Archive for Q1 Blog

Hootsuite: The Road to Become Canada’s Next $1B Technology Company

At Q1, we spend an enormous amount of time researching and tracking Canadian technology companies and one of them is Vancouver-based Hootsuite. Chosen by many to be Canada’s next billion dollar company (aka unicorn), Hootsuite’s road to market leadership illustrates just how much money it takes to become a dominant player, how competitive an attractive and fast growing space can become and how difficult it can be to achieve the right liquidity event, whether that’s an IPO or a sale. Below is our look at Hootsuite’s journey.

Hootsuite's roadmap to success


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Venture Capital is Not For Everyone

Venture capital

Venture Capital Mindset by Dilbert

We are often approached by founders who believe that venture capital is a necessity to guarantee their company’s success. The VC community, to its credit, has done an excellent job of extolling the virtues of and benefits of this source of financing and one might think that the only way to build a successful tech company and exit at a great number is by tapping into venture capital. In fact, while a successful exit by a VC-backed company results in plenty of press, an equally successful exit by a bootstrapped company more often than not goes unnoticed. 

Venture capital plays a very important role in the capital markets and financing high potential growth companies but importantly, it is ONLY appropriate for certain types of companies and those that have phenomenal growth opportunities…a fact that many founders do not understand.  Matching the appropriate type of capital to the company’s opportunity is key and in light of this need to match, we thought that the following article would provide founders with food for thought.  

Eric Paley from Founder Collective wrote an interesting article detailing his thoughts on the negative aspects of rushing into a decision to bring on venture capital investment. Venture Capital is a hell of a drug strikes us as a very balanced view particularly when one considers that many founders do not understand the economics that drives VC investment decisions.  

As you read through the article put some thought into how Paley’s insights might have changed the outcome for Toronto-based Flashstock Technology.  Flashstock, founded December 2013, raised a total of $3.1 million in three rounds: $800,000 in January 2014 from a boutique New York-based VC and $2.3 million from two angels in rounds of $800,000 (June 2015) and $1.5 million (October 2006).  On June 28th, the company announced that it had been acquired by Shutterstock Inc. (NYSE: SSTK) for US$50 million

 The three main observations from Paley’s article are:

Venture capital increases risk for founders
Exit value is a vanity metric
Capital has no insights. Don’t trade a solid business for a lottery ticket

A more detailed summary and direct quotation from Paley’s excellent article follows.

Venture capital increases risk for founders in two ways:

It limits a founders exit

VC cash comes at the cost of reduced exit flexibility and the burden of an increased burn rate. Viewed probabilistically, the most likely positive exit for a start-up is an acquisition for less than $50 million. This outcome has little benefit to VCs, and they will happily trade it for an improbable shot at a higher outcome.

Entrepreneurs agonize over a percent of dilution while ignoring the fact that they are surrendering their most likely exit options for a low-probability shot at building a superstar start-up.

Founders often use the capital infusion to increase burn to dangerous levels 

Beyond signing away exit options, new venture capital typically is raised to fund higher burn rates. That increased burn rate is a great investment when it is being used to fuel a model that is working. Paley observes that more often, the increased burn is used to search for a model that works, and the company quickly learns that capital has no insights; it’s just money. Then the company cannot sustain the burn, the CEO decides to cut the burn way too late and cannot manufacture enough VC enthusiasm to keep the dream alive.

Paley puts forth his view that one rough rule of thumb is that start-ups should be able to triple their post-money valuation in two years. If founders can’t figure out how to get 3X leverage on every dollar they spend, then they are better off not spending the dollars — or raising them in the first place.

According to Paley, “founders need to think of venture capital as a power tool — a fairly dangerous one — but instead often mistake it for some magical, infinitely renewable resource. In the right hands, power tools can solve some real problems. Used incorrectly, they can chop off your hands”.

VCs need billion-dollar exits, founders don’t

Billion-dollar exits are brilliant, but they shouldn’t be how founders calibrate success. The mania for billion-dollar valuations is the result of the business model of the venture capital market — not some legitimate definition of start-up success.

