Category: Money

How Tech Investors are Failing on Due Diligence

This last couple of weeks I’ve been working on a due diligence team looking at a potential investment. As the only accountant on the team it can get pretty lonely.

In September Noam Scheiber of the New Republic published an interesting article on how due diligence really works for a great many early stage investors.

Noam Scheiber article

According to Mr. Scheiber, Seth Bannon was in his late 20s, had the requisite beard…and raised $3 million for his startup from Y Combinator and a number of angel investors. Somehow – when no-one was looking, he managed to rack up liabilities for $500,000 in unpaid employee source deductions, $100,000 in legal fees and a $90,000 penalty to the IRS.

Seth Bannon with requisite beard
Seth Bannon with requisite beard

For the most part my colleagues don’t get the idea of financial due diligence. First, they don’t seem to think there is any point in getting financial statements reviewed by a professional accountant. A good deal of the information investors should be looking at is contained in a properly prepared set of financial statements.

Even if you’re going to end up valuing the IP, and ignoring the operations for the most part, it is comforting to know that someone has done some work to substantiate assets and liabilities – so investors aren’t later ambushed by undisclosed liabilities or option agreements that might put the corporation’s status as a CCPC or an eligible business corporation at risk.

The last 2 companies I’ve looked at have had financial statements prepared by the same firm of public “accountants”. In spite of a fairly complex (for a startup) capital structure, neither company had even prepared notes to the financial statements. As a professional, I typically find as much of interest in the notes as I do in the financials.

In both cases there were operations in 2 or more countries and the accountant was really a bookkeeper with little or no training in accounting. Admittedly he is a university graduate and has a Phd from Cambridge in something or other – if his website can be believed.

My point is, if I am performing due diligence on an early stage company I don’t really have time to perform due diligence on the financial statements as well.

Differing Views of Innovation in Canada

Do concerns regarding the effectiveness of Canada’s SR+ED Program stem from an incomplete understanding of the state of innovation in Canada?

 As recently as September 9th of 2013, the Conference Board warned that “Canada’s economy is on a ‘path to mediocrity’ as innovation lags”. At about the same time the Startup Genome was reaching a much different conclusion. Their dataset was heavily skewed towards early stage startups. The report was co-authored by a number of entrepreneurs, included contributions from Steve Blank (Stanford University) and Ron Berman (UC Berkeley), and was supported by Telefónica Digital – a global business division of Telefónica S.A.

According to STARTUP GENOME study, Toronto, Vancouver and Waterloo are 8th, 9th, and 16th respectively in terms of their importance as global technology hubs. If this is true – and I expect that it is – it may be in large part due to our generous tax incentives. While the US dominates with 6 recognized technology hubs, Canada is clearly performing well with 3 in the top 20.

In their view the greatest challenge facing early stage technology companies is clearly access to capital for commercialization:


  • “If Toronto does not improve its funding climate, entrepreneurs may relocate to the nearby Startup Ecosystems of NYC and Boston where funding prospects are much better.”
  • “Toronto’s startup ecosystem is self-sufficient. However, policy makers can help closing the funding gap by attracting late-stage venture funds through tax breaks and incentives, and investor-friendly policies.”
  • “The funding climate for startups in Vancouver is insufficient, with startups receiving 80% less funding than startups in SV. They receive 72% less in Stage 2 (Validation) and 97% in stage 4 (Scale).  The late stage funding market basically doesn’t exist for Vancouver startups.”

Perhaps the Startup Genome’s perspective is different because they are closer to the action and focused more on start-ups than the Conference Board of Canada. Certainly companies at this very early stage lack resources and experience. As a result, in some ways they actually need more sophisticated help than their later stage counterparts.

In any event it is important to recognize our successes and I believe that Canada’s SR&ED incentive program continues to be a success. The emergence of Toronto, Vancouver and Waterloo as global technology hubs certainly owes a debt to the SR&ED program.

In recent years there has been a great deal of discussion about Canada’s inability to leverage our investment in R&D incentives to improve productivity. I believe that it is the lack of venture capital for commercialization that is the real culprit. However there are certainly some ‘intellectuals’ who have an almost religious aversion to government incentives of any kind. In fact we shouldn’t forget that our current prime minister is a former head of the National Citizens Coalition – a right wing ‘think tank’ that closely resembles the Tea Party in the US.


The SR&ED program was originally introduced by Canada’s progressive conservatives in 1985. At the time Canadians were viewed primarily as ‘hewers of wood and drawers of water’ and R&D was done in the corporate headquarters of US-based multinationals.

