ACST-sponsored report calls for $710 M in seed and pre-seed venture financing

Addresses critical commercialization gap

The federal government is being urged to allocate $240 million over five years towards a series of seed and pre-seed investment funds that could see up to $710 million devoted to moving promising intellectual property into the marketplace. The recommendation is contained in a new report stemming from a roundtable meeting held earlier this year and sponsored by the Advisory Council on Science and Technology (ACST), with the participation of the Medical and Related Sciences (MaRS) Discovery District.

The public-private funding would target what’s been determined as critical gaps in the innovation continuum that must be successfully bridged for firms to retain value and attract subsequent rounds of financing.

Also recommended is additional government funding of $65 million to support two other areas viewed as requiring assistance — the development of commercialization skills and networking designed to enhance the culture of commercialization (see page 3).

Referred to as the Roundtable Seed-Stage Venture Capital (RSSVC) proposal, the report is asking the government to establish a $100-million pilot fund this fall and allow for an 18-month ramp-up. Funding provided to the Business Development Bank of Canada (BDC) in the last Budget could be used to start the financing program this year, with another $140 million identified in next year’s Budget.

The report suggests that an arm’s length non-profit subsidiary of the BDC could be established to provide administrative and oversight of the government funds, allowing for quick implementation.

“There is concern that something needs to happen soon, to send a signal to the community that the government is willing to move,” says Dr Jacquelyn Thayer-Scott, ACST deputy chair and roundtable co-chair. “This proposal is probably more expensive than government would like (but) it’s a high risk area and very labour intensive.”

A high-level group of venture capitalists and university technology transfer practitioners was assembled for a one-day workshop, leading to a draft version of the report. Since the meeting was held just six days before the tabling of the Budget on March 23, some revisions took place to dovetail the report’s recommendations with the Budget’s two commercialization-specific measures: $250 million in specifically targetted funding for the BDC and $75 million over five years for two pilot funds designed to build capacity for commercialization in universities and government laboratories. Also added was the idea for the new BDC subsidiary, to be named Seed Stage Investment Canada.

“The funding in the last Budget for BDC was in three parts, including $100 million for pre-seed investment in collaboration with the private sector. This addresses what the ACST VC group is talking about,” says Marshall Moffat, executive director of the ACST secretariat.

The report comes at a time when sources of seed and pre-seed capital have virtually dried up as VC focuses further downstream and other players are reluctant to enter such a high-risk financing space. Many small firms are finding it exceedingly difficult to add value to their intellectual property before selling equity for larger financing rounds. The fund-of-funds concept would see the leveraging of increasing amounts of private sector investments for follow-on financing as value is added to the intellectual property.

“The fact that the current investment environment is forcing financially weaker seed/pre-seed stage specialty investors to risk being diluted out of their earned returns by later stage investors signals a market imperfection that this initiative is designed to correct,” states the report.

PUBLIC PARTICIPATION CRUCIAL

The proposal’s real value, says one roundtable participant, is its acknowledgement that early-stage investors would benefit from public assistance so that their investments are not diluted before firms are able to attract larger, more traditional funding bodies. The report also recommends that the funds be large enough to accommodate follow-on financing.

“This is the first proposal I’ve seen that addresses the early stage capital requirements of a fledgling business involving public funds. The key is that government funding is non-dilutive. You need a non-dilutive source of capital or you will be unsuccessful in building a commercial case for this. It has to be something that provides enough of an incentive for the shareholders of component funds so that they feel their risk is mitigated,” says Dr Lewis Slotin, a roundtable participant and president/COO of MedTech Partners. “You’re not looking for return in the classic venture capital sense. You’re really setting the table for larger investments of capital. The more maturing you do at early stages, the better your chance of building a successful company and attracting capital.”

Although recent public investments in basic science have set the stage for an aggressive commercialization strategy, Slotin says the challenges are daunting and require an unprecedented degree of collaboration between the public and private sectors.

“The ability to pull opportunities out of (the investment in basic science) is a huge challenge. It requires a large amount of capital and involves high levels of risk,” he says. “Series ‘A’ and ‘B’ financing is equally important but it all has to be linked to seed-level investment. Right now there are no sources of capital to take it further and it’s at that point that the hounds from south of the border move in and take the opportunity.”