Here’s a very rough illustration of billion-dollar VC fund logic:

VC raises a billion-dollar fund, needs to triple the fund to be successful
VC makes ~30 major investments
VC breaks even on 10, loses money on 10, needs remaining 10 to be worth an average of ~$300 million in proceeds to their fund

VC can only expect to own 20-30 percent of any given company (often less); anything less than $1 billion exit of your business isn’t a success in this model

This is why there is so much focus on billion-dollar exits. Not because this outcome is high frequency, but because a few massive funds need it to be so. Let’s not just point fingers at the billion-dollar funds. Similar VC math causes irrational trade-offs for founders whether their investors have billion-dollar funds or quarter-billion-dollar funds.

As a general rule of thumb, assume that your exit needs to be approximately the size of the VC fund to “matter” in its returns. Of course, this is the tail wagging the dog, as the capital gatherers are encouraging irrational behaviors of founders with a sales pitch of “go big or go home.” No one says the truth, which is “go big or ruin your life.”

When the founder’s business fails, which probability says it most likely will, that VC has 29 more shots on goal. You destroyed your single start-up, not to mention the wasted sacrifice over years of your life. In most VC deals, the investor is taking much less risk than the founder.

Exit value is a vanity metric

If one of a founder’s goal is making money, focusing on the exit price is a bad idea. It’s quite possible to sell a start-up for a billion dollars and make less than someone who sells theirs for $100 million.

Venture capital isn’t the right choice for most businesses, but when used well, it can be very powerful. Unfortunately, many VC-backed founders are using it incorrectly.

Eric Paley, Managing Partner, Founder Collective 

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Four Triggers that Drive the Sale of Your Business

Triggers that drive the sale of your business

Trigger the Value of Your Business

Events or developments, either sudden or creeping drive a Founder’s decision to sell their business. We like to call these the four triggers: Strategic, Operational, Financial, or Regulatory.

A February 2017’s  Nationwide’s latest Small Business Survey found that three in five small businesses do not have a succession plan in place and there is no reason to believe that the percentages are different in Canada.  In the survey, “small business” was defined as having fewer than 300 employees and in Canada, 90.3% of private employees work for companies with less than 499 employees.

Reasons cited for having no succession plan include:  business owners simply not believing a plan is necessary (47 percent); not wanting to give up one’s life work (14 percent); not knowing when to create a plan (11 percent) or who to work with (11 percent); not having time to develop a plan (11 percent) and being overwhelmed with government regulations (8 percent).

Whether you believe that good companies are bought and not sold really doesn’t matter, if you want to maximize the value of the sale of your business you have to plan and prepare, otherwise prepared to be disappointed.

Here are our four triggers.  Which ones are appropriate for your business now or a risk in the future?


-The industry is being consolidated and the Founder does not have the interest, capital or resources to be an acquirer.

-The Founder is approached by a competitor or financial buyer with an unsolicited offer that is attractive and meets with the Founder view on valuation.

-Unforeseen competitors have entered the market with a business model that disrupts the incumbents. Examples of this would be UBER disrupting the taxi industry, Airbnb’s disruption of the accommodation sector or Netflix disrupting the home movie and video game rental business.

-The industry’s largest competitor is spending tens of millions of dollars on state-of-the-art manufacturing equipment positioning themselves to significantly change the cost structure of the industry and your Company is not in a position to respond.


-The Founder is looking to retire and as their net worth is almost entirely wrapped up in the business needs to find an acquirer.

-The Founders health is eroding and there is no succession plan in place.

-The Company’s margins are being squeezed by changes in the sources and use of inputs. For example, an IT Services company with large financial sector customers must offshore a percentage of its development work in order to meet RFP requirements or client demands;

-The Company has built its business on enterprise software licenses and has not developed a plan or transition to a SaaS model. Consequently, the entrepreneur is having difficulty attracting the capital required to hire the resources for the transition.


-the Company requires investment capital to grow and sources are limited or too expensive.

-e-Commerce initiatives by competitors or suppliers are driving profit margins down. An example could be Amazon’s early entry into the book-selling business, or a Company’s supplier opening an -e-commerce site that now exposes your company’s margin information and sales to your customers.

-The Founder and his wife are divorcing and the family assets must be liquidated.


-New or changing regulations will change the Company’s growth and profitability opportunities. For example –The US government implements a “Buy American” policy on all new infrastructure projects, severely hampering a Canadian company’s export sales;

-Changes to Cross Border Services Agency (CBSA) regulations or Carbon Tax implementation negatively impact Company profit margins.


