Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 2 - Evidence - October 19, 2011
OTTAWA, Wednesday, October 19, 2011
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:22 p.m. to study the present state of the domestic and international financial system.
Senator Michael A. Meighen (Chair) in the chair.
[Translation]
The Chair: Good morning. I call this meeting of the Standing Senate Committee on Banking, Trade and Commerce to order.
My name is Michael A. Meighen, I am from Ontario and I am honored to chair this committee.
Allow me to introduce the senators who are here with us today. First, I would like to introduce the vice-chair of the committee, senator Céline Hervieux-Payette from Quebec.
[English]
Senator Irving Gerstein is from Ontario, Senator Stephen Greene from Nova Scotia, Senator Larry Smith from Quebec, Senator Mac Harb from Ontario, Senator Wilfred Moore from Nova Scotia, and Senator Stewart Olsen from New Brunswick.
We are embarking today on our special study on the financing of growth capital for small- and medium-sized businesses.
Our first witness today is Barry Gekiere from the MaRS centre in Toronto. Thank you for agreeing to come on short notice and for making the trip down here from Toronto. We appreciate the opportunity to pick your brain and hear about what MaRS is doing in this important area.
Founded in 2000 and open in 2005, the MaRS centre works with entrepreneurs to help them launch and grow their ventures. In addition to proceeds from its work, the MaRS centre is also financed by contributions from a variety of stakeholders, including the Governments of Ontario and Canada, private donors, corporate sponsors and foundations.
Mr. Gekiere manages the MaRS centre's Investment Accelerator Fund, a seed fund that helps early stage Ontario technology companies bring their products and services to market. Our witness has over 25 years of experience in senior management positions, in venture capital, private equity and operations. Mr. Gekiere has a BA from the University of Western Ontario.
Mr. Gekiere, if you have any opening remarks, we would be pleased to hear them, following which we hope you would agree to answer questions.
Barry Gekiere, Managing Director, Investment Accelerator Fund, MaRS Discovery District: Yes. With your permission I will provide a bit more background on MaRS and the Investment Accelerator Fund and provide some comments with respect to the industry and what is happening in the industry right now.
I am pleased to be here today to represent the MaRS Discovery District and the MaRS Investment Accelerator Fund. We have been invited here to discuss the topic of innovation, specifically looking at growth capital for SMEs. Our President, Ilse Treurnicht, could not be here today but sends her regards. I would like to quote from a speech Ilse made recently to the Economic Club of Canada.
How can we kick-start Canadian job creation and long-term growth? The solution, I believe, lies in entrepreneurs building growing companies that need to hire people quickly.
Innovation matters, in an abstract sort of way, but to quote Peter Drucker: ``Innovation is the specific instrument of entrepreneurship.''
Without entrepreneurs, great ideas will never get to the marketplace and great Canadian companies will not develop to create high-quality jobs here at home.
It's already clear that entrepreneurship, combined with rising educational attainment, is driving much of the growth in India, China and other emerging countries — catching the lumbering, wounded economies of developed nations a bit flat footed.
And it's therefore not surprising that, in the OECD nations, governments are now trying to unleash entrepreneurial talent. President Obama has been vocal in his conviction that entrepreneurship is the key to America regaining its global economic leadership. That's why the White House has joined forces with leading U.S. corporations and foundations to create Startup America — a partnership announced recently you amidst great patriotic fanfare. Here at home, the Canadian government has declared 2011 as ``The Year of the Entrepreneur.'' In Ontario, the ONE network is working hard to support entrepreneurs by leveraging the regional strengths.
MaRS overall believes it is essential to support and strengthen Canada's entrepreneurial ecosystem in support of innovation. I have provided you with a brochure of some background on MaRS, but our mandate is very simple. We work closely with innovative entrepreneurs to help them launch, grow and scale their ventures with the goal of becoming global market leaders.
The Chair: I apologize for interrupting. Perhaps others know, but what does MaRS stand for?
Mr. Gekiere: MaRS stands for Medical and Related Sciences. I am glad I know that. It is, as you mentioned earlier, a not-for-profit organization. It provides entrepreneurs with experienced mentors. We take people from the business community to help mentor the entrepreneurs that we work with. There are education programs, market intelligence and, of course, access to capital. The services are offered across several technology sectors, including life sciences and health care, information technology, communications and entertainment, clean tech and advanced materials.
MaRS has mentored over 1200 clients since 2006. In 2010, MaRS provided over 85 educational events that were attended by 8000 attendees and completed over 900 market research requests. Our client companies have raised over $108 million from angel and venture capital investors. As well, government programs and client companies created over 600 new jobs last year.
We are a not-for-profit organization governed by a distinguished board of directors from the private sector chaired by Gord Nixon, the CEO of the Royal Bank. As mentioned, our operations are funded from a range of stakeholders, including the governments of Ontario and Canada and private donors and corporate sponsors. MaRS has a strong entrepreneurial focus and utilizes experienced business people in its education programs and advisory services.
The chair asked me to mention MaRS Innovation. There are a number of groups under the MaRS umbrella. MaRS Innovation is a group that does technology transfer or actually technology commercialization from a variety of the teaching hospitals and also the University of Toronto. It acts for 16 institutions in total.
MaRS is part of what is called the Ontario Network of Excellence, or ONE, which operates at several centres, including Communitech in Waterloo and OCRI in Ottawa. These facilities provide services very much along the lines of MaRS in providing experienced mentorship, education and access to capital in these communities. The Investment Accelerator Fund, or IAF, of which I am the managing director, is also part of the Ontario Network of Excellence and is managed by MaRS.
Prior to joining the IAF, I was partner for 13 years in a company called Ventures West Capital, which is one of Canada's largest and long-standing venture capital companies. I have been a member of the IAF's independent investment committee. I have to be honest that I was somewhat disappointed in some of the previous government initiatives to provide growth capital for the SME sector. I became impressed with what I saw at the IAF, and I welcomed the opportunity to join and work with this program.
As mentioned, the IAF is a seed stage investment fund. It is focused on early stage technology companies. Basically, we are providing essential growth capital to innovative SMEs. You can describe the IAF somewhat as an ongoing experiment of public sector objectives combined with a healthy private sector influence. MaRS believes this experiment is working in probably one of the most challenging economic times for the venture capital industry.
