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September/October 2022 - ENTREPRENEUR OF THE YEAR

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V E N T U R E D E B T It's not just venture capital that has grown exponentially in recent years. A growing number of startups are drawing on venture debt to get their ideas off the ground. "What you've seen is the technology community overall has realized there's more than one way to fund your company," says Randy Garg, founder and managing partner of Vancouver-based Vistara Growth, whose business spans the boundary between equity and debt investments. Borrowing money instead of giving up equity sounds pretty good to a founder who expects to hit some big milestones in the next year or two and move up to a higher valuation. But what's in it for the lender? How safe can it be to lend money to an unprofitable startup with no collateral? Borrowers typically can offer two things, Garg explains. The first is venture backing that the lender trusts and has confidence in (often the VC and lender are one and the same). The second is the widely adopted software-as-a- service (SaaS) model, which ensures even very young companies a measure of recurring revenues. "In the old days as a founder, you woke up on Janu- ary 1 with no revenue on your books," says Garg, a 28-year veteran of technology invest- ing on the West Coast. "Now- adays, companies start the year with at least 80 percent of last year's revenues already in place. That predictability is something debt financiers can hang their hat on." Any startup worth its salt is likely to end the year book- ing at least 150 percent of the previous year's revenue. So for a venture lender or even a bank to put up money in return for a claim on, say, 40 percent of the previous year's receipts no longer looks so risky. And with the still very low cost of capital generally, the interest on those loans will be in the low double or even high single digits—a small price for many founders and seed investors to avoid further dilution. –M.M. of Optimus Information and an angel investor based in Vancouver. It may take months or years to play out, but he predicts that some companies funded at high valuations over the past couple of years will face "down rounds" at lower multiples in the future or run out of money. That will have repercussions: capital losses, broken business relationships, sullied reputations. "I don't feel too bad about it. It's capitalism," Agarwal says, noting the industry went through the same thing in 2000-01 and 2008-09. "It eventually makes the market better." While not quite as gloomy, Yaletown's Knapp expects that "the valuations that would have been attainable as little as four months ago are now going to be rare or entirely unattainable." That's not to say they're going back to pre-pandemic levels, but there will be some retracement, with seed rounds fetching $2 million to $2.5 million, he says. Also, deal terms that were extraordinarily founder-friendly last year will shift toward investors' interests. Winners and losers "Looking back a month in the rear-view mirror, our timing looks good," says Damir Hot, CEO of Canalyst. The Vancouver-based invest- ment analytics company announced a US$70-million round on Janu- ary 18, in the midst of the tech correction. Though Canalyst, whose new shareholders include the august Canada Pension Plan Invest- ment Board, may seem to have made its money heist just under the wire, Hot has confidence that the company—and other B.C. startups "Looking back a month in the rear-view mirror, our timing looks good." –DAMIR HOT, CEO of Canalyst Randy Garg 2 0 2 2 V E N T U R E C A P I TA L R E P O RT like it—would have persevered even with- out the cash infusion at this precise time, whether by accepting a somewhat less lucra- tive deal or opting not to raise money at all. Since Canalyst's founding in 2015, "we've never had trouble raising money," Hot says. Looking forward, "there's still lots of capital out there for good companies." IT companies engaged in "transactional infrastructure" that analyzes and optimizes data relating to commercial transactions, as Canalyst does, will remain popular with investors, Knapp predicts, as will compa- nies with an environmental or energy tran- sition angle. Importantly, companies that get funded will have a "quantifiable story," he adds. The business proposition will be supported by actual sales growth or other performance metrics. Maria Pacella, managing partner of Van- couver-based Pender Ventures, the VC arm of PenderFund Capital Management, agrees that data analytics and enterprise software will stay hot. "The data's still exploding," she says of the information that organizations of all kinds find themselves collecting as they digitize various aspects of their operations. The prominence of the pandemic and cli- mate change will see a continued appetite for greentech and health sciences ventures, too. Pacella points to a rise in VCs' use of ESG (environmental, social and governance) cri- teria, applied not just to startups targeting environmental and social solutions but to all companies seeking funding, as a function of standard due diligence. But other niches are due for a dressing down, including the consumer-facing or so- called B2B2C business models that saw the greatest run-up in valuations, as high as 20 times annual revenue in 2021, Knapp says. Why inflation weighs on tech Understanding the threat posed by infla- tion and rising interest rates on technology finance means understanding the concept of duration. Any investment is theoretically worth the sum total of the return of capital when it matures or is sold, plus any capital gain and/or income it produces during the holding period, minus a discount reflecting SEPTEMBER/OCTOBER 2022 BCBUSINESS 33 BCBUSINESS.CA

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