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What’s Happening at BuildDirect?


Difference Capital, Build Direct


One of the interesting aspects of having a public company such as Difference Capital Financial (DCF-TSX)  as an investor in private companies is that every once in a while an interesting tidbit of information can be found in public filings that can shine a little light on private company developments. Often, individual adjustments to Fair Market Values for small investments ($7 million) are not meaningful to a public company’s results but in this case, Difference’s size and investment model does make the adjustment meaningful and reportable.

So to the point, Difference Capital filed its FY2016 results which reported two interesting adjustments to its Fair Market Value calculations for its Internet investments: a write-down of its investment in BuildDirect and a small write up in its investment in Vision Critical. Technologies Inc. (“BuildDirect”) In October 2016, the Company (being Difference Capital) invested an additional US$1.1 million in secured convertible promissory notes of BuildDirect. During 2016, the Company made fair value adjustments to its investment in BuildDirect common shares based on the debt financings completed by BuildDirect and qualitative observations reflecting the current financial situation of BuildDirect. The adjustments resulted in $9.5 million of unrealized loss during the year.

I would note that during 2014, Difference purchased $2 million of BuildDirect common shares, bringing its total investment to $7 million and also recognized $2.5 million in unrealized appreciation on the value of its investment.  I’ve always found the BuildDirect business model very attractive, albeit a tough one given its earlier focus on becoming the “Amazon” of heavy-weight building and renovation products like marble and granite flooring and composite and wood decking.  I’m a big fan of co-founders Jeff Booth and Rob Banks and they were building a great company so I really would like to see them succeed.  I may be wrong but I’m “guessing” that the Company’s product line expansion into very competitive categories like appliances and home decor where it holds zero advantage may have partially negated their very unique differentiator and first mover advantage.  If that is, in fact, the case and the Difference Capital markdown is an indication of challenges at the business it may be time to “get back” to doing what they did well.

The second Fair Market Value adjustment Difference Capital made was to mark up its private investment in Vision Critical Communications by $0.6 million.  Obviously, that’s a positive indication.

The Fair Value reported as of December 31, 2016 for both Hootsuite Media and Scribble Technologies were not adjusted and continued to reflect the Average Cost reported on Difference’s Balance Sheet as of December 31, 2015.  Looks to me like Hootsuite may have been “growing into” its valuation during 2016.  We need more tech company winners so I’m hoping that bodes well for a 2017 public offering.

Please note that: the decision to make these adjustments was made by Difference Capital as part of its public reporting obligations and may not reflect the view of other investors in the private companies; and, the adjustments are reported as “unrealized gains or losses” and are subject to future adjustments depending on market and company conditions.


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How SNAP’s IPO valuation stacks up

With SNAP being watched so closely as an indicator of an OPEN IPO market I would think that all technology investors are keeping their fingers crossed. SNAP’s performance post-IPO (Company & stock price) makes this Company more important than its actual significance to the technology space. I don’t want to be a Debbie Downer but this chart does not give me the warm and fuzzies. Just wish that the first out of the box was a stronger company…

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Cassius Marcellus “Cash” Coolidge – Dogs Playing Poker 1903

Wednesday, March 1, 2017: The market is excited about the IPO of a company that is not profitable. Jim Cramer is already pimping the stock as a “phenomenal trade”.   I’ve been at this game for more than 25 years, and I know a rerun when I see one.  This looks to be a tired remake of the old poker game played in the 1990s. And even though we all know how this game ends (Market Watch), we can’t stop ourselves from watching or asking the dealer to cut us in. Enjoy!

Forget PokerStars and Amaya, that’s soooo 2000’s. The new big stakes game in online poker hits the street tomorrow with the SNAP IPO, only this time the rules of the game are different. The early players sitting at the table from Lightspeed, Benchmark, IVP, and Kleiner placed their bets and round after round the value of the pot increased. Snap’s co-founder, Evan Spiegel is sitting at the table as the dealer, maintaining his poker face, shuffling the deck, dealing the cards, all the while talking about really cool Snap Spectacles and Bitmojis…step right up, everyone’s a winner!

After nine trips around the table and $2.65 billion in the pot, it’s time to raise the stakes. The Morgan Stanley, Goldman Sachs, JP Morgan, et al. investment bankers sitting at the table, hands sweaty with excitement begin to look for new players to join the game. We gotta take this game on the road and find some pigeons!

