Internet businesses. The plan is for these to be cost-effective, cash generative Internet businesses. Brightspark 3.0 will share resources amongst the new businesses. The goal is for these to be mostly Web 2.0 businesses based on advertising and freemium business models. These businesses will be driven by the Brightspark founders – Tony Davis, Sophie Forest and me. We plan to be involved in the new businesses on an active day-to-day basis. As those who have followed us over our careers, you will know how much we like starting ad running new Internet and software businesses. We believe that, considering current market conditions, this is the best way for us to capitalize on the opportunities in the Internet industry.

These are exciting times as we see the evolution of the venture capital market. We believe that we are leading the market into these new areas.

But, to make sure that the rumours are corrected: We remain VERY active in the Canadian startup market. We are actively running our funds. We are actively “pushing the envelope” in new projects and businesses. Going forward, we intend remaining a leading force in the Canadian software industry.

The evolution of the Canadian emerging technology market

So, word is out that the Canadian VC industry is in crisis. Investments in funds and consequently portfolio companies is down dramatically, particularly in Ontario. 

For those of us who have been at this for a while, this is no surprise. We have watched the industry shrink around us, particularly in Ontario. Today, Brightspark is about the only seed/early stage private VC fund remaining in Toronto. We have watched the Labour sponsored funds being decimated, other funds unable to raise monies or fleeing the market, the fund investor market shrink progressively over a number of years. As I have spoken about in other posts, the Quebec market is holding its own because of the positive moves made to encourage outside funds to move there and establish a strong base. Meantime the Ontario effort has been to keep spending lots of dollars on Mars (great building by the way, but the absolute wrong way to create an industry) and we still hear talk of the $90 million coming for the VC industry – soon to be too little too late. 

The reality is that this is not just an Ontario or a Canadian issue. The VC industry is evolving and rationalizing itself on a global level. The only (relatively) healthy VC markets are Silicon Valley and Israel, each for their own reason. In Silicon Valley, you have an entire industry with an infrastructure, critical mass, momentum and a “working system”. With repeat entrepreneurs, startup culture, sophisticated investors and an industry round it, other areas have not been able to replicate this success. In Israel, you have the support of an economy and government along with great training, which is underpinned by entrepreneurs who understand that startups are the hugest growth area of its economy. This too cannot be repeated anywhere else. 

Other markets have tried to replicate the Silicon Valley/ traditional VC cookie cutter model, including the Canadian market. The US market has always been our curse and blessing in Canada – on the one hand, we have access to this huge marketplace; on the other hand we don’t have the underlying infrastructure to compete. 

And even in the US marketplace, we see many attempts at evolving the model, in particular the early stage/seed model of starting up companies and seed investing in companies. Good examples are Y-combinator, Hitforge, and Charles River’s “Quick start program”. 

The market needs to evolve. We need to find the models that are right for the Canadian market. Because, we have great opportunities to startup technology companies, software companies, Internet companies. We have incredible talent coming from our universities, and we have a population that understand and embrace technology. The angel market is active and the buyout market is active. And there are many players in the VC industry who want to see a successful Canadian investment market and Canadian technology market. While our economy is so buoyant, and while real estate and natural resources are driving the market – now is the time to invest in technology, now is the time to invest in the emerging opportunities that will create the balance that we need. Just as any private investor needs a balanced investment portfolio, our economy needs the same balance.

In my next posts, I will focus on the strengths and weakness of the Canadian market and ways that we can fix it by adopting some new models. 

At Brightspark, we know we are very fortunate to be able to keep raising traditional funds because our portfolio companies are thriving. But, just as we tell our portfolio companies, don’t choose a direction because it the easiest road, don’t just follow traditional business rules – develop your business to maximize your ability to create high value for investors and founders. Lets see if the local market, particular the Ontario market, adapts to the opportunity or if it withers.

More "Bill Gateses", not more graduates

The press in Canada has been full of articles about how Bill Gates thinks that if Canada and the US want to stay ahead, they should "focus on improving the quality of education and expanding the number of young people who study math and science in school". He wants us to create new computer scientists, engineers and researchers.

Academics like Roger Martin answered him in the Globe and Mail by saying that North America has its lead because of our great MBA schools (like The Rotman School of Business where he is Dean) and management studies and the creation of more managers.

And the debate rages about how we need more scientists, management students and other graduates. Even the politicians have been getting into the act by agreeing or disagreeing with Mr. Gates about how far behind we are or aren't, and how many more students we need.

