Let the Sparks Fly!

Mobile Fireworks

Yesterday was the 5th of November, or better known as Guy Fawkes day in England and many commonwealth countries.  Guy Fawkes is celebrated with fireworks and bonfires and commemorates the day when that crazy man, Mr Fawkes, tried to blow up the Houses of Parliament in 1605. The 5th of November 2007 will also be significant and celebrated globally as the G Fone day (G F, get it?). The day when Google lit a fire under the mobile phone industry! I am not sure how we are going to ultimately celebrate it, but maybe once a year our cell phone screens will depict a spectacular fireworks display created by an application on our phone.

Guy Fawkes may not have been successful in his criminal plot, but he certainly made a name for himself! Maybe this is going to be the way that Google is best remembered, or are they in fact going to be successful with their new mobile strategy?

Just in case you have just crawled out of a cheese, here is what happened. Google finally announced their long awaited entry into the mobile phone market. Rumors and fake photo’s predicted a new branded Google phone, however, Google announced that they were going to develop, promote and support an open source mobile operating system and eco-system, called Android. Many industry heavyweights, like Motorola, Qualcomm, HTC, Samsung, LG, T-Mobile, China Mobile and others participated in the announcement and collectively they have formed the OHA (Open Handset Alliance).

At Brightspark, we have been intimately involved in the mobile industry since 2000. We have seen its evolution and witnessed first hand the enormous challenges in this industry. At the same time, mobile computing is without doubt the single largest consumer opportunity since the birth of personal computing. There are over 3 billion cell phones in use worldwide and all of them are computing devices of some sort. However, the challenges of the mobile industry are unique. We have multiple handset manufacturers, which is good, however, unlike in the PC world where each computer is built to run Windows, each phone is created with a unique proprietary user interface using proprietary operating systems and hardware. This means a different user experience from each manufacturer and for each model of phone. There are exceptions, like Windows Mobile and the Symbian based phones (and in many cases these are also customized by both the handset OEM and carrier) but they represent a very small portion of the entire market.

The carriers are perhaps the biggest impediment to the industry. Walt Mossberg, of the WSJ, likens them to the former “Soviet Ministries”, namely, highly bureaucratic organizations where the executives are in their late 50’s and come from a telephony background. But most importantly, they are not in touch with the realities of the Internet and mobile computing. I do feel sorry for the carriers, they are in a tough position; the high capital cost and regulatory restrictions limit the number of carriers in each geography and they need to maximize their investment, which means that they need to attempt to monetize all activity on their network. Can’t blame them, that’s the business they are in, however, if you witness the ways in which they put this into practice it will be obvious that they are inhibiting growth as opposed to fuelling it. As an example, take downloadable applications - literally billions of phones today can (in theory) download and run Java applications. There should be thousands of entrepreneurs and companies creating and selling software for phones, yet all that exists are a handful of the major media companies offering very poor games. Why is this? The carriers decided that their worst nightmare would be to become a “bit pipe”. They believed that they own the network and are as such entitled to make a premium off anything that gets put on their phone, across their network. So, instead of just charging for the data, they put in place elaborate programs where the number of applications made available to their customers would be restricted to applications that met certain criteria in terms of quality and brand recognition (they wont openly admit to this). Also, they decided that they would keep anywhere from 30% to 70% of the revenue from the application. This strategy has proved to be very shortsighted for multiple reasons:
• Their requirements to review and approve each application has created costly overhead and an artificial bottleneck
• The requirement for a revenue share has precluded advertising funded or free applications which would otherwise expose average subscribers to new ways in which to use their phones

The result is that the mobile application market is a relatively small industry dominated by major brands such as Disney, EA, Vivendi, Ubisoft (Gameloft) and others.

The folks at Google figured this out and realized that the only way in which they will be able to participate in mobile computing is to change the rules of the game. This means that you need to change the way that handsets download and present applications. The applications would have to be an intrinsic part of the phone, with full access to the system,  and not a kludgy, restricted addition. Additionally, you would need to get the carriers on board, to prevent them getting in the way of application creation and download. The handset guys and the carriers had to make a choice - bet on Google or bet against them. The members of the OHA bare testament to this difficult decision. We see some notable participants, like HTC, Motorola, Samsung, LG, T-Mobile and Telefonica (there are others) with the notable lack of participation from Verizon, Vodaphone, Nokia, Sony-Ericsson and others. I commend the participants, however, I am eagerly waiting to see how this consortium translates the press release into execution.  As an example, T-Mobile USA has been one of the most restrictive participants in the mobile application space. They have aggressively restricted open access to their network by third parties and so their participation in an open unrestricted platform must represent a serious change of heart.