The pace of the game slows as the search for new players kicks off with the “road show”.  London, New York…the dealer keeps asking 

“Who are these guys and why are they asking these questions about Snap’s business model, stickiness, slow growth, competition and of course the dual class of shares.  What do they mean, our growth curve looks more like Twitter than Facebook? Look guys, real investors don’t understand the value of Twitter.  It must be a very bigly valuable company if POTUS loves using it.  And competition?? How good can they be?  My girlfriend Miranda, did I mention that she was a Victoria’s Secret Angel, doesn’t think much of Facebook because they keep stealing all of my ideas. I was the one that came up with the idea for disappearing pictures and yes, they really do disappear and I promise they will never come back to haunt you because they are not stored somewhere in the cloud, whatever that is… and who else had the foresight to buy Bitstrips for $100 million?  I just love those funny little comic faces, makes me laugh all the way to the bank. A lawsuit about misleading user growth metrics, bah humbug. Look what I did with the last lawsuit…a quick $157.5 million settlement and it went away, it’s not like it’s my money! And just so we’re perfectly clear, it’s not software that’s eating the world, it’s consumer hardware products!  Just look at the successful GoPro and Fitbit IPOs and those guys with the fancy Flip camera, boy did they do well when Cisco acquired them…besides, who is that Andreessen guy and what has he ever done?”

Ok, let’s cut to the chase, our dealer and his buddy Bobby get your money and keep control of their business as well…nothing to share here 

The bankers calm everyone’s nerves… 

“Everyone relax, we’re off to a slow start but just wait until we hit the west coast, they’ll love ya and just to make sure we’ve signed up with Twitch so that millions of players can watch the game”.  

Monday and Tuesday go like clockwork and by Wednesday numerous news sources are saying that the deal is “multiple times oversubscribed”  Tough decisions to make, the ducks are quacking and it’s time to feed them – do we increase the issue price? increase the size of the issue? or both?…decisions, decisions.

Tomorrow’s the big day, the bankers want to make sure that we don’t price too high or we won’t get the big first-day bump.  Gotta make money for our IPO investors because they pay for our place in the Hamptons and besides, the Company shouldn’t consider the IPO being priced below market, it’s really just the cost of publicity. We need excitement, froth, FOMO and just let the human greed do its thing.

The Cristal is on ice, Evan and Bobby get their Cheshire Cat emojis ready to snap when he rings the bell.  The new “Investors” who subscribed for shares may have been cut back on their allotment but nonetheless, their traders have their twitchy fingers on the sell key.  The bell rings, shares trade hands at a frenzied pace and ever rising price. The “investors” are having a great day…early players at the table reach into the pot and take back their money and lots more. The dealer smiles and fills his pocket, still wondering if this is all a dream.  Miranda assures him it’s not, “we’re just playing our part to help make America again”.

Over the next couple of weeks Snap’s share price peaks and then begins a slow descent as the first day buyers begin to understand that they didn’t pay for ownership in Snap, only the chance to ride a roller coaster held together with funky glasses, a product that really isn’t that special and a burn rate that sucks, not to mention the lack of a business model or any visibility to profitability.  Not to worry, Snap will figure out a way to monetize all of those kids…we can push them advertising for sugary drinks, driverless cars, the newest smartphones or the next Star Wars episode.  Hang in there, it’s going to take at least six months to see what’s really going to happen. By then we’ll know if Snap is worth tens of billions of dollars, but let’s hope we have a sense before escrow shares become freely trading!  Maybe it’s time for the first-dayers to cash in what’s left of their table stakes and drag their butt home.  

Oh well, there always a chance to win big when WeWork does an IPO.  Surely there are great prospects for that company with long term fixed liabilities matched by short term contracts signed by a young transient workforce.  

Can anyone say Regus, vintage 2003?


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No Doubt – Interesting Year Ahead

Image courtesy of randalldsmith

As we move into 2017, industry pundits are almost unanimously calling for a strong year for both M&A and IPO markets.

According to Global Capital Confidence Barometer conducted by E&Y, the general consensus among corporate executives is buoyant and full of optimism on the prospects for 2017 with 57% of executives expecting to pursue acquisitions within the next 12 months and 49% of those surveyed already having more than five deals in the pipeline.