I provided a handout that outlines the need for the IAF, its mandate and performance, so I will not go through that in detail.
I believe overall everyone recognizes the importance of a strong venture capital infrastructure in fostering innovation and job creation and building a strong economy. The current problem in Canada is that the venture capital industry is broken. The amount of capital raised has been in a declining trend over the last nine years. In 2010, the capital raised dropped by 24 per cent to its lowest level in 16 years. Even more disconcerting, if you look at the first six months of this year, the amount of venture capital raised was down again 46 per cent. I would describe this as being at critically low levels. This lack of new capital for financing innovation will impact building companies going forward. It may not be impacting today, but there could be a lost generation of entrepreneurial job creators who will not be able to find the capital.
The BDC tabled a comprehensive report to the standing committee in March of this year outlining the state of the venture capital industry and the reasons for its decline, so I will not repeat what was presented. However, in that report, they depicted the VC ecosystem in a diagram that I have included on slide 5 of the handouts. The point made in the BDC report was that at each stage of the VC ecosystem, all parts must be working to create a vibrant VC infrastructure. The six steps in that circle have to kick in together. This VC infrastructure in support of SMEs is needed to drive sustainable and high value job creation.
We are always told that the U.S. is well ahead of Canada with respect to the state of its venture capital industry, but by U.S. standards, the Canadian venture capital industry is relatively young and still evolving. Now is not the time to abandon the industry. We do not believe that governments can be the total solution, but we believe that they can be a catalyst to the private sector. We need to see is a rebuilding of the VC infrastructure. As the diagram shows, this has to start with the first two steps, which means supporting talented entrepreneurs and finding early stage angel and skilled VC seed-stage investors. This is where MaRS Discovery District and the Investment Accelerator Fund are focused. MaRS provides the education and experienced mentorship to the innovative SME entrepreneurs and the IAF provides much needed capital and acts as a catalyst for additional funding from angel investors and seed-stage venture capitalists.
The overall mandate of the IAF is to bridge the funding gap for seed-stage technology companies in Ontario to the wider investment community and to assist these companies with resources and networks needed to validate their ideas and bring them to market. The IAF employs experienced investment officers. We undertake rigorous due diligence and make equity related investments that must be approved by an independent investment committee made up of experienced venture capitalists and angel investors.
Our mandate is not solely a return on capital like a venture capitalist but rather to support the most promising early stage technology companies that are most capable of sustainable job creation. However, the objective of supporting only the most promising and economically viable companies plus the requirement of going through an independent investment committee brings a private sector discipline to the process. We think this has helped our performance within the IAF.
The IAF has been in operation for 3.5 years. It has invested in 45 companies. We think it is making us the most active seed-stage investor in Ontario, if not in Canada. The fund has invested $19.2 million as of September 30, 2011. We have attracted over $72 million in follow-on investments from angel investors and other seed-stage VCs. We have been able to leverage our investment by 3.8 to 1. The portfolio companies employ over 534 people, and this has been growing month over month. I have been with the IAF for a little over one year. As a venture capitalist seeing the seed- stage fund at the stage it is in, given the economic environment we are in, I think the fund is in good shape.
We have had four successful sales or exits to date that have provided a profit to the fund. As of today, we have had 16 significant follow-on investments. We go on by way of a convertible debenture, and there has been a significant follow-on financing that has converted us to equity, which is a very positive thing within the portfolio. For a seed-stage portfolio, it is doing very well.
We are a bit biased, as you can tell by the pitch that I am giving. We think that the IAF, with the support of MaRS and the Ontario Network of Excellence, has been highly effective in bringing these companies along and addressing the growth capital requirement for early stage technology SMEs.
The IAF is very encouraged by recent government initiatives in trying to help these companies, especially at the federal and provincial levels. There appears to be a healthy dialogue between the private and public sectors in looking at finding good programs to try to kick start and provide more venture capital to the community. Of particular note is FedDev Ontario, which is investing in a business innovation program designed to be in support of angel and VC investing. This is a significant program that is helping our companies within the IAF portfolio. The other welcome initiative is the proposed angel investor tax credit announced by the Ontario government. It is similar to what is already in place in British Columbia, where it has been very successful. We are welcome to see it brought into Ontario.
These programs are not a total solution to the overall lack of risk capital within Canada today, but they are an important step and are directed at the foundation of what is required to build a vibrant risk capital industry. They are focused on helping to develop talented and experienced entrepreneurs and to provide them with the critical seed capital to kick-start their businesses. We need to see continued support of these programs and MaRS encourages all levels of government to work together with the goal of complementing each other rather than forming directly competing programs. Not only will this better leverage the dollars available but also will make the process easier and more efficient for the entrepreneur.
In conclusion, MaRS believes it is essential that all stakeholders do everything possible to strengthen Canada's entrepreneurial ecosystem for innovation. With a strong ecosystem, high growth ventures will develop and flourish in all sectors of the economy and all parts of the country. In the process, these ventures will create new jobs, build a foundation for long-term economic growth and promote a stronger culture of made-in-Canada innovation.
I thank you for your attention. I would be pleased to answer any questions that you may have.
The Chair: Thank you for your presentation, Mr. Gekiere. You raised a number of interesting points and dispensed some bouquets and some brickbats. All senators will be anxious to question you about solutions. Since I am chair, I will abuse my privilege by asking you the first question.
This subject seems to be very popular all of a sudden, perhaps because we, the Standing Senate Committee on Banking, Trade and Commerce, decided to study it. Everyone seems to be weighing in on the topic. I, for one, am trying to pick up the common threads of the comments in Mr. Jenkins' reports and the newspaper columns on the subject; and Deloitte produced a report recently. I would like your opinion. There seems to be a general criticism that there are too many programs that are not well-known, perhaps conflicting and that do not have a needed coherence to them.
I see form the chart that Canada, for example, is heavy in indirect support through R & D tax incentives and very light on direct government funding of Business Expenditures and Research and Development. I do not know whether that is right or wrong. Do you have an opinion? If you were the minister and had unlimited powers, what would you do?
Mr. Gekiere: That is a good but difficult question. I have my opinions, which would not necessarily reflect all of MaRS' opinions.
