1. Philanthropic giving is much like venture capital investing. When we invest in a company we make sure the business has enough money to cover its basic operating costs but also ensure it has some extra funds in order to try new initiatives. I think you should take the same approach to your charitable contributions. A percentage of your giving should be done with no strings attached and should be to allow organizations to cover their basic overhead costs. If a charity can’t pay the rent, pay its staff and turn on the lights it can’t do its basic job.  On the other hand, we also need to ensure charitable organizations have adequate funds to be able to try new innovative ideas. Again, this is not unlike venture investing. In a recent transaction a company came to us looking for $1 million in financing we decided to invest $2 million because we knew giving the company $1 million meant they would not have the ability to take risks and make mistakes. Shouldn’t we take the same approach to philanthropic investing? It is impossible to innovate without making mistakes and taking risks. This is clearly acknowledged in the business world yet we don’t give our non-profit leaders the same flexibility. Far too often CEOs and Executive Directors of charitable organizations live in fear of making mistakes because they simply don’t have the financial resources to take risks. I encourage you to allocate some portion of your charitable giving to funding innovative ideas. In some cases the ideas won’t pan out but unless we invest in these opportunities we will not give the leadership at our non-profit organizations the resources to “change the world”.
2. Tied to idea #1 is the notion of supporting strong leadership teams at organizations you are assisting financially. In the venture world we know that most management teams are prepared to trade off some cash compensation for equity but we never go out looking to hire the most inexpensive management team we can find. Often this is not the case in the non-profit world. Too many boards pride themselves on keeping CEO and ED salaries very low. I am an adamant opponent of this strategy and truly believe “you get what you pay for”. This doesn’t mean that organizations have to pay through the nose but it does mean that minimizing management salaries shouldn’t be a goal. Several of the charitable organizations where I have been board chair have significantly increased compensation for the head staff person and in all cases the organization has moved to the “next level” as they have been able to attract outstanding candidates. I encourage you to get involved with the organizations you are supporting financially by letting them know it is okay to use your contributions to compensate the staff team appropriately.

We all want to live and work in a healthy vibrant community. In order for this to occur we all have a role to play in supporting our non-profit and charitable entities. As we approach a new year, I hope you will take some time to think strategically about what role you will play in supporting these organizations in 2010.

1. Charitable giving is about more than writing cheques. The gifts we can contribute are often described as the “three Ts” being Time, Treasure and Talent. In thinking about your contributions I think you should be giving all three. That doesn’t mean you have to do all for each entity you support. In some cases I am very involved with organizations, sitting on the board, volunteering time at events and providing financial support. In some instances I just provide financial assistance or in other cases will provide a skill set to help with an issue without  providing financial assistance. Evaluate how much you think you can give for each of the Ts and allocate accordingly.
2. When it comes to financial contributions I am often asked “how much should I be giving”? There is no easy answer to this question but I do think a general guideline should be that your giving should “hurt” a bit. What I mean by that is I encourage you to give to the point where you have to make a small sacrifice personally in order to make your financial contributions. This will be a different level for everyone. For some it will be $100 a year for others $50,000 a year. My point is that while it is different for everyone you should know when you hit it.
3. Be strategic about your giving – balancing ongoing support with being able to respond to new requests. I have several core organizations I support each year because I believe in their mandate but I leave some room each year for “one off” situations that come up.
4. If you are unsure where to start, you may want to chat with some friends and decide collectively to support a charity or project. This is the way groups like SVPI work (www.svpi.org). Jacqui Murphy and I attended the SVPI annual conference this year and hope to have a Waterloo Region branch approved at their 2010 annual conference.

Stay tuned for some thoughts on how you can approach charitable giving in the same way we approach venture capital investing…

I’ve just picked up Creative Capital: Georges Doriot and the Birth of Venture Capital by Spencer E. Ante and my favourite (note the Canadian spelling) book for entrepreneurs these days is One Hen by Katie Smith Milway. You might sense a “back to basics” theme in these two books… Enjoy.

To shed some light on these questions I directed the audience to the slide below which I have titled the Murphy Balance of Power Equations after the originator and my partner, Jacqui Murphy. I will allow that these formulae may not have the mathematical rigor of those presented by Fischer Black and Myron Scholes for which they were awarded a Nobel prize. But I think you may find them more intuitive.

As Murphy points out, the entrepreneur can find money and maximize price by shifting the balance of power in his/her direction.