Creating a fund-of-funds for seed and pre-seed investment won’t come cheap. The roundtable is recommending fees of 3% annually for the first five years based on the total amount of capital committed. If the full $710 million is realized, that amounts to $21.3 million annually. Fee levels drop to 2.5% for the next five years and decline again to 2% for the last two years of the 12-year life of the funds. The report recommends that the government pay $5 million or 2.5% of funds committed at the seed and pre-seed stage ($200 million), with the vast majority “extracted from the fund and thus borne by all investors”.

“It’s a way to get some of our sectors kickstarted. The funds will help to encourage others like pension funds that are risk averse,” says Dr Murray McLaughlin, president/CEO of Foragen Technology Ventures, a private, early-stage fund dedicated to the agriculture and agri-food sectors. “We have great research and science and this will get it into the commercialization phase without losing it south of the border or have it stuck on a shelf. But we have to be careful that by solving a gap in one area we don’t create one somewhere else.”

SKILLS AND CULTURE

For the report’s recommendations on skills training and culture, there is the potential to utilize the two pilot funds announced in the last Budget The report calls for consideration of several measures, including a mentoring program attached to each fund. Interns would be located at “venture capital firms, technology transfer offices and technology companies to help develop a more entrepreneurial environment and to develop commercialization skills”, states the report.

The report calls for an organization to be identified to deliver the skills and culture portion of the proposal and issue a call for proposals for its design and implementation. The three identified thrusts are an entrepreneur-in-residence program, a program to attract retired or semi-retired professionals to “regions and ... organizations that need them most”, and “an active networking program to advance a culture of commercialization”.

The ACST’s Moffat says the pilot commercialization programs announced in the last Budget have similar objectives to the skills and culture component of the roundtable proposal and could be merged.

“It will depend on the private sector advisory committee for the two pilot funds and they haven’t met yet,” he says. “The general area of building commercialization capacity in the university and federal lab sectors will contribute to what the roundtable participants are talking about.”

Among the report’s observations and assertions is the contention that there needs to be a change in the role of university technology transfer offices (see call-out above). Thayer-Scott acknowledges that this is a difficult issue but asserts that “change is imperative”.

“University culture is not monolithic on this (but) they must be flexible,” she says. “Thinking has evolved on this since the Fortier report.” ACST member Dr Pierre Fortier chaired an expert panel in 1999 that reported on the commercialization of university research (R$, April 28/99).

SIMILAR PROPOSALS

The proposed roundtable model is unprecedented in its exclusive focus on seed and pre-seed financing but it’s not the first to recommend the blending of private and public money for a fund-of-funds. Earlier this year, the Toronto Region Research Alliance (TRRA) developed the Ontario Next Step Commercialization Program, which called for $500 million in public-private funding to help grow early-stage, Ontario-based firms (R$, May 10/04). John Eckert, managing partner at McLean Watson Capital, was a participant in both initiatives.

“The TRRA was a group process as well so it’s not surprising that the results are similar. There are some differences but a lot of similarities,” says Thayer-Scott, adding that another complementary initiative is occurring in British Columbia.

In June, a group of experts from across the financing spectrum gathered in Vancouver along with government and university representatives to share ideas on how to effectively exploit Canada’s investment in the science and technology pipeline.

Led by Dr Dan Muzyka, dean of commerce and administration at the Univ of British Columbia, the group included veteran BC financier Michael Brown, Peter Nicholson, senior advisor to the prime minister and Dr Michael Raymont, acting president of the National Research Council.

“We need to look at the whole financing ecosystem and look at it holistically. There are multiple stages in the initiation and growth of companies,” says Muzyka. “We need to start looking downstream. Do we have adequate capital and is it there at all stages of business development? If we want to realize the benefits of (government investments in science) we have to look at these things.”

The decision to deal with a specific aspect of commercialization in a small group setting demonstrates one of the ways in which the ACST can provide valuable advice to government. Since the Council’s revival in late 2002, members have instituted a flexible structure to provide government with advice in a more timely manner. Thayer-Scott says the experience of using roundtables has proven to be highly satisfactory. It has allowed the ACST to respond to government requests to drill down into specific issues raised in its December/03 report, which has yet to be released publicly.

“When we sent out the draft paper to the roundtable participants we got a 100% response. There was agreement on the 11 principles right away,” she says. “There could be more detailed reports stemming from our original commercialization report. We will discuss this next week with the minister.”

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