I will reflect on the R & D tax credit. I have read the summary of Mr. Jenkins' report. I operated a company recently for 18 months that applied for Scientific Research and Experimental Development tax credits. This company was probably in the same category and did not deserve to get SR&ED tax credits. Mr. Jenkins is making the recommendation that it should be focused more on early innovation and early technology companies; sometimes it is not necessarily used for that purpose. Some of Mr. Jenkins' recommendations are valid and good. You have to look at that program and make it as efficient as possible. Is it a good program? It has to be made efficient, but I will leave that because it is not my area. I will stick to venture capital, which is my area.
The challenge that the venture capital industry is facing now is that there have not been positive rates of return. Money follows returns. Unfortunately, financial institutions manage or look at opportunities through the rear-view mirror a bit. They look at where the returns have been and not where they potentially are coming from. This asset class is positioned well for some positive rates of return. When there is a shortage of capital, you usually see the best rates of return. We had a situation where there was a significant surplus of venture capital funds available in the early 2000s that generated some weak returns. Today, we are in a situation where we will see some positive returns. Even with the Investment Accelerator Fund, we are having fairly good success in our initial investments. There will be change, and you have to see that change. The government needs to assist as much as possible the people that are willing to make those investments now. I do not think you will convince the major pension funds to suddenly change their investment strategy and embrace this asset class. They will not do it until they see more return on investments. There are some high net worth individuals, angels and certain niche venture capital funds being formed that I can give examples of.
There is one called Mantella Venture Partners and another called Extreme Venture Partners that have pulled together high net worth individuals and are making new investments. I think you need to support that ecosystem — that angel early seed-stage VC — and that will start generating some returns. As the returns are generated, you will see more capital flow towards this sector.
That being said, there is still a shortage of later stage or follow-on capital for these companies as well. The Ontario government is working on that stage with a fund called the Ontario Emerging Technologies Fund, doing a matching program. I think it is important that there is a lead and you are looking to other investors from the private sector to make the initial investment and qualification. Then you are following on in these investments from the government point of view. That is what the OETF is trying to do. The FedDev program says, ``If there is an accredited angel or accredited seed-stage VC, we will follow on, giving leverage and that company more capital so it will improve.'' The entrepreneur is not spending his time trying to find new capital. He is spending his time growing and developing his business.
The Chair: Normally the vice-chair of this committee is the clean-up hitter. She knows more about this business than others.
Senator Hervieux-Payette: I have a few short questions. We have two sectors that have been doing well in raising money. Mining is not necessarily the lowest risk area and most of it is financed through tax incentives. The individual can put $100 on it and receive a tax deduction. It is making money and even producing product. I am happy. We have a good model that works. It is not very high-tech, but at least exploration is now going on in Quebec and other provinces.
With energy, it is the same. There are risks associated with the energy sector as well, but they have money. I would like you to tell us if we have the right mechanism in manufacturing? Whether it is high-tech or low-tech, this is the area that is really producing jobs. I have visited your centre and I was very impressed. I thought the model would work. My colleagues know that we have to finance at various stages.
When you have a proven concept, you go to the pilot project, the development side so you have a commercial product, and then you have to do the marketing.
Where are the flaws? Usually the biggest amount of money needed is when the pilot and development have been done and you have a real product that you can sell. It could be mitigation or other things. We have a product, so why not get in the market so people can sell it and make profit? I am talking about the investor. Why do the investment banks not put their money there? Do they have sufficient knowledge? As far as I am concerned, I suspect they may not hire a lot of Ph.D.'s in biology and chemistry. Do they have people to analyze the projects and be able to assess risks?
My concern is that there is money for certain sectors and they are doing extremely well. There are some risks associated with those sectors, especially in mining. There is money there. Venture is one thing, but it seems with venture we have dried up that sector. It is very little. Why is it that the pension funds and investment bankers are not putting money in and do not have the trained people to assess it? In the United States, they have it and they do it.
Mr. Gekiere: It is a good question. Part of the answer is that the mining and energy sectors are well known. They are profitable. You can identify the companies. They are large companies where there is a fair amount of liquidity. If I make an investment, I look at the price of the stock and I know I can sell my investment at any time. I know that is attractive to investors and investment bankers in this environment. There is a fair amount of capital. It is a known quantity. I can look at the financial statements and I have liquidity with respect to my investment.
If you are in a situation in the technology or manufacturing sectors — and you have a company that gets to market and can show evidence of its success — they will not have a significant problem in raising capital. There will be capital available for those companies as well. The real challenge is the fact that in the technology sector — life sciences and even in IT and other areas — it is the length of time to market, the amount of capital required, and where there is no liquidity. As an investor you go into these companies and you do not know what your value is and have no way of gaining liquidity. For many investors it is not an attractive asset class for that reason.
In addition, returns in the mining and gas sectors have been pretty good until recently. Venture capital is a cyclical market. It will come back, but the returns in the short term have not been as good. It makes it more difficult for those kinds of programs to work.
There has been discussion on flow-through shares or this kind of tax incentive for the individual investor. This is my opinion. I will caution against that because it comes back to what we had in Ontario called the Labour Sponsored Investment Funds Program. There was a tax incentive for individuals to make investments in these hard-to-determine, illiquid assets. For a variety of reasons, that program was not successful. If there is a flow-through share program, it has to be done with certain parameters in mind so you do not have a duplication of the Labour Sponsored Investment Funds Program.
It really gets back to the lack of liquidity in this asset class and the length of time to market, given the amount of capital that is required.
Senator Hervieux-Payette: Which sector of development is more difficult? Is it just before you have a product totally finished? The amount of money to be spent for the first phase is not that huge and it is at a later date when you go to the marketing sector. Are we weak in supporting? Should we be asking those who have money to make some effort on the marketing side? Fabulous products sometimes never get to the market.
Mr. Gekiere: That is definitely a challenge with Canadian technology companies. The toughest time to fund a company is before it has any market traction. If you have a company in today's environment showing it has commercialization, sales, and can demonstrate a track record, it is not as difficult to find capital. There will be capital available. It can come from the investment banking sector, and even U.S. venture capital firms will look at Canadian companies at that stage. The real challenge is at the higher risk development stage, prior to being able to commercialize the product and show success in the marketplace. That is the challenge.