No Revenue = No Power: Pre revenue transactions are hard to get done at the best of times. However, even today these deals can get done if there is something special about them… A brand name management team or a locked down go to market channel are two examples of what that pixie dust might be. Having said that, even these entrepreneurs will be price takers.

A Little Revenue = Less Power: The second formula may be somewhat counter intuitive. There are a couple of reasons for this. First, in all likelihood the company will have under performed relative to their initial budget which hands a huge negotiating chip to the investor. Second, there is a huge gap between first revenue and a sustainable business model. Most investors know that the way you generate first revenue is not ultimately how you will be selling to scale.  However, they don’t know how long it will take you to find that secret. It is a bit like being in a taxi cab, the meter ticks away while you are stopped at the light.  This isn’t new, it has been commented on by many. Geoffrey Moore’s Crossing the Chasm presents one formulation: Hitting first revenue with no cash is no fun!

Self Sustainable = Oh the Power!: Being able to present investors with a sustainable business is like holding a pair of aces. There is no doubt that you will attract attention. Be careful not to over play your hand as it is still way easier to say no to a deal than to say yes.

All this makes me wonder, why is it exactly that we are focusing on the finer points of valuation rather than the finer points of sales…which brings me back to a prior TCP blog post: Stop Pitching and Focus on Building

The consensus appears to be that yes, we do have great entrepreneurs and great innovation in this country. I for one believe this is true and have worked with a good number of entrepreneurs who have built (with their teams of course) very successful companies.

Lately, I’ve been spending a ton of time thinking about what we as a venture capital community and the broader technology industry can do to support these entrepreneurs. When I look around at the venture capital ecosystem in Canada (and elsewhere) most VCs are either out of cash or have very little cash left to invest (there are obviously exceptions and some VCs have raised funds in the last couple of years). I’m not sure that the majority of entrepreneurs have heard this message. When I look at the amount of time and effort that Canadian entrepreneurs invest in pitching their companies to VCs (here and elsewhere), it makes me want to scream. If we could harness this time and effort and direct it towards selling products and services to real customers, imagine how much revenue all of these companies could generate.

Looking at the funding process today, entrepreneurs pitch their companies to VCs who pitch to LPs. Wouldn’t it be great if entrepreneurs never had to pitch VCs? What if we turned the process on its head and built such great companies that entrepreneurs could choose whether or not to fund their companies with venture capital? And what if VCs had to demonstrate value beyond money for entrepreneurs to want them to invest in their companies…? And wouldn’t it be great if VCs never had to pitch LPs to raise new funds because of off the chart returns?

So how can we help entrepreneurs beyond providing capital?

* By helping them generate revenue more quickly *

Here’s what I’m proposing:

1. Entrepreneurs/companies:

• Map out your industry ecosystem: a) Types of companies you sell to (e.g. carriers) b) Types of companies you would partner with in order to sell (e.g. network equipment vendors)
• Identify the specific companies that fall into this ecosystem: a) Potential customers b) Potential partners
• Identify the specific person/people at each of these companies that you need to get in front of in order to sell your products (great tools for this include LinkedIn and Jigsaw). Figure out where these people are located. Group by geography. Plan trips to visit these regions.
• Search on LinkedIn to identify “connectors” who can introduce you to these potential customers/partners so that you can set up initial calls and then face-to-face meetings with them.
• Commit to building out your LinkedIn rolodex and sharing the connections you make with other entrepreneurs.

Now, these first few steps can be difficult and will take a significant amount of time. If anyone can come up with a cost effective way to help entrepreneurs work through this process, please weigh in below in the comments…

Communitech is one organization that has been supportive in finding creative ways to help entrepreneurs work through this process.

2. VCs and other supporters of entrepreneurs:

• Spend some time building out our LinkedIn rolodexes (many of us know many more people than the ones we currently have listed in LinkedIn).
• Highlight the market sectors where we have experience on our LinkedIn profiles.
• Respond to entrepreneurs who reach out to us for introductions. Go for coffee to learn more about them and their businesses. Introduce them to potential customers/partners and others who can help them generate revenue more quickly.

I spoke with a group of entrepreneurs last week on this topic — “Leveraging Non-Existing Networks Into Guerrilla Revenue Generating Strategies”. Many were skeptical at the beginning of the discussion but by the end, there was a real energy in the room.

I understand why people might hesitate to open up their rolodexes and connect people.

My response:

1. I am not proposing that we destroy our reputations by spamming our rolodexes with Canadian content . I am proposing that we spend a bit of quality time, interacting with entrepreneurs in our sectors and connecting them with potential customers/partners when/where we feel comfortable doing so.