Recently concerns in Ottawa around the effectiveness of the SR&ED program culminated with the Jenkins Report that made the same mistake that the Conference Board made in September of 2013″

…from the Jenkins Report (2011):

“the panel believes the government should rebalance the mix of direct and indirect funding by decreasing spending through the SR&ED program and directing the savings to complementary initiatives strategically focused on serving the needs of innovative Canadian firms, especially small and medium-sized enterprises”

…from the Conference Board of Canada (2013):

“The federal government recognizes that, despite its high level of federal R&D support, Canada continues to lag other countries in business R&D spending, rates of commercialization of new products and services, and productivity growth”’

The notion of reducing or eliminating the $3.6 billion SR&ED program sits very well with a government that detests taxation – particularly leading up to an election year. But don’t hold your breath waiting for Jenkins’ “complementary initiatives strategically focused on serving the needs of innovative Canadian firms, especially small and medium-sized enterprises”. These kind of direct funding initiatives will clearly not make it before the election budget is delivered, since the beneficiaries are too far removed from – and misunderstood by – middle class voters that all politicians are trying to appeal to.

For traditionalists perhaps it is comforting to realize that Canada is once again becoming a primarily resource-based economy. We appear to have pinned our hopes on the oil sands in Alberta and liquefied natural gas in BC – to the dismay of manufacturers in Ontario and Quebec. Canadians can now choose to firmly embrace the 19th century and ignore those troubling ‘left-wing” notions of climate change and evolution – that our avowedly fundamentalist prime minister seems to have such difficulty with.

Subordinated Debt (aka “sub-debt” or mezzanine financing)


according to Wikipedia:


In finance, subordinated debt (also known as subordinated loansubordinated bondsubordinated debenture or junior debt) is debt which ranks after other debts should a company fall in to liquidation or bankruptcy.


Such debt is referred to as ‘subordinate’, because the debt providers (the lenders) have subordinate status in relationship to the normal debt. A typical example for this would be when a promoter of a company invests money in the form of debt rather than in the form of stock. In the case of liquidation (e.g. the company winds up its affairs and dissolves), the promoter would be paid just before stockholders — assuming there are assets to distribute after all other liabilities and debts have been paid.


Subordinated debt has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, and ranks below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors. Because subordinated debts are repayable after other debts have been paid, they are more risky for the lender of the money. The debts may be secured or unsecured, but have a lower ranking priority than that of any senior debt claim on the same asset.


Subordinated loans typically have a lower credit rating, and, therefore, a higher yield than senior debt. While subordinated debt may be issued in a public offering, major shareholders and parent companies are more frequent buyers of subordinated loans.



Most lenders lend against assets. In other words they register an interest in the borrower’s property as collateral, in case the borrower defaults on the loan. However some commercial lenders – or “quasi-commercial lenders” do issue sub-debt to growing companies that have turned the corner to profitability. For these emerging companies, sub-debt can be an alternative to asset-backed borrowing.

Clearly sub-debt is expensive when compared to more traditional asset-backed loans. However it is much cheaper than equity financing.

Not all lenders offer subordinated debt products. In Canada the Business Development Bank is one alternative. For BC-based companies VanCity offers alternatives as well



Here are some typical scenarios:

Management buyouts Subordinate financing can provide the necessary funds for an existing management team to invest in a company and launch an MBO.
Mergers & Acquisitions Naturally involve both fixed assets and more difficult-to-finance intangible assets such as “goodwill.” Subordinate financing can help companies purchase the goodwill while preserving their cash flow during a period where some uncertainty may exist.
Working capital for growth Subordinate financing is often used to finance working capital for growth, which enables companies to increase revenues and profits. Entrepreneurs looking to invest money in market penetration, improve product R&D or finance additional headcount can take advantage of subordinate financing without compromising their regular cash flow used for daily operations.


Creating Customer Value

What is Value Anyway? (Why Creating Customer Value is at the Heart of Building a Business)

The following is Part II of a multi-part series on value, segmentation and pricing by guest contributor Steven Forth, Partner at Rocket Builders and eFund Member. Read Part I here.

Steven ForthThe founder of modern management, Peter Drucker, famously said that the purpose of a company is to create and keep a customer.

It is about customers. You can only build a real business if you can get customers and then keep them. And you keep them by providing value.

But what is value? It is one of those words that we use all the time to mean many different things. But in business it means

  • The value that you provide to a customer
  • Relative to an alternative

The money you spent developing your product or how much it costs to deliver your service is not its value. It’s value to the customer and not the cost to you.

But I still haven’t said what I mean by value. So here we go …

Value is an emotional or economic benefit to the customer. In most cases, emotional value is more important in business-to-consumer (B2C) and economic value is more important in business-to-business (B2B) but in both cases there are cross overs.

