Company Logo Thursday, October 26, 2000

Money is just the starting point; Good venture capital firms often play the role of business partner

Gary Will, Special To The Record

Last December, Jeff Fedor received a $500,000 seed investment from Waterloo Ventures to build Ardesic Corp., a new e-commerce software company he had founded.

Within the next nine months, Ardesic had raised $10 million in its first round of financing, grown to 21 employees, and had announced its first customer, an online medical exchange based in the United Kingdom.

In July 1998, Rob Kroeger received seed financing from another venture fund to develop a technology he had invented as a graduate student at the University of Waterloo.

But his story differs from that of Ardesic.

Over the 18 months that followed, Kroeger grew increasingly frustrated as his company, LiquiMedia Inc., seemed to make little progress in creating and executing a business plan.

And by January of this year, the company had shut its doors. Its technology was in limbo.

FUEL FOR GROWTH
Venture capital has fuelled the rapid growth of the high-tech sector in the Internet era.

Over the last five years alone, many good ideas -- and many ideas that seemed good at the time -- have been developed into business enterprises through the investment of billions of dollars from venture capital firms. Early-stage investment carries higher risks, but has the potential for higher reward.

One successful investment can make up for many others that failed along the way, but, unlike venture capitalists, entrepreneurs don't get the opportunity to spread their risk.

The companies they create will either soar or fizzle. Some, like Ardesic, get off the blocks cleanly. Others go the way of LiquiMedia and get swept under the rug.

In Canada, capital is more readily available than ever before and an entrepreneur with a compelling business plan isn't going to have problems finding money, says Andrew Abouchar, fund manager for Waterloo Ventures.

At the same time, he notes, every venture capitalist firm will have its own idea of what comprises a compelling plan.

"If you're having trouble finding money, you've got to think carefully about what it is about your business plan, the management team, the strategy, or the business model that makes it unattractive. There is something that is turning these guys off, because they've all got a lot of money."

Money, however, is just the starting point in the relationship between a venture capital firm and the companies it funds.

To entrepreneurs who are looking for capital, Fedor's first bit of advice is to realize that they're not just getting money, they're getting a business partner.

Abouchar agrees. He also believes entrepreneurs should look elsewhere, in fact, if money is all they're being offered.

"What we do at Waterloo Ventures is much more than write a cheque.

"Because, frankly, we don't write very big cheques. But you're going to get a partner whose idea of adding value is a lot more than just showing up for a quarterly board meeting."

The "Rolodex factor" should also be a key issue for entrepreneurs, he says.

"If venture capitalists aren't saying to you, 'My contacts are your contacts, let's go build this together,' you've got the wrong venture capitalist."

How a company fits into the venture capital firm's existing portfolio is another factor to consider when looking for financing.

You should ideally find a firm with existing investments in companies that could be potential customers or partners, Fedor says.

Or find someone with a track record in building great companies.

Ardesic, both men agree, has benefitted from the strong working relationship they have been able to develop.

"Very early on, we started to build a trust relationship and it has allowed us to work very closely together," Abouchar says.

And ideally, he adds, both sides must get to know each other before closing any deal.

"You need to understand how they do business, what makes them tick. Can you work with them day-in and day-out for 12 to 18 months? It's personality as much as anything else."

Fedor's success shows how well the process can work when a good match is made.

PAINFUL EXPERIENCE
A post-mortem of Kroeger's experience, on the other hand, provides a reminder of what can happen when a pairing goes wrong.

Kroeger's introduction to the world of venture capital was not typical.

He never sought out a venture capital firm; he had one come to him, an experience many business founders would envy.

"I always wanted to productize my thesis," Kroeger says.

"It was a running joke that I was more interested in developing a product than I was in writing a thesis."

About that time, a "company creator" for a Toronto-based technology start-up fund was making the rounds of various universities and paid a visit to the University of Waterloo. He asked professors if they had any ideas they wanted to spin off into companies.

Kroeger's supervisor introduced him to the visitor and the first impressions were encouraging.

"We met, we talked, he was intrigued ... He seemed enthusiastic and capable."

The company creator's role was to get the company financed and then take care of setting up the corporate business structure, such as incorporating and hiring full-time management.

"Essentially he would put together a team to develop the business for the next round of financing."

Kroeger had developed the basic concept for a real-time operating system in 1995 as a doctoral student in computer science. He thought this was the opportunity he had been hoping for, to turn his thesis into a product, initially targeted at multimedia applications.