While we certainly look forward to 2017 being a very positive year, we’re thinking that for companies north of the border “interesting” and “unsettling” may turn out to be better descriptors.


On the positive side:
  • 2016 finished on a very strong note with M&A announcements fueling expectations for a very strong 2017;
  • Certainly moving into 2017 capital market sentiment continues to be bullish;
Down Jones Industrial Average (Trailing 5 Year to January 15, 2017) NASDAQ Composite Index (Trailing 5 Year to January 15, 2017)
S&P 500 Index (Trailing 5 Year to January 15, 2017) S&P/TSX Composite Index (Trailing 5 Year to January 15, 2017)
Source: BigCharts

  • Stock prices continue to trade close to record-high levels, in large part due to the potential of: lowered US capital gains and estate taxes; the possibility of reduced taxes to incentivize US corporations to repatriate offshore cash holdings; a less restrictive regulatory environment; and, future stimulus spending;
  • Cash balances continue to grow on strategic buyers’ balance sheets, there is plenty of undeployed capital at private equity funds and debt financing is readily available;
  • While the stock markets drive higher, overall GDP growth 0f 3.0% will continue to drive the necessity for companies to make strategic acquisition to maintain competitive positioning and meet market expectations. Acquisition drivers will include increasing digitalization, changing business models (SaaS, Blockchain), entering new markets and pursing product extensions;
  • Interest rates, despite the forecast for an increase, remain near or at historic lows;
  • CAD/USD exchange rate continues to make Canadian companies attractive to US acquirers;
2017 Yield Durve
Source: InvestingForMe
Canadian Dollars
Source: Bank of Canada


So how do we see the upcoming year unfolding?
  • The uncertainty experienced during the run-up to the US election ended in November. Unfortunately, a new type and level of uncertainty is now beginning to take hold. Only time will tell as to the ultimate impact of the new Trump presidency, regime and GOP majorities but I’m pretty confident that you can count on three things: Canadian exporters could find it a very rough go during the next four years; markets hate uncertainty and associated risk so we can expect to see increased volatility, and traders are going to make tons of money in volatile markets.
  • It’s anyone’s guess as to the near and long-term impact of impending NAFTA discussions. While it appears that the main focus could be on the US/Mexico relationship it is difficult to see where there is any upside for Canadian companies in any renegotiation.
  • Probably more important than any NAFTA discussion, the possibility of the US implementing a “border adjusted tax” which would apply to goods imported by US companies would present huge challenges for Canadian exporters. Not only would such a policy have a devastating impact on Canadian exporters, I believe that it would also reduce US acquirer interest in Canadian companies while at the same time forcing more Canadian companies to look south of the border to acquire companies to protect market share and revenues.  In effect, the pool of potential buyers of Canadian companies could get smaller.
  • Large private companies and their institutional (VC and Corporate) investors have been sitting on the sidelines waiting impatiently for the right “market” to take their companies public. The first pure technology company out of the box in 2017 would have been AppDynamics (APPD-Nasdaq), an application performance management software company looking to complete a US$132 million offering priced in the $10 to $12 range.  Founded in 2008, AppDynamics reported revenues of $206 million for the 12-months ending October 31 2016 and is looking to value the firm on IPO at $1.76 billion or 8.5X trailing revenues.  Unexpectedly,  Cisco stepped in just the day before AppDynamics was to set its IPO pricing and acquired the business for US$3.7B or approximately 18X trailing revenues. So much for our first technology IPO test case of the year…
  • IPOs in both the US and Canada should rebound but we would expect to see valuations moderated towards the lower end of company and the bankers’ expectations, but this may change as a result of the large premium to IPO price that strategic buyers, like Cisco, was willing to pay for AppDynamics.
  • With the current S&P 500 PE Ratio in the range of 26.1 (historical mean 15.6), the Price to Sales Ratio in the 2.0 range (historical mean 1.4) and the Price to Book Value at 2.97 (historical mean 2.75) valuations for the broader market are high relative to historical levels. Near term valuations appear poised to rise but in longer term one should expect to see valuation levels decline closer to “normal” levels.
S&P 500 Price to Earnings Ratio
S&P 500 Price to Sales Ratio
Source: Multpl


The obvious:

  • Cybersecurity will become a “more” dominant theme in 2017 (duh!)
  • Sub-$50 million acquisitions will continue to dominate the number to M&A transactions;
  • Sluggish growth for companies competing in the small to mid-markets may lead to owner fatigue and accelerate their interest in looking for an exit;
  • The “biological imperative” (read – getting older) will continue to drive baby boomers to look for exits;
  • Slow organic growth rates drive buyer’s acquisition strategy.


