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The growth of a seed or start-up company is heavily dependent on the availability of risk capital. In early-stage companies, traditional sources of financing come from personal savings, family and friends, and severance packages. This form of financing, sometimes called “love money,” is usually sufficient to finance market research and to explore a product concept, but is rarely enough to reach prototype development. At this stage, entrepreneurs must begin looking for new sources of financing. In most cases, venture financing is not appropriate, as venture capitalists are reluctant to examine opportunities where the total financing is less than $1 million. As a result, angel investors, who are typically successful entrepreneurs with seed capital and acumen, help to bridge this financing gap.

When love money has been expended, many start-ups will pursue grants and government funding. In Canada, examples of these funding sources include the Scientific Research and Experimental Development Program (SR&ED) and the National Research Council’s Industrial Research Assistance Program (IRAP). Some may choose debt financing in the form of low-interest loans or credit card advances, while others pursue supplier or angel capital. Despite these multiple sources, raising early-stage capital to fill the gap between love money (e.g., $150,000) and professional venture capital financing (e.g., $1 million) is still difficult.


Angel financing is one of the few early-stage “smart money” sources that can fill the early-stage financing gap. As Carleton University professor Allan Riding remarked at the University of Toronto’s “Financing Innovative Ventures in Canada” roundtable series: “I have spent considering why it is that angels are important, and the first item, of course is money. Angels fill the gap between “family” and “friends” financing and venture capital.” (Riding, Canadian Investment Review June 2000). In the past couple of years, however, this role has been a challenging and difficult one.


Both angels and VCs have


been hard hit by the devaluation of technology and telecom companies in North America and a continuing slow economy. As a result, start-ups are facing much higher scrutiny for new financing. Doug Hewson, a partner at Axis Capital in Ottawa noted, “It’s an awfully cold environment for angels right now. A lot of them have seen their personal net worth drop considerably.” (Hewson, Financial Post, February 2001).

In order for angels to continue the cycle of investing in early-stage companies, they need to generate investment returns. Achieving satisfactory returns in 2002, however, was almost impossible because of the prolonged economic downturn, a poor IPO market and crushing down-round valuations, a phenomenon of declining valuations that occurs when new investors come into subsequent financing rounds. During these periods, earlier investors – typically family, friends and angels – have their equity stake diminished, and sometimes, wiped out completely. Says local Ottawa venture capitalist Pat DiPietro: “I invested in five start-ups as an angel and every one of them has crashed (in terms of price)…angel investing is a tough business.” (DiPietro, Ottawa Citizen February 2003).

Similarly, Coralie Lalonde, another Ottawa angel investor with Katsura Investments, states: “Many angels have lost private equity investments because of financing terms that wipe out their ability to achieve a return on their investment, regardless of how well the company does.” (Lalonde, Ottawa Citizen February 2003)

Anecdotes about declining valuations are not surprising in light of recent 2001 data on Canadian venture capital and private equity returns. The Canadian Venture Capital Association (CVCA) showed a negative return of 10.7% for all venture capital in 2001. (Note: Recognizing the importance of industry performance data, Macdonald & Associates, in conjunction with CVCA, has begun, for the first time, releasing Canadian investment performance data. 2002 return data was not available as part of the March 5, 2003 press release.)

Canadian Private Equity Performance (As of 12/31/2001)

Percentage IRR

FUND TYPE 1 Yr 3 Yr 10 Yr
Early stage -7.2 22.5 17.5
Balanced venture capital -12.2 14.3 12.8
All venture capital -10.7 15.7 13.3
Buyout & Mezzanine 10.6 9.2 15.7
All private equity -7.9 14.6 13.7

Source: CVCA, Macdonald & Associates Limited

More recent U.S. 2002 performance data also paints a bleak picture. For the period ending Sept. 30, 2002, one-year returns for U.S. venture capital funds were negative 22.3%. The table below provides evidence of this cold investing environment in 2002 for all U.S. private equity.