A deal was reached and LiquiMedia received a six-figure sum to develop the technology, prove it worked and start applying for patents.

Kroeger and the fund each received a seat on the company's board, while a third seat was to go to an independent party.

While Kroeger worked at developing and describing the technology, the company creator, now LiquiMedia's president and chief executive officer in addition to his role with the fund, was to establish a business model and figure out how and when the company would generate revenues.

Kroeger says he met the technical targets, which triggered the investment of a second amount of money by the fund in January of 1999.

On the business side, the objectives were now to hire a full-time management team and for the company creator to step out of his day-to-day role of managing LiquiMedia.

Kroeger, who had been developing the technology on his own to this point, hired a small staff to build a prototype.

But by the spring he was worrying about what he saw as a lack of progress on the business end.

"I started getting upset about this," he says. "We still didn't have a business model or revenue model. There was still no business plan, or full-time management hired."

BREAKTHROUGH ANNOUNCED
In June that year, LiquiMedia attended JavaOne, a major conference in San Francisco for Java developers, organized by Sun Microsystems. While there, it issued three news releases heralding the completion of what it called "breakthrough" technology.

"We go to JavaOne, show off the prototype, do a lot of meetings, excite people with the technology," Kroeger recalls.

"The response was, 'Well, that's pretty neat, but tell me how it's going to make me money.'

"The answer to that didn't exist. I didn't know better, but I should have had an answer to that."

Increasingly exasperated by what he felt was a lack of execution on the business side, Kroeger's relationship with the CEO and venture fund (where the CEO continued to work as a senior associate) began to crumble.

"We had been in business for a year and still didn't know what we were supposed to be building, since the core technology is applicable in many contexts," Kroeger says.

"There seemed to be a new idea every week that required a total shift in the direction of the development process.

"Finally, by early September, I decided enough was enough."

Kroeger says he attempted to put together his own business plan.

"I recruited someone with an MBA and persuaded them to work on this for no money."

Kroeger also developed a revenue model.

"It wasn't necessarily a good one because it didn't have early-stage revenue," he says.

"It would have required living off venture capital for two or three years."

By now, the relationship with the venture capital firm was probably strained beyond repair. Kroeger tried to get the CEO replaced, but without luck. Then the fund decided to appoint the CEO to its seat on the board, making him LiquiMedia's president, CEO and director.

The CEO, representing the fund, presented Kroeger with a term sheet for a proposed round of financing.

"It was punitive," says Kroeger. "It was so abundantly unacceptable that I decided to walk away."

In January this year the company ceased operations and, on the advice of his lawyer, Kroeger resigned his board seat a month later. At the same time, the Globe & Mail newspaper carried a report listing the moribund LiquiMedia as one of Waterloo's high-tech "rising stars."

Kroeger still owns shares in LiquiMedia. A shareholders' agreement prevents either him or the fund from doing anything with the company or its technology without the other's permission.

Kroeger now works for a start-up company in Palo Alto, Calif., right next door to Menlo Park, the centre of the venture capital universe.

If he could do it over again, he says he would go to more than one venture capitalist and only begin after developing at least a rudimentary revenue model and business plan.

"I'd have the story for them that this is how we're going to make money."

Kroeger advises entrepreneurs that, for their own mental health, they should set clear milestones up front with their venture capitalists.

"Everybody needs to understand that this means success and we go on, and this means failure and we stop."

Kroeger also recommends deciding, right from the start, what will happen if the business goes nowhere, which he realizes isn't a easy topic to bring up when everyone is dreaming of hitting a home run.

"But it should be set up so this limbo condition isn't possible. It should live or die. It shouldn't be in a coma."

LACK OF EXECUTION
Despite their financial backing, many venture-backed companies fail to make progress as businesses. And, Abouchar says, lack of execution is often the culprit.

"Sometimes you wonder if a company has confused formulating a strategy with executing that strategy.

"There are times when you can't afford to sit and think strategically ... you just have to go execute. Wear out the shoe leather."

Could a deal be structured to avoid the kind of impasse Kroeger faces?

You can't look to lawyers to make a relationship work, Abouchar says. "No amount of structuring is going to turn a bad deal into a good deal."

Although he still sees a wide range of potential applications for his technology, Kroeger says he accepts that LiquiMedia was a high-risk investment and may not have suited the venture fund's objectives.