Senator Hervieux-Payette: My last question is why we have paid money —through our union fund in Quebec, for example, with angel investors — and in the end we have a fabulous product, but they do not have money for the marketing, and a U.S. company walks away with what we have developed? We have paid $20 million or more at the development stage. It is not that there was no money. At the end of the day, researchers end up with 1 per cent of the company. They have to sell because they need the money to continue the operation. There is almost nothing left for the person who invented the new process or product. How do we prevent that? We finance and accompany them with BDC. It will be a successful product that will be marketed and a profit will appear, but in the hands of a foreign company?
Mr. Gekiere: That is another common concern of anyone looking at this from any of the levels of government that look at this industry. I think you will never be able to totally stop international companies coming in and acquiring companies in any particular country. What does hurt us is that the venture capital industry is not strong here. The stronger it gets, the more capital there is available to fund these companies here and fund them to a later stage, the higher the probability they will be able to remain in Canada.
Again, it is indicative of some of the problems in the industry at this point; it is sort of exacerbating that problem. The stronger the industry is, the better the valuations for these companies. It also protects those founders and initial researchers that have developed their product to maintain more of the company. That is always a challenge in an environment where there is a shortage of capital and the cost of capital is that much greater.
It will take time. I will go for the next question.
Senator Harb: Not long ago we had one of the finest companies in the world, Nortel. It was funny that no one jumped in in order to support them, yet we sunk billions of dollars into General Motors and other companies that were not necessarily high-tech.
What specifically do you think that the federal government should do in order to solve this problem?
Mr. Gekiere: That is a very good question. There are a lot of facets to it.
To me, it is trying to be as supportive as possible to the private sector here. As I mentioned, we need to support those that are willing to invest in this industry and try to do more to leverage that capital.
There are high net worth individuals, people who are repeat entrepreneurs that have made their capital in innovative companies and are looking to reinvest back into companies. There are some funds that have been assembled that are interested in innovation and technology companies. We need to add to those dollar amounts. We need to figure out ways to match programs that give them more capital.
Senator Harb: How? You have to tell us.
Mr. Gekiere: I will take Ontario, for example, because it is the one I am most familiar with. They did a lot of work in sitting down with the private sector and asking, how do we make this work?
They have three initiatives they came up with. They have the Investment Accelerator Fund, which you know about. We are different in that we are an investor. Then we look to lever our money by finding other co-investors after de- risking the business. We go in and de-risk a company. We say we will give you the first $500,000 to get rid of some of the risk and that will make other people feel more comfortable. That is our job.
The Government of Ontario then came in and said for the next round of financing, what do we do there? They set up a $250 million fund; they can do $50 million a year. They go out and say we will follow intelligent investors. If there is a good venture capitalist that has made a decision to invest in this company, we will match it. Therefore, if the company wants $4 million but it can only find $2 million from a venture capital firm, they will provide the other $2 million. That is significant. That is a strong benefit.
They then have a third arm that is not working as well. This is the Ontario Venture Capital Fund. They are saying we need to create more funds and have more capital available in general. They went along with the pension funds and have said we will work with you to find new investment funds. It has not worked because their criteria is way too narrow. Also, institutional investors are not interested in the asset class. That is just a fact. They will not come back to this asset class.
It is partially government funded. I mean, it is an Ontario government fund, but it takes about a 25 per cent interest in a fund and then requires the private sector to come in for the other 75 per cent. It does not fully support the fund, which is a good idea because we want to make sure we are seeing other funds that have vetted the managers; they know this is a good fund, they are willing to support these managers and the province will come in and provide some capital in addition to that. The problem is that there are not many institutional investors that want to play in this sector.
What you need to do then is look where there is capital available. There are high net worth individuals that would be willing to pool their money and raise $25 or $50 million. Well then, match that fund. Let us set up some new funds for new managers.
There are talented young managers out there that do not have a track record. If you do not have a track record, you cannot raise money. How will I get there? Roll the dice. Risk it. Back these guys; they are bright people. That is what I would do.
Senator Harb: On page 5 of your presentation, you said a number of things. First, now is not the time to abandon the industry. Then you say that government cannot be the solution but can be the catalyst.
Specifically, you brought the example of Ontario, which is very interesting; I am quite familiar with some of the good work being done in this province. However, at the federal level, for example, should we set up a one-stop shop? Then when you walk in as a small entrepreneur or a big entrepreneur and you want to set up a venture of some sort, you go to that place and find all the answers — provincial, municipal as well as federal.
As another example, should we do something on the regulatory front? Should we introduce a law in order to make it mandatory for Sam, Jim and Sue to put in money for venture capital?
What we need to hear from you are hardcore recommendations that we can take to the government, to the Senate and the House of Commons, saying we spoke with Barry and this is what he told us specifically. I am not interested in hearing pie in the sky because it will not help me. You have to tell us what we need to do, even if it hurts.
The Chair: He did give us one example of what is happening.
Mr. Gekiere: The federal government should be doing the matching of the Angel Investment Tax Credit. We should be going out there and encouraging high net worth individuals that are risk takers. What is efficient about this is they look after their own money. There are no professional money managers hanging around this. Guys are out there putting their own money up. Give them more capital.
In British Columbia it worked. If you talk to the angel investors there, they say when you gave me a 30 per cent tax credit, I did not spend 30 per cent less. Instead of investing $1 million, I invested $1.3 million. I am investing more money; it works. You need to support that program.
Looking at Ontario, FedDev is coming into Ontario and saying we like this idea of matching. If someone is willing to put their money up, we will match that. They are doing it in a relatively efficient way, by way of a loan structure. They have approached the Investment Accelerator Fund, which I think is great, and said if you approve a company because you are doing the due diligence, we will then automatically approve it. It streamlines it. Working with these programs, if they can work together, they should be looking down and saying how can we enhance what you are doing at the provincial level?
What is important in any program — this is my private sector voice coming out here — is that you have to have the investment decisions made by the private sector and then lever those investment decisions. Do not try to set up an organization that will make those investment decisions. As I say that, we are an organization that was set up to make investment decisions, but we used a structure where we have an independent investment committee that has a final say in our investments; we cannot make investments without that independent committee's approval.
Senator Harb: To what extent does the geography of the country play a role in not allowing the type of success that we would like to see in the venture capital sector? For example, to fly from Newfoundland to Vancouver, it takes seven hours or so, which is longer than it would take to fly from Ottawa to the United Kingdom. As a result, it does not matter how good your product is if you do not have a market; you do not have the resources to ship your products from Newfoundland to British Columbia.
