Building a culture of Entrepreneurial Venture Capital

02Apr10

by Chris Arsenault, Managing Partner at iNovia Capital

Earlier this month I was invited by Rob Hyndman to post some of my views on the topic of: The Future of Venture Capital in Canada,  as part of a series of posts at  The MarkCanada’s daily online forum for news, commentary, and debate. I ended up posting a short view of the “VC Ecosystem”, outlining only but a few key elements critical to having a stronger and most importantly a viable tech industry supported by venture capital in order to compete on a world wide basis. David Crow, added some valuable comments relating to “Creating a Venture Culture” so as did ex-VC and entrepreneur Rick Segal, tech CFO Mark MacLeod and others, participated in the discussion and shared their views on the topic. If you haven’t read the posts, I strongly suggest you give it a read.

I fundamentally believe in the early stage venture capital model that supports promising high growth tech startup entrepreneurs. And through my efforts and those of my colleagues and partners at iNovia Capital, MSBi Valorization, the CVCA, the C100 and numerous other initiatives, we are trying to make the model work by approaching venture capital the same way you one would build any other tech business: with the right people/team at the right time (entrepreneurs vs. operators); by  building a strong network of knowledgeable partners with complementary skills sets and long term relationships; and by understanding what startups and entrepreneurs need from their early stage VC’s and deliver results/returns to our Limited Partners while properly managing expectations. Building an Ecosystem takes time, commitment and passion.  Building an Entrepreneurial Ecosystem requires the right culture and mindset! For the last 12 years I’ve dedicated my entrepreneurial life towards helping to build successful tech business via my role as an active early stage investor. Over this same period of time I’ve witness important changes across the Canadian VC landscape which continues to evolve and now seems to be driven by a more entrepreneurial culture, one that includes Venture Capital savvy Entrepreneurs that understands the role of VC funding more than ever before. Hopefully the pieces will continue to fall in place and we will see the next generation of successful Canadian tech entrepreneurs that will change the way we work and live be funded by Canadian VC’s.

Earlier in March I was given the opportunity/challenge to discuss Entrepreneurial Venture Capital by giving a, “fast, 15 seconds per slide, 5 minute 20 slide presentation” at Ignite  Montreal. My presentation was specifically on the topic of trying to communicate how to “Make Venture Capital Work”. I really like the Ignite presentation model, but it’s indeed a challenging concept, too bad I ended up doing the basic mistake of trying to say too much in too little time… thus not saying as much as I could if I would of said less!

So, many entrepreneurs these days are talking about “How the Venture Capital Model is Broken”, which is the wrong way to address the lack of capital Canadian entrepreneurs face! The VC Model isn’t broken because it never really worked in the first place, period!

With the exception of the 1980’ and the few last years of the Internet bubble, the model has never been successful for the masses, but has been only for a handful. And, when it comes down to Canadian numbers, we have to account for an additional level of difficulty: the fact that Canada doesn’t have the “weight” of numbers in its favor. Not only does Canada have a less mature IT and Biotech industry when compared to the US, it also has a small and nascent private equity and venture capital industry, and still only has a handful of privately managed venture capital funds today.

The stories about the highly successful technology entrepreneurs as well as those about the rockstar venture capitalists (note: over 80% of all venture capital returns are generated by less than 25% of the venture capital funds out there) created the impression that the only thing needed to build a high valued successful startups was an entrepreneur with an idea and an investor with cash! This meant that venture capitalists could blame poor returns on unsuccessful entrepreneurs while those entrepreneurs could blame their failures on the lack of capital or restrictions tied to the capital they did raise.

The math is the same for a Canadian venture capital fund as it is for a US venture capital fund. Investors in venture capital funds usually expect a high IRR (internal rate of return) – Top tier venture capital expected returns in the +30% IRR,  a rate that is far above banking rates due to the high level of risk involved. A Venture Capital fund will usually has a ten year life and will require a certain level of management fees over that period. Therefore, in order to understand the type of capital that needs to be returned to the investors of the Fund (the Limited Partners) one needs to plan on generating three times (3x) return of capital to be successful and part of the Top tier firms that are able to continuously raise additional capital and funds.

In a nutshell, that means that a $100M size fund must return approximately $300M in order to generate the expected level of returns of a Top tier fund! So, knowing that for an early stage venture capital fund, one can expect it owning on average 20% of any given company in a portfolio of around 15 companies (for a $100M size fund), this would translates into $1.5 billion of aggregate portfolio enterprise value at exit, or $150M in cumulative EBITDA based on a 10x EBITDA exit valuation, needed to generate those type of returns. That’s pretty demanding! Managing expectations also sets the bar as regards the type of actions that will be put forward to achieve those expectations. Maybe it’s time we set an aggressive but achievable bar that would benefit the whole industry, no?

Reality is that entrepreneurs operate in a living “Ecosystem” that feeds itself by growing and building new connection. No party can do it alone! The community feeds itself off its own growth. High growth technology companies need venture capital to succeed and the venture capitalists need to back successful entrepreneurs to generate strong returns. Not only do we need to have better return expectations for venture capital funds, we also need better collaboration within the community to build networks strong enough to support promising technology companies and deliver high shareholder value.