2. We would be connecting our contacts with entrepreneurs who have developed products and services that have real value propositions. Our contacts may well benefit from being introduced to these entrepreneurs.

3. What good are our relationships if we don’t leverage them? We become more powerful and influential by sharing and connecting.

“He who receives ideas from me, receives instruction himself without lessening mine; as he who lights his taper at mine receives light without darkening me” – Thomas Jefferson (tip of the hat to Michael Masnick)

Some ideas to get started:

1. I’ve been told that there are about 300,000 expat Canadians living in Silicon Valley (yes, 300,000). Have you reached out to a Canadian expat today?

2. There’s a small but mighty group called Canada Connects on LinkedIn. Same objective as this post. Please join to help get our Canadian entrepreneurs on steroids.

I’ll be the first to admit this plan is not perfect. Constructive criticism with suggestions for improvement are absolutely appreciated.

Your market size is a reflection of the people who are likely to actually buy/use your product/service and not the entire installed base of whatever

That’s pretty much it. We want to know what the Total Addressable Market (TAM) is and as indicated in the quote above, this should only include people that one would reasonably expect to be interested in your product/service.

Sounds pretty straightforward but more often than not, market sizing is a muted effort. The problems I see over and over tend to be of two varieties: (1) failing to segment the market and (2) using peripheral numbers.

Segmentation
Depending on the market, segmentation isn’t always an easy task. To start, you should define who the target customer is and from there you can make some reasonable assumptions (make sure you state them) or find some relevant stats to come up with a TAM. I can’t count how many times I’ve seen a slide that details the target customer in a very narrow fashion and then later on the Market Size slide has a number approaching the GDP of Canada. It just doesn’t add up.

Example: An entrepreneur has shown some great stats on the overall market but doesn’t do the math to determine the TAM for the product/service. Instead, the entrepreneur opts to take path of “everybody in this age group needs this service” – usually any primary research would show this statement to be untrue – So the overall market size sounds great at the outset but once you start to crunch the numbers the size dwindles rather quickly.

I’ve seen many presentations where all the ingredients for determining a reasonable market size are present but the entrepreneur refuses to do the math and instead focuses on the biggest number.

Peripheral Numbers
This is when the market size number presented actually has little or no relation to the Total Addressable Market (TAM).

Example: There are 100m people in North America that spend $8000/yr on widgets which means there is an $800B widget market.

It sounds great until you realize the company doesn’t sell widgets, they provide a service to help people find widgets and the business model is not based on referrals with a revenue share but a subscription model. A dollar increase in the widget market does not correlate to an increase in potential revenue for the business. Sure, the widget market size is related to their business but think about it this way, if you were to capture 100% of the market would that be $800B in revenue? The obvious answer is no since you aren’t selling widgets. So if that is the case then why use that number for market sizing purposes when you will never actually capture any of that potential revenue. Instead, the entrepreneur should use the stats that are known about the target customer (i.e. 30% of people are interested in using widget finding services and are willing to pay anywhere from $10 to $30 a month for this service). So 100m people * 30% * $10 = $300m is a good place to start for the TAM on the low side and $900m on the high side.

But people like big numbers
Sure, big numbers turn heads but at some point the numbers are going to have to hold. Having a realistic and well thought out market size speaks volumes about the knowledge and understanding you have about your customers and the market.

There is one final thing that should be mentioned and that is the use of the word ‘Conservative’. However harsh it sounds, in most cases when you use the word conservative while talking about the size of your market, your numbers almost instantly become suspect, especially when the number is extremely large to begin with. Almost everybody at some point in their presentation says their numbers are conservative. I’m not saying you can’t use the word, because in some cases the numbers are actually conservative estimates. What you need to realize is that it is a relative term and if you’re going to use it then back it up with a clear and concise explanation.

For Canadian-Controlled Private Corporations (CCPC) the refundable portion of the Quebec SR&ED credit is for 37.5% of the eligible expenses up to $3,000,000 and 17.5% thereafter. This compares to the Ontario rate of 10% of eligible expenses up to the same limit. The Quebec system, like in Ontario, piggy backs on the feds for eligibility and audits etc so that transition is pretty simple. There are, however, some subtleties that are worth noting. First, in Ontario once you have crossed the limit, there are no refundable tax credits where as in Quebec the credits are refundable at all levels. Second, in Ontario you can claim some materials and equipment as well as overhead expenses (65%) but on the Quebec side the rate is applied just to salaries. Third, in Ontario the tax credit is earned on 100% of the qualifying expenditures for payments made to contractors whereas in Quebec the tax credit is earned on only 50%.