U.S. Private Equity Performance (As of 09/30/2002)

FUND TYPE 1 Yr 3 Yr 10 Yr
Early stage -28.6% 19.4% 34.2%
All venture -22.3 15.1 26.3
All private equity -12.3 1.0 15.1

Source: Thomson Venture Economics

That being said, the situation in Canada appears to be improving. According to the CVCA, Canada, relative to the U.S., showed positive improvements in the capital deployed (i.e., change from Q3 to Q4, 2002) and the percentage of funds allocated to support early-stage investments (i.e., early stage $ share), that is often follow-on financing to angel-backed investments.

Canada vs. U.S. Venture Capital Activity (As of 12/31/2002)

$ Invested $1.6 B USD $21.2 B USD
Drop in $ Invested from 2001 35% 49%
Change from Q3 to Q4, 2002 +51% -7%
Early Stage $ Share 42% 19%
New Capital Raised $2.1 B USD $6.9 B USD

 Source: CVCA, Macdonald & Associates Ltd.

Nonetheless, disbursements levels in Canada were down 35% from $3.8 billion CDN in 2001. This lower level of activity suggests that venture investors are still being impacted by lower stock market valuations, an uncertain economy, and higher market risk which ultimately lead to fewer exit opportunities. Consequently, Canadian angels are likely to face on-going difficulties, despite the recent signs of improvements, and to remain very cautious with new investments.


If angels are unable to realize necessary returns, they will be unable to fulfill their critical role. For Canadian angels, the pain is real because tax laws prohibit them from writing off the investment without disposing of the equity stake. With the appropriate change in government policy, Canadian angels could at least write off capital losses during down-rounds.

Consequently, angels need to explore other ways to improve the opportunity for returns in the current economic climate. In particular, they must guard against excessive dilution, additional down-round valuations and high-risk bets. If, however, angels can focus on investment diversification through networking amongst themselves, their investment risk may be reduced.

Small local angel networks in Canada, such as Ottawa’s Band of Scoundrels and the Purple Angels, and larger groups, including the recently established National Angel Organization, have emerged to provide a framework for simplifying, diversifying and reducing the risks inherent in early-stage investment opportunities.

California’s Band of Angels is a popular and oft-cited example of a long-running and successful angel group. The group consists of about 150 semi-retired Silicon Valley executives and is regarded as the benchmark for such organizations. Since its founding in 1995, the Band has invested an estimated $75 million of its members’ money in over 100 companies.

Angel networks can achieve scale and benefits that couldn’t possibly be achieved by a single angel. That being said, negative market pressures may still force nascent angel networks to co-partner with venture capitalists, and in particular, corporate venture capitalists.


There are major advantages to angel networks in partnering with corporate venture organizations.

First, angels can obtain insight into growth markets and corporate spending, which is especially important in periods of reduced capital expenditure. Angel networks must have insight into growth markets and corporate spending to make better investment decisions. This is particularly true in the current economic cycle of reduced capital expenditures, with investors tending to favour traditional technology suppliers over start-ups, due to the latters’ questionable long-term viability.

Corporate venture capitalists, in particular, are in a unique position to see where demand will materialize, since they are familiar with their firm’s two-to-three year technology capital expenditure roadmap. Consequently, a CVC can anticipate where real demand will occur and what problems can

be solved by a start-up versus a current supplier. By partnering with a CVC, angels can make better investment choices because they will better understand time-to-revenue considerations and potential competitive threats.

Second, Angels can obtain customer feedback to improve their due diligence before an investment and product development insight after an investment. Because of the strong links to its parent company, a CVC can solicit feedback from the parent’s technical and product development personnel. While CVCs don’t do this frequently, the angel investors that do obtain feedback through their CVC partner can benefit tremendously from improved due diligence (pre-investment) and greater customer involvement during product development (post-investment). The start-up can also improve product development through the corporation’s involvement and better identify product issues and deficiencies.

Third, angels can employ “other people’s money” to co-invest and gain another source of follow-on financing. Partnering with a CVC can also create additional opportunities to attract further funding. For example, an angel network could create a seed fund and accept external venture capital financing. The California-based Band of Angels has created a fund that co-invests in deals that are subscribed by its members. Not only does this provide additional financing, it acts as a bridge to subsequent follow-on financing. In some instances, the angel network can also leverage non-equity project financing offered by some CVCs. For example, in Canada, Bell Mobility’s Accelerator Fund offers start-ups project financing for compelling wireless concepts.

