Let the Sparks Fly!

Summer’s over, but it feels a little like spring…

Normally this is the time of the year that really stresses me out. It is late September in Ontario, summer is over, the leaves are starting to change colour, and while it is still pretty nice out, it’s real clear that it is downhill from here to winter, with warm days more than seven months away.

But something in the local tech industry feels a little different, and it feels like things are getting better. Some of us have been lamenting the state of the Canadian VC industry for years now, and Rim’s woes should by all rights make the local scene seem even bleaker – but people in the industry don’t seem to be listening. A whole lot of activities that are happening seem to signal an awakening spring and everyone seems just a little more optimistic.

Of note are more entrepreneurs pitching really interesting offerings. I keep meeting Canadian entrepreneurs with great ideas, great opportunities and a yearning for success.

Surrounding that are a number of exits from local companies – most notably (for the industry and especially for us at Brightspark, where we saw more than a 23X return on our investment) is the Radian6 sale to Salesforce.com. This exit proved that great, money-making businesses can be hatched in Canada with local talent, local VCs and a positive outcome for the local economy. Add to that a series of other small acquisitions along with some interesting exits.

And then there are the new micro-funds which are growing despite the stalling of the traditional industry, with experienced and talented managers helping a new series of companies – I am referring to our colleagues - Duncan and Robin at Mantella; Matt at GoldenVP; the teams at Xtreme, bnotions and Real Ventures; Daniel at Klass Capital; Bill Dinardo; and Joel at Trilogy; all who are making a very meaningful difference to our industry. MaRS is expanding, IAF is investing, I hear some traditional Canadian VCs may be finalizing new funds, and the government funds continue their part in providing capital.

We aren’t out of the woods yet, but it definitely feels like now is a great time to be part of the Internet, software, mobile, Cloud, and payment industries. Markets are growing, and these industries are creating value while the rest of the economy questions itself. If this really is a marathon, now is a great time to be heading out…

If we can keep up this momentum and deliver a few more winners, we may look back at this time as the period when the new Canadian industry started thriving.

At Brightspark, we remain thrilled with our VC fund’s performance. Our multiple exits puts our performance way ahead of top quartile funds anywhere in the world. And we think the remaining companies in our portfolio have the potential of taking our fund to new levels. Our focus on investing in great teams, markets we understand, and with an early stage fund of entrepreneurs helping entrepreneurs is paying off really well.

To those people who have written off our participation in the industry, we continue to focus on remaining a significant part of this industry and we think the next few years could be very exciting for our funds and the Canadian industry. 

Welcome to spring!

Kickstarting an industry

Last month, I was lucky enough to join about 250 other attendees at Kinnernet 2009, a “Foo-type” Internet geek camp/ un-conference held on the shores of the Sea of Galilee in Israel. Kinnernet is a by-invitation networking event hosted by Yossi Vardi. If you have never heard of Yossi, he was the founding investor of ICQ (when I met him in 1997). Yossi has invested in well over 80 tech companies – mainly young Internet companies, and has often been called the Godfather of the Israeli web industry.

Yossi has an approach to the market that I think the Canadian startup industry can learn a lot from:
    - Startups need cash, and the biggest help you can give them is cash. It is said that Vardi invests a few hundred thousand dollars in his startups, that he takes common stock with simple terms and no negotiations.
    - If someone has failed before he’s even more likely to invest - “It makes them want to win even more,” he is quoted as saying.
    - He generally invests in young entrepreneurs.
    - Yossi usually hardly looks at business plans at all, and mainly invests in the individual. My favourite Yossi quote is: “Business plans are like sausages, if you knew what went into them you wouldn't eat them.” Another unauthenticated quote: “Judge the individual over the business plan”.

From what I saw at Kinnernet, Vardi has played a major part in stimulating Israeli startups. At every turn, I met another young entrepreneur eager to tell me about their startup. Full of positive energy and drive, it was extremely energizing to meet these entrepreneurs.

In addition to financing, Vardi orchestrates events like Kinnernet where all his startups can interact with each other along with many experienced and connected people from all over the world. And he relentlessly works on business development and finding opportunities for his startups.

It would be amazing if we had a similar process in Canada. If we could find a way of kickstarting 50 (or more!) tech startups with a few hundred thousand dollars each; if we could find a way to orchestrate ways for them to work with each other; if we could help them meet people ready to advise them on lessons learned. 

We have all the ingredients – great universities, superb talent, high enthusiastic young people with ideas. Now we need a way to get the right money to the right people and we may be able to create an industry…..

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.

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.

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.

Angels and VCs

I have attended a number of early-stage investment conferences over the past month and I've taken note of some common themes and controversial comments that I thought I would share over the coming days. 