It can be difficult to do an apples to apples comparison without a live example. So imagine a company with $3,500,000 in eligible salaries and $200,000 in materials and expenses. The side by side comparison looks as follows:

If that eye popping number for the Quebec claim isn’t enough to pique your interest, here is another little surprise for you. There is a credit system for employees who are not engaged in SR&ED eligible activities called the e-business credit which is 1/3 of a salary up to $20,000 per person for businesses larger than 6 employees. Wow.

Mind you, Ontario has a 30% refundable tax credit for companies that develop products that educate, entertain or inform. Also, for taxation years ending after December 31, 2008 Ontario will provide an additional 4.5% non-refundable tax credit on qualifying expenditures in respect of SR&ED.

I can understand why a company located in Toronto or Waterloo might find relocation difficult even with these incentives, but in Ottawa… the distance from Kanata to Gatineau is about the same as the distance between San Jose and Palo Alto. In today’s liquidity constrained environment, I would be surprised if every start-up in Ottawa wasn’t giving this serious consideration.

In an effort to be balanced, I spoke to a CFO in the Ottawa area who has had experience in these matters. Indeed one of the companies he works with did the Quebec shuffle only to return to Kanata. He pointed to three reasons which caused this particular company to move back. First when they started looking for significant amounts of space (20,000+ sq ft) they found a lack of suitable space in Gatineau. Admittedly this was a couple of years ago so that data point may be out of date. Second, in this firm many of the employees live in Kanata or Stitsville which caused the commute to mushroom from 15 to 45 minutes – not much by Toronto standards but the kind of thing that folks in Ottawa are not enamored with. Finally there is a capital tax issue which this fellow said amounted to four or five thousand dollars which he admitted was pretty minor in the context of the discussion.

I understand from folks in Ottawa these programs have caused increasing pressure on the community. Additionally, I have heard of a company that has a Waterloo and a Montreal presence which I think may be a matter of coincidence rather than a result of the tax programs. Nonetheless, in time this matter will be an increasing issue and I certainly hope the Ontario government is considering harmonizing its SR&ED plan with Quebec.

Canadian technology companies believe they might secure financing by participating in these events. The reality is, VCs don’t typically fund companies that participate in these events because the companies have already pitched (unsuccessfully) most of the VCs prior to the competition…

Rather than pitch competitions, we need events that provide support for our entrepreneurs. If we give entrepreneurs the education and tools they need to build successful companies, the money will come. We need to stop focusing on pitching and financing, and start focusing on education, networks and revenue.

There are some events in Canada that I would like to shine a spotlight on. These events are focused on entrepreneurs as opposed to VCs — which, in my opinion, is how it should be. Events like mesh, StartupEmpire and Entrepreneur Week provide opportunities for entrepreneurs to learn, build their networks, and develop strategic partnerships. I am also a huge fan of the “Camp” un-conferences (BarCamp, DemoCamp, StartupCamp, etc.) where entrepreneurs support and encourage each other.

VCs are at these events looking for entrepreneurs who are focused on building their companies. A couple of weeks ago, almost every VC firm in Canada was represented at StartupEmpire and the Founders & Funders dinner during Entrepreneur Week was packed with VCs — all of whom were working the room. Build a great company and we will be there (of course, by then, you might not need us, which is great).

And you probably have seen:
Ron Conway: Cut expenses now
Benchmark: Conserve Capital

Whether you are funded or embarking on fundraising, these are very well argued essays on capital management that might inform your approach.

I hesitate to add the following link because of the gratuitous use of the F-bomb, so be forewarned. However, Dave McClure does add an interesting counter perspective to the discussion

Dave McClure: Fear is the Mind Killer of the Silicon Valley

I concur with the need to focus on efficient deployment of capital. However, I would argue that there is an important difference in the Canadian VC market…

We have been living in a low liquidity market for 2 to 3 years.  At this point, liquidity in the Canadian VC market is lower than I have ever seen it and the specter of the formation of new capital pools gets bleaker by the day.

Attracting capital today is a monumental task.  A build it and they will come, “Field of Dreams”, strategy based on a solid dose of hope is not the kind of plan that would attract a lot of attention.