Finally, one of the most significant pieces of the Google announcement was their focus on providing a comprehensive SDK (software development kit) so that developers would be free to create any application for the mobile phone. The SDK is due to be announced next week. This is another piece of the puzzle that does not fit well into reality. In reality, mobile phones come in various shapes and sizes, with different screen sizes, colors per pixel, input methods, peripherals, network speeds, keypads, etc. Java on mobile phones has existed for the last 7 years and is present on most modern mobile devices. It presents a standard API to developers, but reality has proved that the actual implementation of the API’s differ between different manufacturers and even between models from the same manufacturer. This same issue will undoubtedly be a factor with Android, unless the consortium all agree on a standard one size fits all device (which I doubt). One of our portfolio companies , Tira Wireless, has made a business out of providing the tools and services for creating mobile applications that will work on the majority of modern mobile phones. I look forward to seeing how Google has solved this complex issues. (Remember when Microsoft demanded all Windows on PCs to be the same it led to standard applications, but Microsoft being called a monopolistic bully. Google does not want to look like Microsoft of old, but can they create standards without being a bully?)

So, will this announcement lead to Cell phone nirvana? I doubt it. I think the carriers are filled with too many bean counters and lawyers who will inhibit the open software initiative. The actual devices will almost certainly be cool, but to application developers, it will be just another platform to support, and even within the platform, there is bound to be fragmentation. After all, it is an open source platform and anybody can modify it. The only good news is that some major carriers have stood up and proclaimed their support for open platforms. I anxiously await to see their reaction to other initiatives from companies like Tira Wireless and Cascada Mobile who are extending mobile computing to all software developers.

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.

Pitch4Profit Momentum Grows

Entries for the Pitch4Profit contest by Canadian Business and Profit Magazine continue to grow.  For those looking for some help to get their video pitches completed, the CBC  camera crew will be at the Toronto Venture Group breakfast event this Wednesday February 14th to tape pitches and to help  submit them to the site.

Contest details can be found here and more information about the TVG event can be found here.

Good luck to all participants!

Startup Exposure

Canadian Business and Profit Magazine have launched a Pitch contest for all aspiring entrepreneurs in Canada.  You can find out more information here:  www.canadianbusiness.com/pitch4profit

Just submit your 90 second audio or video elevator pitch and let the judges and audience vote for the best ideas.  The contest closes February 15, 2007.

For those seeking less than $1M - the 3 best pitches get a spot on Dragons' Den season two on CBC.

For those seeking more than $1M - the 3 best pitches get to participate in the Great Canadian Pitch Off at this year's Canadian Venture Forum. 

Get your submissions in early. 

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...

Capital Efficiency

There has been lots of talk lately about whether the venture capital model is “broken”. It is quite a complicated question (with no obvious answer) that I will leave to others more adept at statistical analysis than me to try and answer. I have been watching and listening though.

I was at an early stage investor’s conference in the Valley a couple weeks ago where this very question was asked to a panel of well-established, Sand Hill Road-based, VCs. These investors ran the gamut of pure early-stage $150M funds, to $1B+ plus funds who also claim they do early stage. Their answers?  Well, it’s been two weeks of racking my brain and I’m still not sure that what they said makes sense.

Basically they said the model is not broken if you invest properly, and of course, they all invest properly. It must only be the guys at Sevin Rosen funds that are stupid investors I guess!

All sarcasm aside, there were a few very important issues that came up during this panel (and conference) that are worth discussing further. By far, the greatest recurring theme was CAPITAL EFFICIENCY. The tech IPO market is still on life support, and even though the M&A market is strong and providing liquidity opportunities, without a strong IPO market to goose up valuations, the average M&A valuation of less than $50M is a big problem.

Some high-level stats from the U.S. for 2006 YTD:

• $23B paid over 311 M&A deals for an average of $73M per exit, BUT the median exit is actually closer to $25M
• The median amount invested in these 311 companies - $50M
  

For a $250M fund, the math doesn’t work if portfolio companies continue to get funded with $50M when the exits average what they do...something has to change.

Hence, Capital Efficiency. Companies need to do more with less. Not exactly a novel idea here in Canada, but one that VCs in the Valley are (finally) talking about more and more. No more over-funding of companies – this is where the current VC market falls apart and appears broken. Whereas software and internet companies were being funded to the tune of $40-50M prior to an exit, the new reality is that they must be able to reach the same end-game with as little as $10-15M. The popularity of blogs, open source, the continual increase in powerful computing chips provides start-ups with a lot of options to appear much bigger, and move much faster, than previously with less capital.

So, I see two challenges with this new-found approach to the VC market:

1. While you still have less money going into companies, you still have way too many “me too” companies all chasing a limited number of exit opportunities
2. The balance between “Capital Efficiency” and being “Penny Wise, Pound Foolish”.

This second point is especially important, and one that separates the successful companies (and VCs) from those that could be, but aren’t successful. The recurring argument in Canada as to why the VC community has not posted the same positive results as the US is that we don’t fund our companies to reach $1B+ in value and are happy to settle for the $50M exits – not the “go big or go home” attitude.

How to balance this with the new realities of Capital Efficiency will separate the truly successful VCs from the rest of the pack.