I think that they are all wrong. What we really need is more Bill Gateses. We need entrepreneurs who are willing to "go for it", start new companies and create startups like Microsoft was not so long ago. Can you imagine if we could find the formula to create more people like Bill Gates?

As far as I remember, Mr. Gates dropped out of university. He was not a product of any MBA school or school of engineering. He did what he did because of his own drive to succeed, and a market environment that let a Microsoft be created.

Let's create an environment that lets entrepreneurs thrive. Let's help them however we can to get started.

On the other hand, if Mr. Gates succeeds in convincing us that we need more "scientists, engineers and researchers", imagine how many more copies of Windows he could sell...

Startup Crisis

So, when do you panic? As an investor in many startups, we are always dealing with a major crisis in one of our companies. 

The reality of startups is that it is actually part of the normal process to have an occasional crisis. In fact, I use “crisis measurement” as one way of monitoring startups. 

Without over-generalizing, I think it is normal for a startup to have one crisis about every six months. Within a couple of years, it may go down to once yearly. More than one crisis every six months probably means that the company is being too aggressive/ too reckless and less than one crisis every six months probably means that the company is not taking enough risks/ pushing the envelope hard enough. 

The type of crisis I am referring to can range from market or customer issues all the way to existential crises where the company needs to completely question the path it is taking.

The success of a startup often depends on just how well the team, CEO, investors, board and employees manage the crisis. The worst way to manage any one of these crises is to ignore them or hope they go away. They don’t go away. They just get worse. The sooner you deal with issues and face them head on, the better your chance of recovery. 

I keep reminding myself and our startups that one of the biggest advantages startups have over “real companies” is their ability to make changes easily and quickly. Big companies cannot change very fast or very easily – they have to worry about existing customers and previous products. Startups can redefine themselves quickly and easily. In fact, they need to keep reminding themselves that they can make these changes easily. 

The best startups keep testing their assumptions. They put stakes in the ground. They take big bets. BUT, they make sure that they can a) keep evaluating these bets and b) they create a corporate culture and infrastructure that lets them change direction easily when they need to. 

I never think our startups are failing when they have a major crisis. I never think our startups are failing when they make some huge zigs and zags. I do think our startups are failing when they can’t easily adapt to changes in the marketplace or the realization that the facts have changed. I think they have failed when they keep going down a road that they know is the wrong one, but feel that they have an obligation to “finish what they have started”. 

There are lots of factors that cannot be controlled in the startup environment. Making change in the face of these factors can be controlled. Anyone founding a company, investing in a startup or working in a startup has to be comfortable with change. Otherwise, don’t dabble with startups.

Government programs need to stimulate an industry, not become the industry

The largest contrast between the Israeli and Canadian technology company programs is focus – the Israeli model is focused on supporting a software industry driven by private, professionally managed VC funds while the Canadian model tries to simulate the software industry in a general unfocused manner. I believe that, if there is one MAJOR difference in approach between government programs, it is this underlying issue. And, as you’ve probably gathered, I strongly believe this is the focus that we need in Canada.

The fundamental aim of government VC programs in Israel is focused - to establish professionally managed VC funds. The Yozma program was a $100m program started to try and create an industry of seed and early stage VC funds. The program offered $8m to ANY fund that met various objective criteria in terms of other funds raised, professional management and focus. The funds had a 5 year option to buy out the $8m at predetermined conditions. They quickly established 10 such funds (of which 8 exercised their option and bought out the government). Yozma made direct investments according to a fixed formula with the single aim to create a VC industry. At the end, more than $100m was returned to Yozma, and Yozma was taken private. The Chief scientist incentives, incubator programs, R&D and Investments grants, tax exemptions to foreign investors are all designed with one thing in mind – creating a strong, independent VC industry run by professional investors.

Contrast that with Canadian programs. The fundamental aim of government VC programs is to try and stimulate the industry at every level in a very unfocused way. Some Canadian examples:
- The “SRED” program which helps pay for R&D with tax credits (and often cash).
- The BDC (Business Development Corporation) which as its opening page on its web site says “supports the needs of entrepreneurs at every stage of growth”. At this level, BDC competes with the VC industry. BDC is a Canadian crown corporation that has a group called BDC Venture Capital that describes itself on its web site as “a major venture capital investor”.
- BDC also has a “fund of funds” where it selectively invests in Canadian Venture Funds. These funds are not given to any commercial fund that meets fixed criteria, but are completely subjectively chosen.