It is true that some consumer products are sold primarily on their economic benefits. We often buy at discount stores in order to save money. But let’s face it, we often do this because it makes us feel that we are saving money and not because we are actually adding up all the costs of driving, parking, buying more than we need and those inevitable impulse purchases. Emotions govern consumer purchases.

The best way to understand emotional value in the context of Maslow’s hierarchy of human needs.

Basically, the higher your appeal the higher the price you can realize. Companies that position themselves on self-actualization (Apple comes to mind with its Think Different campaign or locally Lululemon and itsmanifesto) will command higher prices and higher profits. Companies that pitch themself to appeal to more basic needs will find prices pushed down closer to their costs and will have to make this up on volume (think Wal-Mart). The problem with this is that most start-ups and even most Canadian companies will not be the cost leaders, and competing on cost for basic needs is a tough place to be.

Economics governs B2B. If you are developing a B2B product or service ask yourself “How much money does I make for (for, not from) my customer? You can help your customer make money in different ways.

  • Revenue
    • Can you help your customer access a new market?
    • Do you help them increase market share in an existing market?
    • Do you help them win bids against a specific competitor?
    • Do you help your customer provide additional value?
  • Costs
    • Do you reduce costs, not because you are cheap, but because you simplify some part of their business or make it more effective>
  • Operating capital
    • Do you reduce inventory costs?
    • Can you accelerate collections?
    • What impact do you have on your customer’s financing costs?
  • Capital investment
    • Do you help defer a major investment by increasing capacity?
    • Do you make the capital asset more effective or less costly?
    • Do you help shift costs onto the balance sheet so they can be amortised? (Public companies tend to like this)

Of course, different customers will get values from you in different ways, and in different amounts. This is why value is such a powerful way to segment a market and target customers (see the previous post on Why target market segments). And ideally you want your price, how much you charge, to track how much value your customer is getting (that will be the subject of the next post).

Not everything translates into economic value of course, but in B2B, when you push a little deeper with your customers, you can be surprised just how much actually ties back to the economics. For example, there is no question that brand strength can influence B2B buying decisions. “Nobody ever got fired for buying IBM.”

Ed Arnold, VP Product at my old company LeveragePoint, has a great post on how to quantity intangibles like brand strength. He once told me about a dialog that went sort of as follows:

  • Sales Guy: “People buy us because of our brand.”
  • Ed: “OK, what is the most important thing about your brand?”
  • Sales Guy: “Reliability. Our stud just doesn’t break.”
  • Ed: “Why does that matter?”
  • Sales Guy: “Our customers rely on us to keep operating. If our stuff breaks then they go down. It can cost them millions.”
  • Ed: “So there is an economic benefit. What does it cost a customer when they go down? And how much do you reduce the risk of that happening?”
  • Sales Guy: “Huh, I’m not sure, but I can talk to our customers and find out.”

That’s it. Talk to customers and find out. But you have to know what you are trying to find out and that is how much value you provide compared to the alternatives available.

You have to be careful when you talk about customer value. If you Google the term you will find that most results are about how much value the customer provides to the seller. And there are lots of consultants and some software tools that will help you segment your market by the most profitable (to you) customers. This is a great way to refine an established business, but it is a terrible way to think about start-ups.

As a start-up your first job is to figure out how to create differentiated value for a specific group of customers (aka product/market fit).

And then make sure that your unit economics make sense. (Unit economics is the cost of selling something relative to the net revenue you get from selling it.)

So get out there, and have conversations with your customers or target customers about how you provide value. And what the customer sees as the alternatives.


Rocket Builders will be coaching growth companies on how to use segmentation to choose a market entry point in the Rocket Builder’s Go-to-Market Program. This program is designed for early-stage companies that have initial customers and want to accelerate growth and attract investment.

Steven Forth is a Vancouver consultant, investor and serial entrepreneur. He is a partner atRocket Builders where his work is focused on market strategy including market segmentation, pricing and the design of revenue generation systems. He invests througheFund where he occasionally leads due diligence teams. His newest venture isNugg, a VentureLabs start-up building a platform for team building and collaboration.

Popular Boomerang eMail App Founder Advises Against VC Funding

It’s time to stop chasing VC funds already

Alex Moore co-founder of Baydin, Inc – developer of the popular Boomerang email app – advises against wasting time chasing VC funding.

For his company – and probably for most other early stage companies that is sound advice. Moore and his wife and co-founder Aye Moah, chose not to pursue venture capital funding and focus instead on managing their business. The fact is that their business is really a ‘lifestyle’ business. But what is a lifestyle business?

While many investors think of the term as a negative – current thinking even among many VCs is that companies need to focus quickly on gaining traction. Traction allows companies to survive. If companies don’t have traction they won’t have enough resources to waste chasing investment.

Entrepreneurs need to be honest with themselves and understand their motivation. Do they really want to to build and run a business, or do they just make a lot of make money?

