Guardian angels for Ottawa start-ups

Ottawa is in an access to credit crisis.

“None of us in the angel capital community really expected it to take on the life that is has.” – Bryan Watson, executive director of the National Angel Capital Association.

The city’s residents have the ideas and talent to generate successful start-ups. Think of all the jobless Nortel talent now looking for innovative ways of making a living, but these ideas will evaporate without funding and funding is hard to come by.

Venture capital has dried up.

That’s why angel investors are creating a new Ottawa network. They hope to make credit more available by joining with the richest investors across Canada, sharing expertise, and reducing risk.

Michelle Scarborough is the vice president of investment and commercialization at the Ottawa Centre for Research and Innovation. She also chairs the new angel capital network which is set to have its first meeting in late February.

“There are a number of angel investment groups in the city, and the newly formed capital network is trying to bring those groups together so they can look at stuff together and make investments,” she says.

Some of these angel investment groups include Purple Angel and the Ottawa Angel Alliance. Their unification is an important step towards finding a way to finance Ottawa’s start-ups.

“Last year we saw a significant increase in the number of start-up companies,” says Scarborough, “and instead of a steady state they’re actually growing.”

Hard to invest

It’s hard for angels to invest in these budding companies because they’re not sure if there is enough credit available to take the company from a plan scrawled on graph paper in someone’s basement, to a company producing a real product that actually earns profits from a solid customer base.

Angel investors typically invest anywhere from $20,000 to $1 million in a company at its earliest stage, then start-ups depend on venture capital for later stage funding before they can fully stand on their own feet, says Scarborough.

The problem is venture capital has disappeared in Ottawa, and it won’t come back until it’s dramatically restructured, she says.

Skypoint Capital and Ventures West are examples of venture capital firms that had funds in Ottawa investing in early-stage technology, both of which are now fully deployed and not being replenished, says Rainer Paduch, who co-manages the Ottawa Angel Alliance.

“There’s huge risk because there’s not full on financing,” he says.

Bad strategies

“The venture capital industry has hit almost a perfect storm.”

Venture capital activity in Canada in 2009 was the weakest recorded in 14 years, according to a joint report by Canada’s Venture Capital and Private Equity Association and Thomson Reuters. In the first nine months of the year $698 million was invested, down from $1.1 billion at the same time in 2008.

Ottawa venture capitalists provided roughly $29 million of that, says Scarborough, but that money probably didn’t go to start-ups because most firms were not expanding their portfolio.

“The venture capital industry has hit almost a perfect storm,” says Richard Rémillard, executive director of Canada’s Venture Capital and Private Equity Association. “Fundraising is down and continues to drop,” he says.

The problem for venture capital is that the banks and other institutional investors they depend on for fundraising are no longer willing to let them take the high-level risks they were taking, says Paduch.

“Banks don’t want to invest in venture capital because they don’t like their system anymore,” he says.

Venture capital developed bad strategies, says Paduch. They invested in risky companies that still had to prove control over their slice of the market, and got around the risk by imposing strict financial mechanisms on them, he says.

Calling all angels

With venture capital in a downward spiral, angel capital is stepping up to the plate.

“None of us in the angel capital community really expected it to take on the life that is has,” says Bryan Watson, executive director of the National Angel Capital Association.

The extra risk from the lack of credit means the strategy for angels is to work together, says Watson.

Angel investors have organized into groups so they can make larger investments and stay with the companies longer, but they’ve also taken another step and joined those groups into networks, he says.

“One deal done in Ottawa was a co-investment between an Ottawa group of angels, a group of angels here in Toronto, and a couple other angel groups I think,” says Watson.

In Ottawa, the new angel network is designed to facilitate more of this type of interaction between angel groups across the country, says Scarborough.

“We feel this is a good model for the Ottawa market,” she says.

Angel investing used to be people just writing cheques and hoping for the best. Now it is much more sophisticated because angels invest in industries they’re familiar with and provide guidance, mentorship, and door openings, says Scarborough.

By collecting angels into large networks there is a useful transfer of expertise, she says.

Hunting for big money

But this still leaves the problem of getting money from big institutional investors such as pension funds and banks back into the market. They were big investors in venture capital funds.

Improving access to credit is economically important because if we don’t replace our big companies such as Nortel with new taxable entities, our huge structural deficit will cause individuals to accept a lower standard of living, says John Reid, president and CEO of the Canadian Advanced Technology Alliance.

“We’ve really injected a lot of caution into the system, and that really squeezes the sort of front end of business creation,” he says.

Canada’s Venture Capital and Private Equity Association is strongly suggesting to government that they increase their funding for operations such as the Ontario venture fund, which invests in venture capital funds, says Rémillard.

“I’m sure creative minds can think of ways of incenting institutional investors to invest in venture capital,” says Rémillard.

The more capital there is available, the less risk there is that start-ups will be orphaned. In turn, this attracts more angel capital.

That’s why most of the 2009 start-ups that received angel money in Ottawa were also receiving government money from funds such as the investment accelerator fund, says Scarborough.