"It would have required a lot of money before we saw much revenue. But that was their call. They could have said, 'This is silly,' and not invested."

Both Abouchar and Fedor emphasize that being "fundable" is a stumbling block many entrepreneurs don't consider when they look for capital.

"It sounds obvious, but the number of business plans I see that are not fundable is remarkable," Abouchar says.

Different venture capitalist firms have different criteria for determining what they fund. So entrepreneurs need to find out which funds might back their particular project.

They also need to be sure that their business plan offers the high return that a venture capitalist requires.

"Big ideas are important," explains Abouchar.

"It's got to be big enough that we can go out and build a $500 million company or a $1 billion company.

"As a seed venture capitalist, I can't earn a return for my shareholders by building $50-million companies.

"The deals that we are looking for have a more profound impact on the way we live and on the way we do business."

Even Fedor failed to clear the bar in his initial pitch to Waterloo Ventures.

"The first business plan that I saw from Ardesic was not fundable," says Abouchar. "Jeff went away, did some more research, and came back with a plan that I thought was very good."

With his first-round financing now closed, Fedor says the worst part of the process is that it's a full-time job.

"You can easily lose sight of the fact that you have a business to run in parallel with your financing activity."

Along with having a big idea and a fundable business model, the other factor entrepreneurs can control before contacting a venture capital firm is the calibre of the management team, Abouchar says.

"I have to evaluate if management is capable enough and sophisticated enough to reach the targets they've set.

"Sound pretty subjective? It is."

BUSINESS PLANS TURN UP BY E-MAIL
His initial contact with an entrepreneur often turns up simply in the form of an e-mailed business plan, says Andrew Abouchar, Waterloo Ventures fund manager.

"There's no point in creating some enormous tome," he says. "The most important thing to communicate in a business plan is that you have a very clear, very focused strategy and you know exactly how you are going to execute it."

All venture capitalists bring their own preferences and prejudices to bear on the business plans they receive. And at some point, Abouchar says, they all make errors: funding a loser, or not funding a winner.

"You're going to miss stuff. That's life."

When he declines a deal, Abouchar says, he prefers just to say, 'No thanks,' and move on. But he is willing to explain his specific reasons, under one condition:

"I'm not opening the floor for debate. Believe it or not, venture capitalists are human, too, and we don't want to hurt people's feelings."

Gary Will
Special To The Record

Last December, Jeff Fedor received a $500,000 seed investment from Waterloo Ventures to build Ardesic Corp., a new e-commerce software company he had founded.

Within the next nine months, Ardesic had raised $10 million in its first round of financing, grown to 21 employees, and had announced its first customer, an online medical exchange based in the United Kingdom.

In July 1998, Rob Kroeger received seed financing from another venture fund to develop a technology he had invented as a graduate student at the University of Waterloo.

But his story differs from that of Ardesic.

Over the 18 months that followed, Kroeger grew increasingly frustrated as his company, LiquiMedia Inc., seemed to make little progress in creating and executing a business plan.

And by January of this year, the company had shut its doors. Its technology was in limbo.

FUEL FOR GROWTH
Venture capital has fuelled the rapid growth of the high-tech sector in the Internet era.

Over the last five years alone, many good ideas -- and many ideas that seemed good at the time -- have been developed into business enterprises through the investment of billions of dollars from venture capital firms. Early-stage investment carries higher risks, but has the potential for higher reward.

One successful investment can make up for many others that failed along the way, but, unlike venture capitalists, entrepreneurs don't get the opportunity to spread their risk.

The companies they create will either soar or fizzle. Some, like Ardesic, get off the blocks cleanly. Others go the way of LiquiMedia and get swept under the rug.

In Canada, capital is more readily available than ever before and an entrepreneur with a compelling business plan isn't going to have problems finding money, says Andrew Abouchar, fund manager for Waterloo Ventures.

At the same time, he notes, every venture capitalist firm will have its own idea of what comprises a compelling plan.

"If you're having trouble finding money, you've got to think carefully about what it is about your business plan, the management team, the strategy, or the business model that makes it unattractive. There is something that is turning these guys off, because they've all got a lot of money."

Money, however, is just the starting point in the relationship between a venture capital firm and the companies it funds.

To entrepreneurs who are looking for capital, Fedor's first bit of advice is to realize that they're not just getting money, they're getting a business partner.

Abouchar agrees. He also believes entrepreneurs should look elsewhere, in fact, if money is all they're being offered.