Other generalized programs are in place in Canada.  For example, at a provincial level, in Ontario there has been huge impetus behind the MARS discovery district. This is a huge real estate facility which acts as a “facilitator and enabler”. The government of Canada and government of Ontario each donated $20m to the project. And almost $100m has been raised for the project. MARS is undertaking a number of other projects and is trying to directly help young companies.

I am not trying to be negative about the Canadian programs such as BDC and its efforts, or MARS and its efforts. I think that they stimulate the industry in a general way and help companies to become established.

However, the Canadian model has failed to create a software industry. I believe that Canadian government programs could go a long way to help create a software industry if they would become focused. The general approach of government programs should be to motivate professional, independent fund managers to be successful. The model in Israel speaks for itself. In Israel, we find a mature VC industry with more that 60 Venture Capital firms, weekly exits and a thriving industry. In Canada, we have a struggling VC industry. The reason for the difference is that the Israeli model is focused on creating a software industry and the Canadian model is focused on helping individual companies.

Ten years later, we now see that the Israeli model works and the Canadian model is broken. The Quebec programs have taken the first steps to fix this. Let’s learn from this. Let’s stop spending our tax dollars on real estate and government run programs. Let’s create an industry.

Contrasting the funding of a seed VC startup in Israel and Canada

Coming back to Canada from our trip to Israel, I wanted to highlight some programs that I think could make a huge difference to the Canadian VC market. I am not making these suggestions as criticism of existing or past programs, but rather as a constructive way of trying to help the Canadian VC market catch up with the Israeli VC market.

 

At Brightspark, as one of the only private seed VC funds in Canada, we OFTEN see really interesting ideas presented to us. The challenge we have is to try and select the companies that we think are going to be able to flourish and become successful as a “VC investment”.
 

One problem we often encounter is the very high risk of trying to evaluate extremely early stage technology companies. Sometimes it makes sense to invest in a marketplace with huge potential (meaning where LOTS of money is being spent, such as wireless), and we often do just that. But at other times, we are presented with ideas that need to worked on before we know how successful they can be, and very often we need to turn down these investment opportunities because they are too risky. 

An example case in point: We were presented by a small software company which was creating software to improve productivity in an existing market. The concept was developed by very knowledgeable domain experts, including professors at one of Canada’s leading universities, and recognized leaders in the field. The company was self-funded, along with a few Angel investors, and they had created some prototypes and concepts that “demo’d really well”. Our challenge at Brightspark was trying to evaluate how much better than the existing products would this new product be? We consulted with experts in the field, potential customers, and evaluated competitive existing products. Our eventual conclusion was that the company would need to spend in excess of $1 million dollars to get the product to the point where we would be able to start answering these questions. It would still have “VC-type” risk at the end of that process. As a result, we turned down the investment. We were not willing to invest up to $1m of our investors' monies to get that answer – the risk was simply too high.

In Israel, we met VCs and incubators that are undertaking quite a number of these early trials. How do they do that? They have access to risk capital from the “Incubator Program” and Chief Scientist office. In the above example, the startup would have received two thirds - about $650k in the form of a non-recourse loan which would be matched with $350k from the early stage VC/incubator. These loans are given according to a formula – if the company and VC/incubator meet the formula, they get the loan. 

This is not theory, but linked to REAL examples. I know of many startups that have not been able to be launched in Canada because it was too risky without these types of programs. And, we met a number of later stage startups that grew with these programs.

It’s not hard to set up or to run programs like this in Canada. It just needs the government programs to realize that their role is to stimulate the industry and grow it. And the way to stimulate the industry is not to compete with the private VC professionals but by fostering a healthy private VC driven market like in the US and Israel. The focus for government programs needs to be the creation of a software industry.

VC Industry Lessons

I have recently returned from a 10 day trip to Israel with my partners at Brightspark. We were busy the entire trip with meetings every day including some touring as well. It was a wonderful opportunity to see the Israeli VC industry “in action”. We met with a number of VCs, especially early stage VCs, software companies – early and later stage, angel investors, operating companies, incubators, and investment bankers. We were treated very well, and we learned a lot – now to get rid of the jet lag...
Instead of composing a long blog post, I am composing a few smaller entries with some thoughts and ideas after our travels.