The more successful entrepreneurs are, the more successful venture capital funds will be, leading in turn to more funding for entrepreneurs.

We have to learn how to expect more and know how to get more. Yes, funds and large institutional investors like pension funds and insurance companies should expect better returns from their venture capital investments. The last 10 years of Canadian venture capital returns represent -0.2%, yet expectations were in the unrealistic + 30% range, while solid manageable returns should be more in the 15% level. Large institutional investors can help themselves achieve such realistic returns by selecting fund managers with entrepreneurial backgrounds and experience with building successful companies. Managers who think and act like the entrepreneurs they back are better suited to select the ones who understand how build a successful start-up and have the most chances of succeeding.

Likewise, entrepreneurs should expect more from themselves, their teams and their investors. Entrepreneurs need to understand what is expected from the capital they raise and they can do this by selecting the right potential investors and doing due-diligence on them, by understanding the ecosystem they are operating in and making sure they surround themselves with people who are stronger than themselves, and generate stronger returns by setting themselves up for success.

High but achievable expectations create and define leaders!

Entrepreneurs are natural leaders, because they are able to execute on ideas, they transform opportunities into tangibles such as jobs, products and profits. So by having more entrepreneurs funding other entrepreneurs, we have more chances of building a sustainable ecosystem. It takes time to build a viable company, and by understanding the type of returns that are expected from the different source of funding, entrepreneurs and fund managers alike will be able to create a model that works.

The venture capital model is broken only to those who don’t understand it those who aren’t willing or interested in investing the energy to adapt it to their reality. Like other industries, the venture capital industry will continue to evolve over time.

I’m looking forward to seeing the level of returns over the next five to 10 years as the Canadian venture capital industry begins this evolution – where entrepreneurs are funding entrepreneurs

Now, some questions for you:

– What do limited partners think of the emerging number of entrepreneurial driven Venture capital Funds?

– What do entrepreneurs think of the new breed of entrepreneurial VC’s?

– Is the Canadian market mature enough to trigger the level of collaboration required to build a strong ecosystem around Canadian technology companies?

– What is expected by the entrepreneur of the early stage VC’s (other than the obvious $)?

– How will you be part of the “make it Happen” generation?

For those interested in participating, take a look at the following few links to recent articles and you’ll get a feel for the energy and around the subject:

The Mark: The Future of Venture Capital in Canada

La Presse: Jacques Bernier, de Tralys: le goût du risque

Tech vibes: Venture Capital Funding Outlook In Canada

Financial Post: Venture capital finally gets a break

TechCrunch: Strength In Numbers: Canadian Entrepreneurs Flock To The C100

CVCA: Canadian Venture Capital Investments in 2009 – Lowest recorded in 13 YEARS

StartupNorth: What is being a startup really about?

Bootup Labs: Startup Visa Canada




7 Responses to “Building a culture of Entrepreneurial Venture Capital”

  1. Hi Chris,
    I loved your take on the Canadian VC ecosystem and what needs to be done to make entrepreneurial success both organic and cyclical in Canada. One quick question, a large part of your post mentions setting high but achievable expectations (with yourself, your team and your investors). How often did you need to reset expectations while building your ventures? Was it a transparent process?

    Thanks for the post.
    -Rob

  2. I would say it was. And we evolved allot! The hardest part is to be “able” to do the homework before moving forward with a plan. When done, its easier to adapt, evolve, take advantage of your strengths and new learnings because you are ready for it. Changing a business plan is a non-issue, not understanding what you are getting into or what it takes to succeed is an issue. Validation is key, knowing what you are doing with other peoples cash is also as important. Being lucky and learning everything as you go is part of the landscape, but not something you should expect funding for.

  3. 3 Kevin

    Great post, Chris. Great to see this kind of thinking in Canada. I completely agree with your entrepreneurial VC approach. I am adamant that this is one of the biggest things lacking in our city (Edmonton), in addition to few serial entrepreneurs.

    The entrepreneurs also have to realize that they need to be part of building this ecosystem and having a “make it happen” attitude rather than complaining about the lack of funding available. Being an entrepreneur doesn’t mean having money handed to you, but rather going out and making it happen yourself.

    Keep the posts coming! Glad to see these topics being discussed.

  4. 4 Abdallah AlHakim

    This is a great article and it is the first one I come across that proposes lowering expectation on the returns. Having said that, I think more should be expected from entrepreneurs and they should be held to the highest standard. I don’t think this is a problem for entrepreneurs because as the article stated they are natural leaders and do strive for the best. I am looking forward to seeing a growing startup culture in Canada and I think many of the initiatives such as startupdrinks.ca and the newly formed C100 group are a step in the right direction. Thanks again for the post.

  5. Chris, I know I already invited you at vcrant, but just to make sure you get the invite (as well as your audience here), come over to Flames Central on April 28th. Podium Funds launches its first corporation. Register here: /launch-event at the site. Hope to see you all at the event.


  1. 1 Great expectations or Can you build VC in Canada? « A Musing

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