Early stage financing in the communications sector needs fixing

It's a relationship that's spawned several success stories, delivered innovation to consumers and made many people rich, but the once bright union between venture capitalists and communications companies is on the rocks. And some experts are saying that this marriage needs more than time to heal its wounds. "The future is certainly not bright," says John Ruffolo, national leader for Deloitte's technology, media and telecommunications practice. "I'm always optimistic, but I've never seen the situation so dire."According to data produced by Thomson Financial, less than $68 million in venture capital has been invested in Canadian communications firms during the first half of 2007. Last year, the same sector drew nearly double the funds, with more than $130 million invested during the same time period. The market is prone to fluctuations and quarterly differences can be skewed by a single large investment, however, the level of VC spending in the sector has been decreasing for years. In 2002, communications and networking companies received more than $650 million in VC funds. But by 2006 the amount decreased by more than $400 million. "Funding has been quite challenging since the dot.com bubble burst. It has stabilized over the past two or three years, but at lower levels," explains Canada's Venture Capital and Private Equity Association's executive director, Richard Remillard. "Overall, investments across all sectors are down by about 40% over the past five years. The main challenge for VCs is to find a way to get more capital invested and more investments recycled," he adds.Ruffolo agrees, referring to a Deloitte study on the national and global state of VC, scheduled for release in coming weeks. "The problem in Canada is largely around the seed, or A, B and C, rounds . There's been a big decrease in capital that's been invested in those , and that funding is needed in order for them to make the necessary investments in technology companies.""There are several reasons why this has happened. In some cases there have been some legislative changes that have collapsed some of those investors. In Ontario, the provincial government has essentially shut down many of the benefits for the Labour Sponsored Investment Funds (LSIF)," Ruffolo says, referring to government's 2005 decision to eliminate the 15% tax credit for investors in such funds. "Most of the financing, and virtually all of the wireless financing, happens in Ontario. It literally just devastated the sector. LSIFs have invested $4 billion since 1997, more than half of those investments were in Ontario," he adds for emphasis.But the blame for the downturn doesn't lie solely on the Ontario government's shoulders. After the dot.com bubble burst in the early 2000's, many VC firms had poor returns. "Because their returns weren't good, a lot of investment funds decided not to reinvest in venture capital. So, you really got a double whammy," Ruffolo summarizes.Without sufficient domestic investments at the early and mid-stages, many wireless companies have difficulty attracting US and global dollars. "A lot of the global players are looking for Canadian VCs to pony up first. Global companies are looking for strong local partners," says Pat DiPietro, a managing general partner with VenGrowth Private Equity Partners. "It's really like an ecosystem; if you don't have somebody investing at the angel and stage A rounds, you can't even get to B or C. When it's broken at the early stages, foreign venture capitalists don't come in to fill the void," says Ruffolo in agreement.But that doesn't mean international investors have turned their backs on Canadian firms. David Arnoff, a general partner with IDG Ventures Boston, says the Canadian market is ripe with opportunity. IDG Boston recently led Montreal-based Mobivox's series A round of financing, adding another Canadian firm to its portfolio. The North American market as a whole suffered after the dot.com bust, he says adding, "I expect things to turn around. These things are cyclical."Still, many don't think the relationship between VC funds and communications firms can be saved without outside help. "There are fewer VC funds in Canada today then there were in the 1990s and that's a bit of a problem," says David McCarthy, managing director at Summerhill Venture Partners' Ottawa branch. "I don't think there's any magic fixes. You need a combination of continued investing by strong investing groups and increased government support."In an attempt to bolster investments, the Ontario government has since introduced a series of initiatives, including the Ontario Venture Capital Fund. A $90 million project, it invests in Ontario-based firms in partnership with venture capital funds, pension funds and the federal government. But this, says Ruffolo, is only a drop in the bucket."I believe you have to address the solution at the investment stages, because the solutions are actually different," he says, suggesting the government's policy will primarily assist firms at the B and C stages of funding. "On the angel side, my suggestion would be to offer some tax incentives to get higher-wealth individuals to want to invest in the sector. On the A round, you have to turn around what the government did to the LSIFs." While most venture capitalists agree that action must be taken to spur investments, some believe the numbers don't paint an accurate picture of the day-to-day realities. "Those numbers don't reflect the potential or the importance of the area, or what is necessarily happening across North America or on a global basis," says Joe Catalfamo, managing director, Summerhill Venture Partners, from his Toronto office. In fact, 25% of the companies listed in Deloitte's Wireless Fast 50, a ranking of North America's fastest growing wireless companies based on fiscal year revenue growth over five years, are Canadian."The whole area of wireless is evolving and very exciting for a lot of reasons going forward, and will be for the next five to nine years," Catalfamo adds, listing a series of areas poised for growth, including mobile search, content delivery, video streaming, mobile commerce and location based applications. "I think that Canada is good place to incubate a lot of technologies and I think there are good opportunities here," he asserts. The question is not whether the industry has potential, but whether it can weather the investment drought. This is one of those rare times where a relationship's woes can be fixed by throwing money at it.

Early stage financing in the communications sector needs fixing

News | 10/25/2007 1:14 pm EDT

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