Trying to compare the Canadian and Israeli VC software markets – not much to compare

I have been fortunate to participate in the Israeli and Canadian software industries over the last twenty five years. My first programming jobs were on Data General computers in Israel in the early 80’s when hardware was so expensive that we battled to squeeze business software on to underpowered hardware. Soon thereafter, I came into contact with the software publishing industry when Ontario, Canada led the market (with Atari and Commodore software). By the early 90’s, we had some major software companies in Canada when Delrina, Corel and other led their marketplaces.

Ten years ago, the Canadian and Israeli VC marketplaces were poised to take off from a leveled starting point. The Internet was emerging; both markets had some of the best computer science universities in the world; governments were trying to figure out how to help. When I founded a software company called Balisoft in 1997, we created a software company that had early leading VCs from both countries - Sofinov (CDP) and J.L. Albright from Canada, and Gemini from Israel with government assistance via CIIRDF.

Fast-forward 10 years to 2006. Canada has a VC based software industry that I would describe as quite unhealthy, and the Israeli industry has created huge momentum that seems to be driving an entire economy. The contrasts are amazing. During our trip to Israel, we spent four days traveling from hi-tech area to hi-tech area. We kept saying to each other that we could easily have been in Silicon Valley. And we never even got close to visiting any meaningful proportion of the industry – we mainly visited just the North Tel Aviv Area. We found an industry with more than 60 private VC firms, with exits taking place regularly on a weekly basis, established government programs in place that are driving innovation, and a new presence from the major US VC firms.

Contrast that with the Canadian industry. We seem to have fewer VC’s in existence each year. At the seed and early stage, outside of Quebec we have very, very few funds. It seems to me that the Quebec government is doing something right because they are attracting outside VCs and new activity. But outside of that one glimmer, we seem to have an industry where the best talent moves quickly to the USA, we have very few repeat entrepreneurs, very little momentum in creating success stories; and while we keep hearing about new potential new government programs, there seems to be almost no visible success from these programs.

Sadly for the Canadian software industry, we find that if Israel and Canada were at the same place in the VC industry 10 years ago, we now find Canada very far behind.

We can find excuses and explanations, and there are no simple solutions, but it is interesting to look at what I think are some of the reasons for the difference and what can be done about it. This will be the topic of other blogs posts, but I believe that well focused government programs have been a huge contributing factor to the success of the Israeli industry, and that Canada should learn from this success.

Fortunately, it’s not too late to fix...

Corporate culture is what gets it all done

This week, we had a reunion in Toronto for the company that I co-founded in the 80s/90s called Delrina.  (For some history, see wikipedia).  Amazingly, close to 200 ex-Delrina employees attended (see photos here at Flickr),  but more amazingly this was more than 10 years since we exited the company.  Most people at the reunion had not worked for Delrina for at least 10 years, but still came out to meet their old colleagues.

As we all know, 10 years in this industry is a lifetime.  Yet, people were genuinely interested in catching-up with others that they seemed to really care about.  And most people felt a strong connection with others.  I was amazed how many people came up to me and told me what an incredible experience working at Delrina was and how it formed a strong basis for what they have done since.

I think that a lot of what people experienced in those days was the opportunity for young, inexperienced employees to be empowered.  (A quote from an email I received afterwards: "I wanted to say that working under your leadership gave me the confidence and inspiration to be an entrepreneur.  I run a successful manufacturing business and the basic "think on your feet" management style you had is one that I have used on a daily basis in the complex world of business.")

I got to thinking about what it was that allowed us to be so successful with a team that had lots of expertise and not a lot of experience.  And what was it that has kept people connected all these years later?  I am convinced that it is commonality of purpose and a strong corporate culture.  From the beginning, we were all focused on one thing - winning.  Coming second was not an option, losing was not an option, mediocrity was not an option.

We started Delrina in 1988 and I remember being turned down by VCs in Toronto, Boston and Silicon Valley.  They all said, "You guys have never done this before, and you are based in Toronto, Canada for goodness sake".  (Yes, I have been on the "other side of the table" many times).  We were determined to prove ourselves and were driven to succeed and we found financing from other sources.  Over the next 8 years, we were constantly told how we could not succeed at this from Canada, how our products would not be competitive and why we would not succeed.  But instead, we drove sales to nearly $150M annually, sold more than 30 million copies of WinFax and then sold the company for more than $550M.

The glue that held this together was a strong corporate culture.  A culture of working together, empowerment, trust, respect and caring about the people you work with, and an executive team made up of complementary talents with common goals.  We were a community that was a bit of an island.  There weren't many (any?) other companies like us in Toronto and once we started becoming successful, we started getting noticed.  The more the focus on us being unique, the more the focus on us being public in Toronto and Nasdaq, the more our team worked together and achieved.  This same culture permeated throughout our offices in California and Europe.

