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 Is Your Boat Starting To Float?
Is Your Boat Starting To Float?
The good times are back again. The Canadian economy is healthy, interest rates look to go up this summer and companies are hiring. In the technology industry in BC, the outlook is a lot better now than it has been since late 2007. As someone that lives (and dies) in the world of technology finance and acquisitions, I am well positioned to see where sentiment is at among the investors and the entrepreneurs... in a word: buoyant.
The optimism has translated into positive results for many companies. Growth is back. We can throw out cynical phrases like "flat is the new up". That’s so 2009. Generally speaking, it’s a better time to raise capital. I say "generally speaking" because it depends on where you are in the growth of your company. In the early stages of a recovery (now), the money that is generally available and ready to invest first is the larger pools of capital into the later stage opportunities. Typically this is private equity. The earlier you are, the worse it gets at this stage. It is still tough to get venture capital money and even tougher to get raw start-up capital. To understand the reason for this "backward" thinking, let’s get inside the head of an early stage venture investor. (Beware, some vast generalizations are coming and do not represent everyone’s point of view).
After spending like drunken sailors and investing at "high" valuations in 2007, the downturn brought a world of hurt to the early stage investor. Companies went belly up and those that didn’t were fed meagre capital scraps to stay alive. Venture investors call this "portfolio triage". Through mid-2009, new deals were incredibly difficult to get done because existing companies took priority. Now the sun is starting to shine. Where does the early stage investor want to invest? Well, since returns have been dismal for two years, the investor wants a quick hit – a meaningful return in short order. That only comes from later stage companies being primed for an exit of some type. So, breakeven or profitable companies get priority over start-ups. But wait... aren’t the early stage investors supposed to, well, play early? Aren’t there private equity investors ready to fund later stage, profitable or nearly profitable ventures? Yes and yes.
The result of this collision of private equity and venture capital is that it’s easier for later stage companies at this part of the cycle and they tend to get higher valuations (a classic over-supply of capital). Add to the current situation this glaring fact: the "dry powder" in private equity is at all time highs. That is money not yet placed in these massive funds. In the US, $400 billion of dry powder exists after large funds were raised 3-4 years ago and few investments were done in the past two years. I speak to dozens of these PE funds, focused on technology, every week. They are all looking to place capital now.
So in the rush to improve returns, early stage entrepreneurs are left scratching their heads wondering why, with a "buoyant" sentiment, they aren’t getting funded? Or if they are, it isn’t at better terms? The only thing I can offer is to have patience. The trickle down effect will be that a decent IPO market and a jump in M&A activity will generate the "exits" that early stage investors need. Their renewed confidence will have them investing in the proverbial "ten-bagger" opportunities soon. It will be probably another year or so, but the boats will once again be floating in this "buoyant" market.
By Brent Holliday, Technology Practice, Capital West Partners. Brent can be reached at: brent@capwest.com
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