The scattering of the market for companies, to what extent does that play a role in a sense of venture capital saying, I will not take a risk because there is no market for this? In Canada, unless you are a big corporation, whether in mining or energy, and you are producing en masse and the world becomes your market, you are limited in terms of big you can grow.
Mr. Gekiere: I think the companies that we want to back or that you want to focus your efforts and your capital on are the ones that look international in scope; they will be looking north-south more than east-west. That is important.
Geography plays a role in innovation and where innovation occurs. If you look at the U.S., you would not look to set up a venture capital fund necessarily in Chicago, but you would definitely look to set it up in Silicon Valley or Boston. It plays a role, because you form certain areas where an ecosystem has developed for a variety of different reasons. There is probably one developing in New Brunswick right now where they have had two significant wins. There will be spinoffs from those companies and it will be helpful. People will be targeting that sector and making a little ecosystem with the expertise that comes out of Radiant 6 and Q1 labs. It happens for a variety of reasons, but it is regionalized to some extent.
I do not think the government wants to try to figure out a way to create innovation in a minor market. I think you want to support it where it is happening. You want to continue to build a strong ecosystem in that area, and it will continue to foster significant wealth creation and job creation in those areas. You need the ecosystem for the technology to work, to find and maintain good people.
Senator Ringuette: I find that the federal R & D tax credit is mostly geared for bigger operations that have been operating for a while. They have capital or easier access to capital. Therefore, with regard to angel investors and venture capital, it is not in the game in regard to this particular tax credit.
I am not very familiar with how the angel tax credit works. I know there are some in place already in different provinces.
Mr. Gekiere: In British Columbia, yes.
Senator Ringuette: Is there a risk analysis, a scale of the risk that would be proportional to the tax credit so that it is not just an angel tax credit because it is a risky business? Is there a scale of the degree of risk with the tax credit matching that scale so that the higher the risk you take on an investment the higher your tax credit?
Mr. Gekiere: That is a good question, senator. You are right. Your concern is that it will go the way of the R & D tax credit where it is going to more established companies that do not require it.
Senator Ringuette: Yes, there is no doubt about that.
Mr. Gekiere: There is no easy way to determine the amount of risk, even at a certain stage. I would caution that if you make something too complicated to measure or try to bring those kinds of things into the program, it does not make it as efficient as you would like.
I think it will be a fairly broad parameter. The devil is in the details of just how the tax credit system will come out, but you could do it through some pretty broad parameters with the fact that it may have to be pre-revenue. In other words, if the company does not yet have revenue, it is at much greater risk than a company with significant revenue. So you could put a revenue threshold on the companies. You could use the net tangible assets test. Again, if a company has significant assets, it does not really need tax credit incentives to provide more capital to it.
I would put on some broad financial tests in order to determine the risk you are looking for to ensure that more mature companies are not getting the benefits of that tax credit.
Senator Ringuette: Exactly. The focus of my question, and I think the aim of this committee, is to try to identify ways to increase the level of angel and venture capital investment.
Mr. Gekiere: Correct.
Senator Ringuette: I find that the continuous word in all of that is the risk involved. If the tax credit, whether provincial or federal, were tied in some way to the level of risk and would rise with that, I think greater attention would be paid.
Mr. Gekiere: I could look at a deal and tell you it is risky and my partner will tell me it is not. It is difficult to assess the risk. It is more measurable things like financial parameters that you could place on it that would accomplish a high percentage of what you are trying to do.
Senator Ringuette: My second question is a bit tied to Senator Hervieux-Payette's question. You have the different phases; the R & D, the commercialization, the production, the marketing, et cetera. From your experience, at what phase should we concentrate, or should we concentrate at all on a particular phase that you see there is a gap?
Mr. Gekiere: The biggest gap is at the seed stage level, at the early development level. For example, BDC is a government body. They are a venture firm, but they like to look at something that is a bit later stage and is closer to commercialization. There is a real gap at that early invention stage before there has been commercialization or the product has been brought to market. Once the product has a track record, or if there is evidence of acceptance, it is not as hard to find the capital. The biggest gap is at the seed stage.
Senator Gerstein: Thank you, Mr. Gekiere, for appearing here. If I might start with an observation, I remember when MaRS was started. It has been a successful model and for that we owe a great deal of thanks to the father of MaRS, Dr. John Evans, who developed the idea and attracted private investors and individuals. With that backing he convinced the then minister of finance, the Honourable John Manley, to provide funds. In fact, that is how MaRS got off the ground, and they are doing a great job.
I would like to go to some of the comments that you made in your presentation. On page 3 you talk about the current problem in Canada being that the venture capital industry is broken. I think we knew that. On slide 4 you say that the solution is to rebuild, not to abandon.
I want to back up to Senator Harb's comments. The first three bullets, ``now is not the time to abandon the industry,'' ``government cannot be the solution but can be a catalyst,'' ``the goal should be to support and work with those willing to invest.''
Mr. Gekiere, it is nice to hear it, but it is nothing surprising. You are before the Standing Senate Committee on Banking, Trade and Commerce that is looking to put forward a report on what we can do to help the situation, and, frankly, you have to tighten your recommendations. You know the industry better than we do. We are looking to you to make specific recommendations that we can consider for inclusion in our report. You have mentioned some things that are not in here.
It is odd for us to be recommending to a witness what they might do, but you might want to consider giving further thought to it and, if there are specific recommendations, sending a note to the clerk that could be circulated in order that we can understand how we can help you. We have you before us today as a witness to help us define a program that the federal government can create to help this situation.
Mr. Gekiere: I would first like to thank you for the comments on MaRS, which are accurate, about the work that has been done by a number of parties to build the organization.
I also appreciate the offer to come back with specific recommendations, and we will take you up on that.
The Chair: In the witness's defence, you realize, Senator Gerstein, that he had very short notice.
Senator Gerstein: I understand. I absolutely do not mean to be critical.
Mr. Gekiere: Thank you, Mr. Chair; it was short notice.
I want to ensure that we come back to you with the overall consensus from MaRS. Due to the short time frame, you are getting a lot of my views, and I want to make sure that the recommendations we bring back are well thought out and are supported by the entire organization of MaRS. There are other parts of MaRS, for example, MaRS Innovation and the health care sector, that would like to address their concerns. My focus is more on information technology and communications. I am not as broad as I would like to be to be making recommendations. We will definitely take you up on your offer and come back with specific recommendations to give to the committee.