I am convinced that this is the "secret sauce" that every startup needs to succeed.  When people look at our successes at Delrina such as our OEM strategy of giving away/selling cheaply WinFax Lite and upgrading people to WinFax PRO, it is often attributed to good timing or good luck.  Yes, luck helps, but before we ended out with that strategy, we tried 30 other strategies.  As a startup, the only luxury you have is to reinvent yourself at every opportunity and your competitive edge is to be able to easily make zigs and zags with ease.  And then, when something works, you need a team that can execute well and capitalize on the proven strategy.  We made this happen with a culture of "No Fear" (I still have my No Fear Delrina t-shirt), a culture of not being afraid to test out new ideas - all held together with a culture of winning.

Now I keep looking for the next Delrina to invest in...

The News is NowPublic

Today, Brightspark is pleased to announce an investment in NowPublic (www.nowpublic.com).  My partners and I have been watching the rise of “Web 2.0” companies with cautious optimism.  While I certainly am excited to see the Internet being used as a true platform for user generated content creation and sharing, the challenge for any VC is to identify the real businesses from simple feature companies.  Which companies will truly leverage this platform to create unique value in its industry?  Can this value be defended with the development of strong intellectual property?  Given our investments in the mobile and VoIP space, I have been watching with great fascination how users have so quickly adopted technologies such as blogging, podcasting, and picture messaging.  The intriguing challenge is to understand how these technologies will affect industries outside of mainstream content sharing.  This visioning process brought us to NowPublic.  NowPublic is revolutionizing the news collection and reporting industry by empowering citizen journalists to engage the news conversation.  I am very excited about the progress this company has made in such little time by building a great relationship with its user base and by making smart technology decisions.  This company is truly focused on an innovative business model which will give it much staying power in this “Web 2.0” world.

Read more about this news at NowPublic

When to Say No

We want to see lots of deals, but the challenge is to meet expectations. Given the volume of deals that we see on a weekly basis, we consistently need to be selective in determining which deals we will pursue and which deals we will pass on.  When I look back at our process, the “No” response often falls into 3 categories:

 

1. No because this does not fit our investment criteria

 

These deals are the easiest to say no to.  These are usually opportunities where we don’t see a domain expert, strong intellectual property or a large addressable market. We are disciplined about these three criteria. (At the same time, as early/seed investors we initially place far less attention to stuff that traditional VCs look at like financial projections, sales forecasts, etc).

 

2. No because we can’t add value

 

These deals are tougher to say no to because while the entrepreneur may convincingly make the case for their business, the opportunity is usually so specialized that we struggle to understand how we can add value in the process because it is so outside of our focus area.  As investors, our goal is to actively work with the team to capitalize on an identified market.  If we’re merely going to get in the way, or can’t leverage our past experience to help in the business-building process, then we are better off to stay out of the way of the entrepreneur.  We regularly meet entrepreneurs in this category that we like, but we know our own limits.

 

3. No because this isn’t a VC business

 

These deals are also tough to say no to because we regularly meet impressive entrepreneurs who have built strong businesses.  They have often started with little and have built a good cash-flow positive business.  While we’re greatly impressed by this accomplishment, we struggle to see the opportunity as being a high growth business or having strong intellectual property.  This certainly doesn’t mean that it’s a bad company or doesn’t deserve outside investment, it just means that it’s not a VC-type investment opportunity.  A VC-type investment opportunity means that we can share a vision in a great exit within a reasonable period of time. These deals are tough to say no to because often the entrepreneur has built their business in the face of much criticism and doubt.  This process builds great character and it’s always nice to see these types of people succeed.  While we can’t invest, we’ll try our best to help in other ways, as best we can.

 

Having been in this industry for some time, I’ve learned that it’s best to be direct and quick with our decision.  The last thing I want is to waste the entrepreneur’s valuable time with a passive aggressive approach.  This certainly helps no one.   A quick "No" is much better for everyone than a long "Maybe" leading to a "No".  (And "No" doesn’t always mean no forever. We have been known to revisit opportunities when conditions change and then make an investment).

 

Evaluating deals is at the core of our business so I always encourage entrepreneurs to submit their opportunities. This allows us to start a dialogue, explore partnership opportunities and maybe say "Yes" to many great ideas.