And lastly, let’s go out on a limb!

The Canadian public markets appear to have an appetite for strong technology companies à la Shopify, less so for public tech companies like ViXS Systems (VXS-T).  There is a dearth of large cap Canadian public technology companies and I’m pretty sure that many investors want to see if Hootsuite, Vision Critical, Desire2Learn and BuildDirect present great investment opportunities. Looking into my crystal ball I see Hootsuite filing for an IPO but at a valuation less than $1 billion, BuildDirect, which has drawn the attention of Goldman Sachs with Co-founder Jeff Booth being named one of Goldman’s 100 Most Intriguing Entrepreneurs of 2016 also filing for an IPO, Vision Critical taking additional steps to prepare for an IPO but not in 2017 and Desire2Learn not going the public market route but is instead acquired.

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The Huge Problem with Online Ordering that Nobody Talks About

The article by Jordan Thaeler about the rise of on-demand businesses and the bottom line impact that these business models can have on the restaurant/retailer merchant provoked some interesting thoughts.  In particular, the table detailing the pricing for a selection of providers is an eye opener.  Ultimately, I would expect two or three players to dominate each supplier sector as merchants gravitate to single source suppliers that generate maximum exposure and revenue at a reasonable cost.  Alternatively, the end user can pay a fair share for the convenience of on-demand services and we all know how that will go over.  Twenty percent of users will pay the price while the remaining 80% of free riders will move on to the next ‘disruptive” model.

*Click here to read the article.*

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The Fintech Wave hits Canada

John Stackhouse, Senior Vice-President, Office of the CEO at RBC  penned a brief article on Fintech.  Three interesting data points of interest:
Fintech adoption rates in Canada are comparatively low –  only 8% of digitally active Canadians had used at least two fintech products in the last six months, compared with 17% in the U.S. and 29% in Hong Kong;
The sector’s growth has been exponential. McKinsey & Co. says there were 1,640 companies in its global fintech database last year, compared with 475 in 2010. The number of Canadian firms in the group jumped to 73 in 2015 from 21 in 2010;
Competition is fierce–global fintech financing reached US$19 billion last year, and the 18 biggest firms had a combined worth of US$50 billion, according to McKinsey.

*Click here to read the article.*

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Canada’s Technology Investment Gap

Yaletown Partners released a short research study and while the paper has a couple of interesting observations, it’s obviously a document to help support their current Yaletown Emerging Growth Fund initiative to raise $135 million. Yaletown’s conclusion was that the capital supply to technology companies was both insufficient and inadequately distributed beyond early stage.   No surprise here…it wasn’t that long ago that I can remember constant complaints from founders that there was no early stage funding available and a view that Canadian VCs were generally risk averse, hence their preference for later stage funding.  We’re now in a phase where early stage financing has been in vogue probably driven as much by high valuation expectations of Series B and C ready technology companies and less by the general VC population’s desire to focus most of their attention on higher risk early stage investing.  My question is: if the VC community is moving to early stage funding, who is going to be providing the follow-on capital for those companies?  Answer: the US VC’s who are becoming very active participants in Series B and C rounds and who have the capital to take a company to the next level, generally with a lower level of risk.

Research highlights from the Yaletown website:

    – The average financing size for Canadian companies is less than one-third of the level in the United States.
    – Companies in the United States are 2.6x more likely to raise $5 to $25 million emerging growth financings.
    • – Since 2000, disclosed exits in Canada valued at greater than $100 million raised on

average 50% less capital

    • compared to those in the United States. Exits valued between $100 and 250 million take

2.5 years longer

    and are half as frequent as in the United States.
    – Since 2000, large exits, greater than $500 million have occurred in 1% of all disclosed Canadian exits versus 10% in the United States.

My take:  Less capital, fewer exits, longer time to exit = more risk.  Nothing has changed.  You don’t have to dig deep to understand why we’re not seeing a wave of multi-billion dollar Canadian tech companies!

*Click here to read the research study*

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