The most controversial comment I heard was from a prominent U.S.based angel investor who said during his presentation (and I paraphrase) that “Angels and VCs should never co-invest”. His rationale? The interests between the groups are not aligned. Angels are investing their own money as opposed to VCs who invest the money of other people and institutions. Angels are not interested in or motivated by raising their “next fund” and therefore are much more patient investors, are not motivated by IRR (which has a time to exit aspect to it) but rather cash on cash return. Therefore time is the angel’s most valuable resource and the strategic decisions to be made by the Company are very different.

I personally don’t buy this, and neither do many of the angels I have spoken to, both locally and in the U.S. We at Brightspark have been developing a strong relationship with the angel community because we believe that our vision of early-stage investing is very much aligned with angels, and have co-invested with angels on occasion. Angels investing their own money are motivated by the same end-game as early stage VC funds – creating tremendous value for the shareholders and founders and positioning the company for the appropriate exit at the appropriate time. Angels I have spoken to are not interested in tying up their own money for 10-15 years in a single investment and while I agree that cash on cash returns are important to VCs as well, the time aspect to an exit has an absolute bearing on investment decisions for any investor. A 5x multiple on an exit within 5 years is much more motivating to an angel than a 5x multiple in 15 years. There is always a time value to money. In the latter case, they may as well buy a 15 year bond and there is much less risk.

At a Early stage investing conference in the Valley, there was a whole panel on how angel organizations presently work together with the VC community – and to a man, they all expounded on the importance of bringing the VCs into the process early on.

In my mind, this was one angel trying to motivate the angel community and give them a feeling of self-importance that they don’t need – the VC community already values the important services they provide to the start-up ecosystem.

Banff Venture Forum

Last week, I had a chance to attend the Banff Venture Forum in Banff, Alberta.  This conference gives young technology companies the opportunity to present to early-stage investors.  The conference was well attended by Angel investor groups, university commercialization groups, as well as venture capital firms.  I also sat on a panel presentation which discussed commercialization strategies for innovations coming out of university labs.  Many feel that there is not enough early-stage private funding in the market to support the commercialization of university research.  Very often, universities spend significant provincial and federal government grants on years worth of research to develop new technologies.  This research is funded based on its academic merit as determined by the University and government professionals.    As this research "graduates" from the university lab and begins its search for outside investment, it far too frequently fails to gain private investor support.  Some investors complain that the innovations are too niche focused, while others argue that they see little market value or customer demand for the proposed solutions.  Regardless of the issue, the fact remains that universities are struggling with the commercialization process.

Rather than starting more government programs or funding more reports to assess this issue, perhaps we need a radical new way to jump start this commercialization process.  My suggestion would be to have universities partner with private investors much earlier in their process to determine which research to fund.  Venture investors have a strong understanding about industry dynamics and market needs.  They also have the ability to support emerging technologies with their venture dollars.  Why not partner these investors with the university groups to priortize university research focus?  Wouldn't it be better to understand which research is most relevant to market needs and which innovations will best be able to get external financing support? Perhaps government research dollars could be spent answering the investor's questions and concerns regarding commercialization viability? It seems to me that this would be a much more market-focused approach to funding technology research.  This way, Investors would also get a first chance to fund new and exciting innovations. By involving more partners and priortitizing their research dollars, perhaps universities can help build greater momentum for their innovations.        

Back to Techies Land

Entering into Fall (it sure feels like Fall with close to freezing point temperatures in Montreal last night), back from vacation with the kids, I am attending Fall VON in Boston this week. It is very busy, as one could guess and filled with new ideas, new technologies and energetic people. A great place to be for a VC, trying to figure out the benefits of the new telecom puzzle.
 
Yesterday, one of our portfolio companies launched an amazing new product called Vox.  You can visit their website at www.voxlib.com and download it for free. It gives you the ability the make a Skype call from any cell phone. We are very proud and happy about this launch. Everybody has been working extremely hard to get it right and make it happen. This first product truly demonstrates how the economics of telecommunications, as we traditionally know it, are completely transformed. This is not a new topic obviously but Voxlib brings it to another level. Judging from the level of downloads yesterday, people were quick to figure out the value of Vox. Congratulation to the team! 

On another note, I just listened to a presentation from a large VoIP provider at VON and it felt like being teleported back to 2000. Charts and graphs were presented on losses, slicing it every possible way, as a % of sales by category, tracking it over time etc. While I do understand the purpose and need of it, I can’t help having this awkward feeling. It reminds me of a few Board meetings of technology companies in the late 90s where some Board members were harassing the CEO because “you are not losing enough money, your competitors are losing faster!” However new or differently the growth an industry may be going through, this will never feel right to me.