"What we do at Waterloo Ventures is much more than write a cheque.

"Because, frankly, we don't write very big cheques. But you're going to get a partner whose idea of adding value is a lot more than just showing up for a quarterly board meeting."

The "Rolodex factor" should also be a key issue for entrepreneurs, he says.

"If venture capitalists aren't saying to you, 'My contacts are your contacts, let's go build this together,' you've got the wrong venture capitalist."

How a company fits into the venture capital firm's existing portfolio is another factor to consider when looking for financing.

You should ideally find a firm with existing investments in companies that could be potential customers or partners, Fedor says.

Or find someone with a track record in building great companies.

Ardesic, both men agree, has benefitted from the strong working relationship they have been able to develop.

"Very early on, we started to build a trust relationship and it has allowed us to work very closely together," Abouchar says.

And ideally, he adds, both sides must get to know each other before closing any deal.

"You need to understand how they do business, what makes them tick. Can you work with them day-in and day-out for 12 to 18 months? It's personality as much as anything else."

Fedor's success shows how well the process can work when a good match is made.

PAINFUL EXPERIENCE
A post-mortem of Kroeger's experience, on the other hand, provides a reminder of what can happen when a pairing goes wrong.

Kroeger's introduction to the world of venture capital was not typical.

He never sought out a venture capital firm; he had one come to him, an experience many business founders would envy.

"I always wanted to productize my thesis," Kroeger says.

"It was a running joke that I was more interested in developing a product than I was in writing a thesis."

About that time, a "company creator" for a Toronto-based technology start-up fund was making the rounds of various universities and paid a visit to the University of Waterloo. He asked professors if they had any ideas they wanted to spin off into companies.

Kroeger's supervisor introduced him to the visitor and the first impressions were encouraging.

"We met, we talked, he was intrigued ... He seemed enthusiastic and capable."

The company creator's role was to get the company financed and then take care of setting up the corporate business structure, such as incorporating and hiring full-time management.

"Essentially he would put together a team to develop the business for the next round of financing."

Kroeger had developed the basic concept for a real-time operating system in 1995 as a doctoral student in computer science. He thought this was the opportunity he had been hoping for, to turn his thesis into a product, initially targeted at multimedia applications.

A deal was reached and LiquiMedia received a six-figure sum to develop the technology, prove it worked and start applying for patents.

Kroeger and the fund each received a seat on the company's board, while a third seat was to go to an independent party.

While Kroeger worked at developing and describing the technology, the company creator, now LiquiMedia's president and chief executive officer in addition to his role with the fund, was to establish a business model and figure out how and when the company would generate revenues.

Kroeger says he met the technical targets, which triggered the investment of a second amount of money by the fund in January of 1999.

On the business side, the objectives were now to hire a full-time management team and for the company creator to step out of his day-to-day role of managing LiquiMedia.

Kroeger, who had been developing the technology on his own to this point, hired a small staff to build a prototype.

But by the spring he was worrying about what he saw as a lack of progress on the business end.

"I started getting upset about this," he says. "We still didn't have a business model or revenue model. There was still no business plan, or full-time management hired."

BREAKTHROUGH ANNOUNCED
In June that year, LiquiMedia attended JavaOne, a major conference in San Francisco for Java developers, organized by Sun Microsystems. While there, it issued three news releases heralding the completion of what it called "breakthrough" technology.

"We go to JavaOne, show off the prototype, do a lot of meetings, excite people with the technology," Kroeger recalls.

"The response was, 'Well, that's pretty neat, but tell me how it's going to make me money.'

"The answer to that didn't exist. I didn't know better, but I should have had an answer to that."

Increasingly exasperated by what he felt was a lack of execution on the business side, Kroeger's relationship with the CEO and venture fund (where the CEO continued to work as a senior associate) began to crumble.

"We had been in business for a year and still didn't know what we were supposed to be building, since the core technology is applicable in many contexts," Kroeger says.

"There seemed to be a new idea every week that required a total shift in the direction of the development process.

"Finally, by early September, I decided enough was enough."

Kroeger says he attempted to put together his own business plan.

"I recruited someone with an MBA and persuaded them to work on this for no money."

Kroeger also developed a revenue model.

"It wasn't necessarily a good one because it didn't have early-stage revenue," he says.

"It would have required living off venture capital for two or three years."

By now, the relationship with the venture capital firm was probably strained beyond repair. Kroeger tried to get the CEO replaced, but without luck. Then the fund decided to appoint the CEO to its seat on the board, making him LiquiMedia's president, CEO and director.