The fact is that it’s hard to build a business. Making a business that has value requires dedication, creativity and a certain amount of luck.

Are Tech CEOs too Focused on the Exit?

A 2014 survey by PwC indicates that most Canadian tech CEOs are focused on an early exit by way of acquisition.

MandA Survey

While PwC concludes that more companies should plan to grow their companies, for my part I am pleased to see that CEOs are becoming more realistic. The fact that only 7% believe that an IPO is the most likely exit, demonstrates that CEOs get it. It is a huge culture shift for companies to evolve from an agile private company to a successful public company.

However companies that want to grow their companies can also look at an MBO (“Management Buy Out”) as another viable exit strategy for angel investors – at least in some circumstances. For BC-based companies the BC VCC Program helps reduce the risk for angel investors. Once a company has traction and has turned the corner to profitability, there are many more conventional financing options available. Mezzanine financing can be used by profitable companies to buy out angel investors particularly where a proven management team is behind the deal. The money isn’t cheap – but it is cheaper than equity!



Towards a National Securities Regulator

The status quo for securities regulation in Canada is really a disaster. Globally we are a tiny market with a population of only about 35 million. In spite of this we have 13 separate securities administrators. Compare this to the US with a single national securities regulator and a population of 314 million.

On July 9 of 2014 according to Reuters, the Federal Government that Saskatchewan and New Brunswick have joined BC and Ontario in pressing for a single national securities regulator.

After decades of failed attempts to get all 10 provinces to agree to a national regulator, Ottawa and the governments of Ontario and British Columbia announced last September that they would go it alone and set up a common capital markets watchdog, similar to the U.S. Securities and Exchange Commission.

The hope was that more provinces would join over time and that the current patchwork system of regulators in each province and territory would be replaced with a national system that would be less costly for companies and governments.

Ontario is Canada’s most populous province and home to Canada’s financial services industry and largest stock market. British Columbia is home to a large number of the country’s mining companies.

The four provinces that have joined the project represent 55 percent of Canadian market capitalization. Saskatchewan and New Brunswick represent only 3 percent to 4 percent of market cap but bring important advantages:

– Saskatchewan brings representation from the Prairie provinces and has mining and oil companies, important in the Canadian economy

– New Brunswick has the largest regulator in the Maritime provinces.

Two additional deputy chief regulator positions are being created, representing Western and Eastern Canada, on top of deputy chief regulators for each of Ontario and British Columbia.


The lower the CEO salary, the more likely a startup is to succeed

According to The Next Web the founders of successful startups pay themselves very modest wages.

The data comes from a new tool called COMPASS from the people behind the STARTUP GENOME PROJECT. It can be set up to pull in data automatically from the likes of Google Analytics, Salesforce, MailchimpQuickbooks, Mixpanel, PayPal and Stripe, and it also accepts directly input data too. This information is used to generate a dashboard that shows startup CEOs how they’re faring against similar companies with regard to revenue growth, customer growth and customer lifetime value.

For many would-be entrepreneurs, raising money is the ultimate goal. With a $500,000 seed round, some fledgling CEOs expect a 6-figure salary as a kind of payback for success at raising capital. Most investors will see this as a sign of immaturity or as an indicator of someone trying to build a lifestyle business. Either way this will send most investors packing.

With the exception of India, the salary ranges for startup founders around the world are remarkably similar. Low founder pay is a particularly striking factor in Silicon Valley, when you consider the high cost of living in cities like San Francisco.

Does the stage that a startup is at affect its founders’ salaries? Not as much as you might think. Founders tend to keep their salaries below $45,000 per year until they hit a high-growth product phase. Even then, the average salary for a startup with a mature product is $70,109…

Of course founders should be looking at winning big on exit…if they are looking to align their interests with their investors’.

Convertible Debt or Convertible Equity for Early Stage Companies

An article by Leena Rao – a senior editor at – suggests that while convertible debt may be getting popular with early stage investors, it can cause a lot of problems. This is especially true where Series A funding doesn’t come along before the notes become due – putting start ups in default.

This is an interesting read – Convertible Debt or Equity – but I’ll let you read it for yourself.

In BC there is a different problem for which convertible equity may also be a solution. With this province’s VCC incentives, angels are in certain circumstances (EBC investments)  encouraged to hang on for 5 years in exchange for an immediate 30% return to investors. While this lowers the risk, it may also extend the amount of time that the money is at risk. Regardless of which investment model is used, it is often difficult for investors to achieve an exit.

As I mentioned in an earlier post – convertible equity may be used by VCC or EBC investors as a means of ‘encouraging’ a management buyout, thereby securing an exit, where funds may be stranded in a ‘lifestyle business’.