Words Heard / Our Take Title: Raising Private Equity in the New Environment What: Gowlings Technology Seminar Where: Marshes Golf Club, Kanata When: September 9, 2005 Who: Martin Aquilina & Andrew Foti, Gowlings Peter Charbonneau, Skypoint Capital What was said: Martin Aquilina set the stage by describing the new legal environment for selling securities such as common shares. A comprehensive disclosure document, the prospectus, is required and the selling activity requires a registered dealer. However, most early-stage financings do not require a registered dealer because they utilize permitted exemptions. The new environment, in effect since mid-September, was created in an attempt to harmonize the patchwork quilt of 12 sets of provincial exemptions. In the end, three classes of exemption were established: 1) private issuer; 2) accredited investors; 3) minimum investment amount. Note that these exemptions can not be used for sales made to the general public. A note of flexibility was sounded by the regulators through their willingness to consider applications from investors to become accredited investors. A counterbalancing note of rigidity was sounded by the removal of the right to syndicate when using the minimum investment amount $150,000. Andrew Foti then made the point that harmonization does not mean simplification for most firms. If your fundraising slide deck contains future financials or a term sheet, it is considered to be an offering document (and therefore requires a formal prospectus and the subsequent required securities legal advice and accountant-prepared statements). Your business plan will also be considered to be an offering document, particularly if it is prepared for the specific purpose of supporting fundraising efforts. Peter Charbonneau reprised the state of venture capital activity and that of the health of carriers and their competitors as a prelude to the supply of capital for early-stage firms. His forecast in one word: grim. The titles of two of his slides make that clear - 'Where Have All the Angels Gone?' and, 'Why Have They Disappeared'. The latter question he answered as follows: returns to angels on common shares have been dismal; their pool of capital has diminished; and too many investments resulted in workouts and turnarounds. One consequence is that there is a new breed of VC: Financially oriented denizens of the VC world have moved on to be replaced by those with company building experience. Our Take: Regulators have once again failed to recognize the fundraising reality of early-stage firms seeking angel (and not VC) funding. The reality is that most angel investors are willing to invest just $25,000 in any one early-stage deal, despite the fact that they may be investing ten times that amount across their total angel portfolio. The imposed fifty shareholder constraint means that early-stage firms can expect to raise a maximum of $1.25M from their accredited investors (angels). Unfortunately, this figure bears no relationship to the amounts early-stage firms require to reach cash-flow breakeven. But then again, perhaps it doesn't matter? Angels with cash to invest are harder to find these days and for good reason: the returns they expect to earn on common shares just aren't competitive with their investment alternatives. So long as technological ferment persists, entrepreneurs will seize the opportunity to apply their skill to build products/services that satisfy customers' needs better than existing solutions. However, under the new investment framework, they should do so knowing that customers are the route to cash, not angels. This customer-financed growth model should produce a flowering of firms built to last, not ones built for a two-year dash. Over time, this new environment could produce a generation of entrepreneurs who will create wealth by building private companies to sales levels of $20M over twenty years (the QNX story). With luck, some of these firms will become the next Cognos or Mitel. 708-350 Sparks Street, Ottawa, ON K1R 7S8, t: (613) 563 4588, f: (613) 563 4689, ourtake@acornpartners.com, www.acornpartners.com If you wish to unsubscribe, reply to this email with "unsubscribe" in the subject.