Fourth, angel networks can improve a start-up’s credibility through a CVC and corporate association. The angel network and CVC partnership can lend a start-up a higher degree of credibility than it could otherwise achieve. In particular, start-ups co-funded by a CVC and angels have more credibility when approaching larger clients. An example is Telus Ventures’ backing of Spotnik Mobile, a Toronto Wi-Fi service provider. This backing helped Spotnik to compete for many contract opportunities such as Toronto’s Pearson International Airport. Spotnik’s advisory board includes senior Telus Mobility management.

Finally, the start-up company can leverage sales channels and generate sales more quickly. Through its relationship to a larger corporation, the start-up can sometimes obtain an immediate sales channel to distribute its product. This channel relationship may also extend to other vendors and partnerships, allowing the start-up to leverage a larger company’s sales force to obtain revenue and sales. This is very important because follow-on investors are looking for tangible signs of market demand in the form of revenue.


Given the foregoing advantages, it would seem natural for angel networks to want to work more closely with CVCs to mitigate risk, diversify and accelerate early-stage angel investments. However, finding common ground between angel networks and CVCs may be challenging given the small number of active CVCs in Canada and their limited interest in seed-stage funding. In addition, the strategic terms demanded by CVCs may detract from the start-up’s focus.

In Canada, the potential for CVC angel network partnering is limited. There are only a handful of companies that have formal or informal venture arms and they tend to focus on three sectors: telecom, energy and financial services.

Canadian corporations involved with venturing activities

Sector Canadian corporations
Telecom • Bell Mobility
• CGI Inc.
• Rogers Communications
• Telesystems (Microcell)
• Telus Ventures
Energy • Hydro-Québec CapiTech
• Mitsubishi Canada
• Noram Engineering
• OPG Ventures (Ontario Power Generation)
Financial Services • e-Scotia Acquisitions
• RBC Technology Ventures
Source: Bell Mobility Research

In addition, the amount of CVC capital committed to seed rounds, in which angels would participate, is likely very small. In Canada, few of the venture arms focus on early-stage seed financing opportunities. From the above list, Bell Mobility’s Accelerator Fund, Hydro-Québec CapiTech, and Noram’s Technology Incubator are venture arms that explore opportunities with seed stage companies. This situation is much the same in the U.S. Ernst & Young revealed in a recent survey (Ernst & Young Corporate Venture Capital Report, Fall 2002), that American CVCs committed only six per cent of available funds in the seed stage round. The results of the survey are illustrated in the graph shown below.


CVCs have also been criticized for having a negative impact on a start-up’s ability to pursue business opportunities. Sometimes a CVC will require local market product exclusivity to differentiate the parent from the competition. Or perhaps a CVC’s ownership may limit others from using the start-up’s product or service. These are valid concerns. A CVC with an equity investment will, however, attempt to balance strategic terms, such as exclusivity, with a suitable return on investment.

Finally, critics argue that CVCs might be temporary investors and not committed to the longer term. For example, in 2000, there were 400 corporations worldwide involved with corporate venturing, whereas two years later, the number had dropped to 300. While this evidence supports the claim, it is worth noting that corporate venture capital as a percentage of total venture capital financing participation has not declined dramatically. U.S. data provided by Ernst & Young’s Corporate Venture Capital Report shows that CVCs continue to participate in 20 per cent of equity investments compared with 27 per cent in 2000. Consequently, it seems premature to discount the CVC as temporary investors.


Percentage of total funds committed of total financings

 Despite these challenges, there can be real value for angels working with innovative CVCs. Within Canada, angel networks can benefit from a unique CVC vehicle that focuses on early-stage developments.


As angel networks look to mitigate risk and diversify their future seed/start-up investments, they can benefit tremendously from closer working relationships with corporate venture capital organizations. Simply put, angel-backed start-ups with CVC support can succeed with better product development, new channels to sales and greater credibility. The key challenge in achieving the benefits of partnering with CVCs is identifying a mutually aligned CVC that participates in seed-stage investing.