The Chair: Before going to a second round, perhaps I could ask you one question.
I was interested in what I took to be a somewhat negative opinion of the idea of transferring flow-through share concept, which, to my untutored mind, seems to have been a huge success in the mining and oil and gas industry. It alleviates the risk, I think, because you get a tax benefit.
Why would it not work in these areas where banks, as Senator Hervieux-Payette pointed out, are not involved in lending because there are no hard assets, and most of the assets leave the office at, if not 5, then 7 or 9 at night? In the bio-science field, for example, could a flow-through share concept not be of benefit? What is your concern about it? It is a question of clarification. I was not sure what you were getting at.
Mr. Gekiere: The concern is that in the other situations you are dealing with large corporations that are well known, usually public corporations. As an investor, I know my risk profile that I am going into with those flow-through shares.
If you are doing this in the early-stage innovation period, you do not know the risk factor. You are asking unsophisticated investors to invest in an asset class that they do not understand. Even the people marketing the investment do not totally understand the risk. You can get a flood of money flowing into these companies because there are a lot of fees to be made from selling these flow-through shares, and that may be going to companies that it should not be going to, because of the risk profile. You do not have the gatekeeper to assess the risk to these companies.
My argument is that you want to have a gatekeeper. You want to have knowledgeable investors who act in these areas, venture capitalists or people who are playing in this space, and back them. However, if you are just saying, ``Here is XYZ company, and there is a huge tax incentive to go into it, and I am selling it to my investment client because this is a great tax break,'' you do not fully understand the business risk that you are taking. That is my concern. In the oil and gas and mining industries it is still risky, but you have a much better understanding, I think, of that risk profile.
The Chair: Thank you very much. That is very helpful.
Senator Hervieux-Payette: First, I think we would like to have one solution fits all, but I do not think every economic sector can use the same approach.
I am thinking of companies like Bombardier, TELUS, Bell and Rogers. They can have many small companies do a lot of innovation, and they partner with them. I am aware of that. They have, in fact, a client, once they do the new process, new technology.
This is a model that has also been used a lot in Germany. In Germany, they are so advanced on the manufacturing side because they have these people to develop the new process.
This would lead not just to the creation of jobs but to increased productivity. These are job-creation companies. Maybe we have a model for that.
Then we have the U.S., where it is working quite well. However, you must know that defence contracts are probably the best place to get money for innovation. There, the money is flowing a lot.
When we go to health care, it is hard to have the same approach. You do not have a Bombardier with big planes. It is much more difficult.
When I look at the billions of dollars that were spent to develop the patient files on the computer, I am scandalized. Both Quebec and Ontario developed this, and we heard about their stories as well.
The Chair: Even the gun registry. Look at all the money we have spent on that.
Senator Hervieux-Payette: That is another story. I am aware of this one, because the president of CGI is a friend of mine. If you want to discuss that, I will discuss that with you, but it has nothing to do with the question of one product for the whole country, one patient file. If I am sick in Vancouver, Alberta, Newfoundland or Quebec, I should have the same file and the same report. If doctors want to share it, to package it, to keep the confidentiality, but to ensure that I will receive proper service would be a good thing. There was a waste of taxpayer money there.
I think we must also look at what the provinces are doing. I have one example for you from Montreal, the city of information technology. They were financing the employees' salaries. There was a big incentive there. In fact, we financed the brains. We did not finance the equipment, but we financed the brains. This has produced a lot of jobs and a buoyant industry.
Would you say that we need to have at least a few models, different tools, depending on the sectors? I do not think we can have one solution fits all. I want your view on that.
Mr. Gekiere: That is a good question, and I think anyone from the different sectors would agree with you. The biggest challenge right now in Canada is on the life sciences side, where the amount of capital required to bring a product to market is significantly greater than in the information technology sector. There is a different requirement there, and there is no easy answer. The life sciences area is probably the toughest area to raise capital in right now and to take these products to market.
What has happened in other sectors is that they have become more capital efficient, with a lack of capital being available. If you can do something less expensive and get something on the market, then you have a much better opportunity. You are correct; it cannot be one size fits all. I think the area that is the most challenging is the life sciences side. I do not have an easy answer for that.
At MaRS we struggle with that, because even in the Investment Accelerator Fund, our $500,000 has to make a difference; for most life sciences, even clean tech companies, it does not make a difference. We cannot really help them with the amount of capital that we have available.
Senator Hervieux-Payette: The government is putting in billions of dollars, and sometimes we have a return; sometimes we do not. We have a return indirectly if people are creating jobs and paying income tax, but I am talking about us, as shareholders.
Do you feel that when the government is putting money directly into companies, we should be participating in the success of the company so that we, in the future, build a larger capital base and generate the money?
The BDC appeared before our committee and to say at this point they would reinvest what they make. They would not reinvest a lot of money. We are always putting new fresh capital on the venture side.
At the end of the day, if we are to package in a different way, should we not also make sure that we own shares and that Canadians who are investing in this company will have some interest if the company is successful? As a private citizen, if the government is there with a share, I may also be interested to go along with them because I have the expertise to analyze the investment through those who have invested a larger amount of money than the regular taxpayer.
In terms of private people investing versus venture capital or investment bankers and the government, there are some who are shareholders and some who may not be shareholders. Do you feel the government should also be a shareholder; maybe passive, but a shareholder?
Mr. Gekiere: Obviously, I would say yes because at the Investment Accelerator Fund we go in by way of a convertible debenture, which is an equity type of investment. We also take a percentage of the company's shares. We usually take 5 per cent of the company's shares, and we have a convertible debenture. If the company does well, we will do well.
Again, it is a situation where not one size fits all. There are programs where the company is so nascent, so early stage, that it really does require a grant. There is the Ontario Centres of Excellence, which has programs for commercialization, and it is a relatively small amount of capital they are putting in the companies. Given the stage of these companies, it would be difficult to even go to the trouble of trying to paper these things with an investment structure.
Having said that, in Ontario we take an equity position in our funds. The Ontario Emerging Technologies Fund takes the same position as the venture capitalist, so it stands right beside it. Whatever the venture capitalist gets, we get; if you make five times your money, so do we.
