Overcoming Barriers to Innovation, Business Growth
By Marilyn Goneau Farago | April 1, 2012
To remain competitive on a global stage, Canadian companies need to step up. Be more innovative. Do a better job of commercializing products. Grow.
Yet it is a lot easier to say what companies should be doing, than to outline what they need to do to innovate, commercialize and grow.Rick Spence is a nationally recognized speaker on entrepreneurship and business issues. He is the long-time former editor and publisher of PROFIT, The Magazine for Canadian Entrepreneurs. His weblog is Canadian Entrepreneur (canentrepreneur.blogspot.com).
In an exclusive three-part interview series for CanadaOne, entrepreneurship expert Rick Spence cuts through the hype on innovation, growth and financing solutions.
Part I: Funding Formulas for Entrepreneurs
For many companies, growth and innovation are intrinsically linked to financing. This is a common bottleneck that stymies opportunities and often limits growth.
Yet some of the options that are discussed the most, like venture capital financing, are little more than a waste of time for the majority of businesses in Canada.
Here is Spence's run-down of how Canadian companies should think about financing their businesses through start-up and growth stages.
"Two Solitudes" in funding
‘Love money’ is one of the most common forms of financing used by entrepreneurs in early stages of business.
“There are two solitudes when it comes to funding for entrepreneurs. Less than 1% of firms attract VC funding. For entrepreneurs this means tapping into personal networks of family and friends,” says Spence.
Approaching friends, family and associates in your network can be a minefield.
“Despite your familiarity with this group, make a professional or semi-professional presentation. Acknowledge the flaws and risks in your plans,” says Spence.
A founder should also indicate how much of his or her own savings are invested in the firm.With luck, friends and family members could be the most lenient investors available. “Their money is patient money,” says Spence. “They don't often make you pledge your house. If the money is a loan, the interest is 4 or 5%, not 11% with security, as a bank would charge,” says Spence. An added bonus is that those in your network may agree to sell back their interest in your company for a nominal return.
Bootstrap Magic: Funding your firm from many sources
It can be easier to complain than to make the effort to piece together a funding formula, admits Spence.
Bootstrapping, if strategic, is the way many million-dollar companies grow. By raising capital from different sources and with careful management of cash flow, entrepreneurs can control their destinies without financiers grabbing a huge share of the pie.
Customers are vital in a bootstrap formula.
The entrepreneur has to solve a significant pain for the customer. Plus enough customers have to be willing to pay for their pain to go away. With a strong level of commitment from customers, a fledgling firm is better able to keep investors in check.
The other trick is to be sure you are not enslaving your firm to a handful of powerful suppliers. Smart vendor and customer strategies allow a firm to grow faster and with limited resources.
Spence states company founders reap many advantages if they have strong connections in the industry into which they are selling. Industry connections can lead to win-win outcomes for the entrepreneur.
Rather than falling for the lure of a rich IPO that many VCs like to dangle in front of prospects, industry-connected entrepreneurs can often craft their own buy-outs with acquisition-minded firms they already know.
More than one kind of ‘Angel Investor’
Angel investors are high wealth individuals who invest their own funds rather than putting their money into a professionally managed venture capital fund.
A working paper published by William R. Kerr, Josh Lerner, and Antoinette Schoar published in the Harvard Business Review in 2010 found evidence that angel-funded firms were significantly more likely to survive at least four years.
Yet before you seek out an angel to help finance your business start-up or growth, you need to recognize that there are now two types: ‘professional angels’ and ‘non-professional angels’.
“Today self-aware professional angel investors operate very much like venture capitalists. The concept of angel funding has shifted,” says Spence.
Professional ‘angel investment’ means lots of paperwork, covenants and the expectation of a high ROI on the part of the investor.
“Another type of angel investor, much less visible than the ‘professional’ angels, are out there,” says Spence. “Low-key and media-shy, this group consists of doctors, dentists or semi-retired entrepreneurs. They may only do a couple of deals a year, but they can easily afford to invest $50,000 or more in your business,” he says.
“The challenge is finding these angels. It requires grit, determination and imagination,” says Spence. No one is going to hand you their contact information. You find them through networking with your banker, lawyers and accountant.
Another approach is to find a respected industry executive who is willing to invest a reasonable amount in your business. This can give your venture credibility with other investors. The advice and networking such an investor can offer minus all the heavy-handed demands of a VC come in handy, too.
The Reality of Venture Capital
According to the Canadian Venture Capital Associations just 444 companies in Canada, at all stages, secured VC funding in 2011. Of those 176 were in traditional sectors.
Yet investment levels were not similar across all sectors.
Science and technology sectors received between $4.2 and $5.9 million on average. In comparison, traditional companies received an average investment of $1.1 million.
To put these numbers in perspective, in 2010 Industry Canada’s Business Record counted 53,897 companies in the manufacturing sector that had at least one person on payroll. Fifty manufacturing companies received venture capital financing, across all stages, in 2011.
“Most companies should not waste their time looking for venture capital funding,” states Spence. “For a venture capitalist, an investment must have the potential for hyper-growth in revenues and profits,” he says.
Midas-like riches for VCs come from "scale."
“Scalable businesses are those that can produce the next widget at a fraction of the cost,” says Spence. Think Microsoft where the incremental cost of a Windows operating system is next to nothing.
“For service or manufacturing firms and most franchises, growth rates of 2 to 20% per year are quite respectable,” says Spence. Unfortunately, those rates fall below the radar of VCs who require companies to grow at “unnatural” rates,” says Spence.
Entrepreneurs, he cautions, should not be taken in by venture capitalist talk of a 20 or 30% return on their own portfolios.
For example, Spence points to an incubator fund experiment at the Wharton School where the overall ROI for 300 companies was 20%. However, only one company hyper-performed to give the fund that return; the other firms tanked.