Companies that have been funded need to recognize that subsequent rounds are not an entitlement.  In fact, it is not necessarily the case that the existing syndicate will be ready to support you.  As we have seen over recent history, when a VC fund finds it has less capital than anticipated it will triage the portfolio in an attempt to allocate cash resources to the perceived winners.  At times, VC funds can use pretty crude metrics to make these decisions which do not necessarily take into account the fact that in technology the path from A to B is never a straight line.

The immediate reaction may be to reduce burn, which of course is pretty easy to do. You might not have much of a company left after blindly cutting costs but it can be  done.  Certainly, one wants to come out of the other side with a strong position in the marketplace rather than being the company that blew its lead due to timidity.  However, slide 49 in the Sequoia presentation is a sobering diagram.

So here is the question I think we all need to be asking:

How do you balance capital conservation with business priorities?
These discussions need to be held at the management level, at the board level, and with the investors.  It is likely there won’t be general agreement so a consensus will need to be built.

Obviously, the specific tactics will differ for every situation.  However for venture backed companies good shareholder management will be a key success factor.  For this, I can offer some general suggestions:

• Be realistic:
  • Your customers will change their buying patters.  Have you included this in your analysis?
• Over communicate with your investors:
  • Nothing is more frustrating than a portfolio company that only reaches out to investors when they need money. Failing to communicate puts your investors on the defensive immediately. If your VCs are half as “value add” as they told you they would be when they invested, they should be able to provide some very good input.
• Set expectations early:
  • Don’t be unnecessarily negative, but now is the time to deliver the bad news. Lay a realistic foundation as a basis to move forward. Setting this baseline now will hopefully keep you from having to spend half of every future meeting explaining missed targets that aren’t realistic in today’s market.
• Determine the ability/appetite of your investors to continue supporting you:
  • Selling your investors on your company is a continuous process.
• And last but not least, be upfront.  And ask your investors to be upfront with you.

Own all intellectual property
Any acquirer is going to want to know they are acquiring all IP rights. This means from early on you need to ensure the company owns all of its intellectual property. You need to ensure that everyone who has played a role in development has assigned their rights to the company. Specifically:

• All individuals who “touched” the IP prior to a company being formed need to have explicitly assigned the IP to the company. Even if you had friends help you brainstorm early on it is important that they sign IP transfer agreements.
• If developed in a university setting, all students will need to sign IP transfer agreements.
• Once incorporated, all employment contracts should explicitly state that the company owns all IP developed by the employees.

Standardize employment agreements
It will drive potential acquirers crazy if every employee has their own form of employment agreement. Best practice is to use one standard form of agreement for all  employees. Obviously items such as salary will change from employee to employee but the basic form of agreement should be consistent. This also makes negotiations with potential employees easier as you can simply say the form is non-negotiable.

Make option agreements comply with regulatory requirements
There is no significant cost to ensure your private company stock option plan is consistent with that of a public company so why not make it compliant from day one. This makes it easier for an acquirer as they will not likely have to take any accounting hits (stock based compensation charges) that could impact their willingness to complete a transaction.

Don’t have change of control provisions in option agreements
During the “bubble” there was a tendency for stock option plans to have a provision that provided for full vesting of options on a change in control (i.e. an acquisition). Today that is not the norm. Full vesting will scare an acquirer who will be concerned about the ability to keep the company intact after acquisition. If they do agree to proceed notwithstanding the acceleration, it will usually mean a reduced price because they will need to allocate some portion of what would have been included in the purchase price towards retention bonuses and/or new stock options to provide an incentive for employees to remain. Today’s market is such that only a handful of employees will usually have accelerated vesting – usually only the CEO and CFO as often both are not retained post acquisition.

Be consistent with customer terms and conditions
Do you have a standard set of terms and conditions that govern sales? If not, you should put a set in place immediately. While I realize early on you need to be flexible and work with customers, you want to try to be as consistent as possible. Ideally you want things like warranty periods and support hours to be consistent from customer to customer. You want to make it easy for an acquirer to get through diligence and standardized terms make it simpler.

Avoid complicated tax/business structures
At the risk of offending well meaning lawyers and other advisors, stay away from complicated corporate structures. Yes, in theory moving your IP to an offshore entity and then licensing back to Canadian and US operating entities may save you some taxes down the road but the reality is you are spending time and money up front for a benefit you will not realize until you are profitable. More importantly, you are unlikely to realize the benefit at all because you will likely be acquired before the benefits kick in. A foreign structure will make it more complicated for an acquirer who may even want the structure unwound before completing the purchase.