Yes, definitely. If you are there leveraging others' capital and providing tax incentives to help them raise that capital, then you should share in the returns.
Senator Hervieux-Payette: Would you put that in your proposal? I am just saying that at least we see the components. Also what is important is to see who we should ask. We are going to spend $35 billion for new shipbuilding. Should there be some there, some research that should have spinoff and create new companies through these contracts? If we ask the Canadian taxpayer to pay for these ships, there are many components there that may fit in other sectors, not necessarily just on a boat.
Mr. Gekiere: That is beyond my scope so I will not touch that one.
Senator Hervieux-Payette: I know, but the spin over I think is important so that large companies that benefit from these innovations will also help these companies to grow and sell elsewhere, not just have one client.
The Chair: As you mention, the U.S. Defence Department is a great source of innovation and encouragement. You are not suggesting we copy that necessarily.
Mr. Gekiere: Mr. Chair, I would like to make one statement along the lines of where governments are spending money. I think Tom Jenkins raises this in his paper, but I am not sure. What would help in some cases — and again it must be based on assessment of the product and must be the right solution — the government could be one of the biggest buyers for Canadian technology. They really are not a significant buyer of Canadian technology. What we would like to see from the venture capital community is, if we have a company that we think has a great product and is getting some traction from other independent sources that validates it, the provincial and the federal governments try to help to support these companies through the procurement policies that they would be able to buy from these companies.
I will try to remember that one for my argumentation as well.
Senator Hervieux-Payette: In the health care system this would be very important. Often you have great research being used in the U.S. that is not being used in Canada. For me that is mind-boggling.
Senator Ringuette: In my area, which is a group of small communities, we do have some innovators. What I am hearing the most from them is not the seed money. For instance, it is the cost to patent. The cost to patent is mostly a federal initiative regulation. What do you think if one of the recommendations that we would make would be for new innovative products from risky companies would have a free patent registration?
Mr. Gekiere: My response would be just patenting a product does not necessarily make it a good, commercially viable product. It is important for that company to be able to attract investment capital based on the assessment that they think it will be a viable company with that patent. If they can make that case, then they will get money to be able to pay for their patent. I would not like to see just a blanket statement saying that anyone who wants to do patenting can come and get a grant for patenting because then you will be giving a lot of companies grants that are not going to be commercially viable even if they have their patent.
I believe it falls under the fact that if you are positioning your company and you can argue that it can be commercially viable once it has this patent, and you can make that case strong enough, then you should be able to attract capital.
I will then get back to my recommendation that is going to come forward. If I can get someone from the community or from an angel investor, someone knowledgeable, to assess that and say yes, there is value here, then I would be supportive of the government matching that investment in order to help pay for that patent, but I would not just have a patent fund or program.
Senator Moore: On page 6 of your slide you mentioned seed stage funding is always in short supply and now a critical situation and that IAF provides pre-seed investment to promising emerging technology companies throughout Ontario. Then on page 8 you list various criteria. Is the criteria listed there for seed? What is the threshold of seed and pre-seed?
Mr. Gekiere: I will be honest with you. I would say there is a very grey line between the two. It is probably one in the same. Our program was designed to come in even prior to angel investors in some cases.
Senator Moore: That is pre-seed?
Mr. Gekiere: Yes. We have come into situations where we would call it friends and family, where friends and family have invested in a company. There has not been a significant third party investor and we would call that a pre-seed. We do not do as much of that and the reason we do not is usually our $500,000 is not enough to get the company to commercialization. The risk you run in any fund is that you cannot put money in unless it gets it somewhere. Otherwise you are building not a bridge but a pier and you are not going to get the company to commercialization. Most companies require more than the $500,000 and we look to syndicate with angel investors and other venture capital firms. I would call that the seed stage.
Senator Moore: You mentioned on page 7 that the IAF puts out $7 million per year?
Mr. Gekiere: Correct.
Senator Moore: Is that all seed money or is some of it pre-seed, as you mentioned?
Mr. Gekiere: It would be a mix.
Senator Moore: What percentage mostly?
Mr. Gekiere: Probably 75 would be seed stage and 25 per cent would be prior. In all fairness, that is not true because in over 60 per cent of our investments we were the first institution or the first non-friends and non-family investor. That is changing though, however. I am saying it is shifting more towards where that is becoming a smaller percentage but we have been around 60 per cent. It is becoming smaller. In about 60 per cent of our investments we were the first and only institutional investor beyond friends and family.
Senator Moore: I find it interesting, on page 8, your criteria, at the second bullet: ``The company has total revenue of less than $500,000 from time of incorporation.''
It could be striking along for a couple of years. You then say: ``Value of total net tangible assets does not exceed $500,000.'' What is the significance of that? If they owned a building and it was valued at 800 I guess it would be disqualified. Are you saying if you have that you should be able to go raise your own money?
Mr. Gekiere: Correct.
Senator Moore: What is the significance of that?
Mr. Gekiere: If you have that amount of net tangible assets then you may not require our capital at this time. You should be able to utilize those assets first to take you a little bit further along. It gets back to having to have some kind of financial test. It goes back to the previous senator's comment where she was asking how I make sure you are at the right stage of risk. We do not want to go into situations where they have $1 million in the bank. Our capital is less expensive than venture capital. You as an entrepreneur, we are going to give you a structure that is helpful to your business and is not as onerous on our cash flow. We are going to help you and price it in a way that is advantageous to you. We do not want you to take advantage of that. You have to really need our capital in order to get our capital. Therefore we have to put some financial tests on the company to make it pre-seed. If a company has generated over $500,000 in revenue, if you have a good business, you should be able to go out and find other capital for it. You are out selling in the marketplace. That is a test. The other one is the net tangible assets test. If you have assets then you should be able to utilize those assets first before you take our money.
Senator Moore: You mentioned convertible debentures and that you take an average of 5 per cent of the issued shares of a company.
Mr. Gekiere: Correct.
Senator Moore: Do the convertible debentures carry an interest rate?
Mr. Gekiere: Yes, they carry an interest rate of prime plus one but it accrues; it is not payable until the debenture matures. There is no cash call on your company until the maturity date and the maturity date is usually three years out where we sit down and talk about what we do with your debenture. The debenture, however, you can force my conversion. I am giving you time to build your business. I give you $500,000 and I want you to go build your business and hopefully get a $10-million valuation when you raise your next round of capital. You can then convert me at that rate.