The CEO, representing the fund, presented Kroeger with a term sheet for a proposed round of financing.

"It was punitive," says Kroeger. "It was so abundantly unacceptable that I decided to walk away."

In January this year the company ceased operations and, on the advice of his lawyer, Kroeger resigned his board seat a month later. At the same time, the Globe & Mail newspaper carried a report listing the moribund LiquiMedia as one of Waterloo's high-tech "rising stars."

Kroeger still owns shares in LiquiMedia. A shareholders' agreement prevents either him or the fund from doing anything with the company or its technology without the other's permission.

Kroeger now works for a start-up company in Palo Alto, Calif., right next door to Menlo Park, the centre of the venture capital universe.

If he could do it over again, he says he would go to more than one venture capitalist and only begin after developing at least a rudimentary revenue model and business plan.

"I'd have the story for them that this is how we're going to make money."

Kroeger advises entrepreneurs that, for their own mental health, they should set clear milestones up front with their venture capitalists.

"Everybody needs to understand that this means success and we go on, and this means failure and we stop."

Kroeger also recommends deciding, right from the start, what will happen if the business goes nowhere, which he realizes isn't a easy topic to bring up when everyone is dreaming of hitting a home run.

"But it should be set up so this limbo condition isn't possible. It should live or die. It shouldn't be in a coma."

LACK OF EXECUTION
Despite their financial backing, many venture-backed companies fail to make progress as businesses. And, Abouchar says, lack of execution is often the culprit.

"Sometimes you wonder if a company has confused formulating a strategy with executing that strategy.

"There are times when you can't afford to sit and think strategically ... you just have to go execute. Wear out the shoe leather."

Could a deal be structured to avoid the kind of impasse Kroeger faces?

You can't look to lawyers to make a relationship work, Abouchar says. "No amount of structuring is going to turn a bad deal into a good deal."

Although he still sees a wide range of potential applications for his technology, Kroeger says he accepts that LiquiMedia was a high-risk investment and may not have suited the venture fund's objectives.

"It would have required a lot of money before we saw much revenue. But that was their call. They could have said, 'This is silly,' and not invested."

Both Abouchar and Fedor emphasize that being "fundable" is a stumbling block many entrepreneurs don't consider when they look for capital.

"It sounds obvious, but the number of business plans I see that are not fundable is remarkable," Abouchar says.

Different venture capitalist firms have different criteria for determining what they fund. So entrepreneurs need to find out which funds might back their particular project.

They also need to be sure that their business plan offers the high return that a venture capitalist requires.

"Big ideas are important," explains Abouchar.

"It's got to be big enough that we can go out and build a $500 million company or a $1 billion company.

"As a seed venture capitalist, I can't earn a return for my shareholders by building $50-million companies.

"The deals that we are looking for have a more profound impact on the way we live and on the way we do business."

Even Fedor failed to clear the bar in his initial pitch to Waterloo Ventures.

"The first business plan that I saw from Ardesic was not fundable," says Abouchar. "Jeff went away, did some more research, and came back with a plan that I thought was very good."

With his first-round financing now closed, Fedor says the worst part of the process is that it's a full-time job.

"You can easily lose sight of the fact that you have a business to run in parallel with your financing activity."

Along with having a big idea and a fundable business model, the other factor entrepreneurs can control before contacting a venture capital firm is the calibre of the management team, Abouchar says.

"I have to evaluate if management is capable enough and sophisticated enough to reach the targets they've set.

"Sound pretty subjective? It is."

BUSINESS PLANS TURN UP BY E-MAIL
His initial contact with an entrepreneur often turns up simply in the form of an e-mailed business plan, says Andrew Abouchar, Waterloo Ventures fund manager.

"There's no point in creating some enormous tome," he says. "The most important thing to communicate in a business plan is that you have a very clear, very focused strategy and you know exactly how you are going to execute it."

All venture capitalists bring their own preferences and prejudices to bear on the business plans they receive. And at some point, Abouchar says, they all make errors: funding a loser, or not funding a winner.

"You're going to miss stuff. That's life."

When he declines a deal, Abouchar says, he prefers just to say, 'No thanks,' and move on. But he is willing to explain his specific reasons, under one condition:

"I'm not opening the floor for debate. Believe it or not, venture capitalists are human, too, and we don't want to hurt people's feelings."

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