I am smiling and laughing because we have a company in Waterloo that just raised $2 million at a $40 million valuation, which I now have to convert my debenture. I actually can convert it at a 20 per cent discount. I have to convert a $32 million value.
That has been excellent for the entrepreneur. He got my money at a $32 million valuation, but great for them because they have been able to attract an industry investor who was willing to put that value on the business.
I think we are user-friendly to the entrepreneur, but to the point I made earlier, we still want to make a profit, if we can.
Senator Moore: How often does the board meet?
Mr. Gekiere: How often does our investment committee meet?
Senator Moore: You have observer status on the board.
Mr. Gekiere: The companies that we sit on, I would say they meet quarterly. We get monthly financial information from our companies in most cases and meet quarterly. We are active on the board. We do not take a board seat because a province does not want the legal risk, but we act as an observer. On the vast majority of our boards, we are a very active adviser to the company. Can I give you examples of the kind of things we do? I do not know if that is of interest to the panel.
As one good example, this is how MaRS and the IAF work together. We have technology at the University of Toronto for high performance computing. The founders had a couple of customers they were able to line up but were not taking this company anywhere. They came to MaRS and asked, ``What do we do to try to kick-start or be more aggressive with this company?'' MaRS brought in an adviser, a senior executive from EMC Corporation who had dealt with cloud computing or in the computing sector. He looked at their technology and found it could be focused in a different direction. He went down to Silicon Valley, where he had a huge network, describing what they were now doing, which was virtualization of the desktop, something that would help companies reduce their capital costs in their data centres. He started to get interest. The Investment Accelerator Fund said, if you are willing to join the company now and help this young group, we will provide the $500,000 to kick-start the company, to de-risk it and take it into this other market. They were then successful after we made our investment that Citrix, which is a major U.S. company in the data centre space, has now invested $400,000 in the company. They went in as a corporate partner. You mentioned you wanted to find the corporate partners to come in and help them, so they are helping this company develop the product along the Citrix platform. That is the kind of thing where the MaRS centre is able to find that embedded executive and provide that to the company. We are able to give them some capital to get them to the next stage, and then there is interest within the firm.
We have several examples. There is another company, two great founders that had a company called REGEN that has an HVAC system. This is a clean-tech company that will do significant cost-savings for large warehouses and large commercial buildings. Let us say air conditioning units talk to each other. If one unit fires up, it will say, ``Hold on a second, I am going to fire up in two minutes from now, so why do I not wait until you drop off?'' They balance and it is all done automatically.
The entrepreneurs were good technicians but were not going to take the company to the next level. Again, the Investment Accelerator Fund gave them some capital to help them finish their product. We also worked with an executive recruiting firm. We brought in an executive that had been with one of the major companies, Johnson Controls. He has done an unbelievable job to get them into the U.S. They are now dealing with Target stores. They just raised a significant amount of capital, $6 million from a company called NGEN, which is a tier-1 U.S. venture capital firm that has come to Canada and said, ``We like this company.'' The IAF helped put the management team in place and helped de-risk that company by letting them get their product to a stage where they could then take it into the market.
Senator Hervieux-Payette: I was wondering if you feel that besides money there is a lack of know-how. Except in the new sectors, very often you have a lot of scientists but business-wise, when I meet with them they say they have already spent the first million, but on how to get there, they do not have much knowledge. How do you fill that gap in terms of management and growing the company at each stage? What you are talking about is when they are at a later stage when you talk to the people in the United States, but here at our own level, these great people have used the tax credit to get a product to a certain stage.
Do you feel we have trained our management schools or engineering schools? Do we have people who can accompany all of these innovators?
Mr. Gekiere: This will come into the specific recommendations as to what recommendation we would give. MaRS is one part of the Ontario Network of Excellence. There is also Communitech, OCRI, ventureLAB in Markham, and a group in Hamilton. They have set up these centres. If you are a budding entrepreneur, you can show up and get one hour's time. The One Investment Program will talk to you and determine whether your idea or company deserves more attention, and then they will provide you with an adviser, if necessary. They will continue to work with you to help you grow your business and they will give you — as the example I gave of the company of the gentleman from the EMC Corporation that came in, you can get that kind of expertise and help coach you to improve your business.
Some of the success of the Investment Accelerator Fund, the reason we have not had as many write-offs as I would have expected in a seed-stage fund is that we are getting a lot of our companies coming through that process. It is a great training ground. It helps mature these companies to a point whereby there is less risk in the companies. It is done relatively inexpensively when they are still developing their product.
That type of network has proven to be very successful in Ontario. It is staffed mostly by volunteer people from the business community. MaRS in their information technology practice I think has 60 advisers that do this on a pro bono basis. In clean-tech, I think there are about 20 or 30. These people are very experienced people, who have been there and done it before.
There is another group called C100, executives from Silicon Valley who again are Canadians living in the valley but want to give back to the community. They are doing a lot of things in the technology sector and there is a lot of support for that group in helping with the training. It is that kind of program that you want to continue to foster. It is just not money; it is money and talent that you want to help the companies with.
Senator Hervieux-Payette: Do the ventures know about these? For instance, if they come up with their project and are not sure of the possibility of management, they would send them to these places where they would get help?
Mr. Gekiere: Exactly. We have a lot of people coming to us because they are not aware of the centres and we will refer them back to Communitech or, here in Ottawa, OCRI. There are talented people here that will help these companies.
The Chair: Thank you, Mr. Gekiere. You have been very helpful to us. We appreciate your frankness and we appreciate particularly your acceptance of Senator Gerstein's suggestion that perhaps you could send us some specific suggestions. This has got us off to an excellent start in our study. We are looking for practical solutions to a complex problem. I doubt we will come up with all of the solutions, but I think perhaps if we could pull some of the ideas floating around out there now into a coherent set of recommendations, we will have made some significant contribution.
[Translation]
Tomorrow, we will welcome a very interesting panel of representatives from the Association pour le développement de la recherche et de l'innovation du Québec (ADRIQ) and from the Centre d'entreprises et d'innovation de Montréal (CEIM).
So, until tomorrow morning, I want to thank you again as well as our witness.
(The committee adjourned.)