Greg Smith, president of Canada’s Venture Capital and Private Equity Association (CVCA), described the current landscape of Canadian entrepreneurship:
“Canada has an historic opportunity to become an innovation leader by making major investments that enable our best technology businesses to realize optimal growth and compete on a global stage,” he said in a statement. “However, in order to act decisively on this opportunity, we must first overcome challenges to supplying VC funds that, in turn, supply entrepreneurs.”
Without VC initiatives, small companies with big ideas are being caged by cash crunch – running low enough on cash so that it has a significant impact on operations. Exponential growth can also cause a company to be short on working capital. Business growth requires a steady cash flow, enabling the acquisition of equipment and personnel. Lacking VC, companies may be forced to unload assets or sell a part of the business to raise crucial funds.
The cheapest forms of financing are the sources taken for granted:
-Cash in bank account
-Revenue from sales
-Financing from tangible assets (accounts receivable factoring, purchase order factoring).
Aside from borrowing from friends and family, the next funding options come from cost-heavy debt or equity financing. Debt financing directs small businesses to traditional institutions, banks and credit unions, and many small businesses run into trouble meeting financing prerequisites. Equity financing or “share capital” – funding through selling common or preferred stock to individual or institutional investors – is dilutive in nature and requires loss of ownership and possibly control of the business.
In order to get to an operable stage, small businesses can also consider bridge financing and financing from intangible assets. Bridge financing is used to gain immediate cash flow while waiting for an expected inflow of cash. Basically bridge financing provides a forwarded payment for future sales or anticipated inflow of cash. Financing on intangible assets, such as SR&ED (Canada’s Scientific Research and Experimental Development credit program), is not often offered by the traditional institutions but is a non-dilutive form of bridge financing. North Innovation Fund (NIF) is one such source of funding, providing accrual SR&ED financing to support small business and entrepreneurs. NIF released their first Fund this month in response to the increasing demand of funding alternatives for start-up companies in Canada. SR&ED financing will bridge the funding gap for companies with R&D initiatives and new ideas to help make the leap to commercialization.
NIF offers a unique opportunity which includes support in identifying SR&ED activities and a friendly approach to funding. Initiatives like NIF will help push Canada to forefront of growth and innovation.
The Globe and Mail recently addressed the fact that in recent years, the relative impact of self-employment across Canada has been waning. Self-employment has always been an important feature of the Canadian economy; the OECD lists Canada as one of the highest concentrations of entrepreneurs within a working population. However in recent years, the ratio of self-employed persons to those working for someone else has dropped back.
Statistics Canada’s Labour Force Survey (ratio of self-employment to those employed by someone else):
- 13.8 per 100 in 1976
- 21.0 per 100 in 1998
- 18.2 per 100 in 2011
What might be some of the causes for this recent decrease?
Some obvious contributors may be the decline of self-employment due to (1) the retirement of baby boomers, and (2) business failures caused by the last recession. If this is the case, then it is even more paramount for the Canadian government to support new business startups. How can we effectively create new startups to displace the ones that have disappeared?
One of the issues that deters entrepreneurship is the current gap that exists between innovation and commercialization. Our best ideas are often acquired by US-backed firms because we may not be effectively funding business commercialization. Private venture capital is lacking in Canada, so without a doubt, the largest contributor to startup commercialization in Canada is the Scientific Research and Experimental Development (SR&ED) program. The SR&ED program provides refundable tax credits to start-up companies, for expenses that have already been incurred. However, it often takes 1-2 years for companies to see these refunds! This is definitely an area that requires improvement if we to remove the commercialization gap. It should be noted that innovative companies such as the North Innovation Fund have recently begun to offer SR&ED financing on unfiled SR&ED claims.
Changes to the SR&ED program are rumoured in the next federal budget. It goes without saying that the SR&ED program is critical to the survival of many small starts-up. Reducing or removing SR&ED will further decrease the likelihood that these startups will be able to commercialize their innovations, and create new jobs. Instead of cutting back funding to startups, we need to invest in startups, and encourage entrepreneurship in Canada in order to create future employment.
The dilutive nature of early stage equity financing (i.e., giving up ownership) makes it the most expensive way to finance growth. When a start-up does not have enough cash in the bank or cash flow to support their growth (hire more employees, fund working capital, etc.), the company is faced with a significant funding barrier that quite often results in tepid acceleration or worse, either bankruptcy or a fire sale.
When seeking various financing options, it always makes sense to start off with the cheapest form of capital until the threshold is met at which point, you would go to the next tranche of financing – for example (in the order of least to most expensive):
- Cash on hand and internally generated cash flows;
- Traditional bank debt;
- Loans from friends and family;
- Alternative debt financing (subordinated/mezzanine debt or factoring); and
- Equity financing.
At the end of the day, all types of financing are based on one of two things: cash flow or hard (tangible) assets. However, by leveraging its vast knowledge and experience in the SR&ED program, North Innovation Fund (NIF) focuses on an intangible asset – SR&ED accruals. NIF is a provider of SR&ED accrual debt financing, which is timely, flexible and more importantly non-dilutive. What differentiates NIF’s SR&ED financing from other SR&ED financiers is the fact that NIF advances funds before the SR&ED claim is filed (i.e., beginning of the fiscal year). This type of funding plays a critical role in an early stage company’s capital structure by providing the runway to a future round of equity investment or a bridge to the next level of growth.
Waterloo and Toronto, February 15, 2012 - North Innovation Fund (NIF), a privately-held alternative financing firm providing ongoing SR&ED accrual loans to early stage Canadian companies in a variety of technology-based sectors, today announced the launch of its first Fund.
The Fund was created to identify high growth and innovative companies that are in need of non-dilutive growth capital to accelerate their transition from early stage to commercialization. NIF’s objective is to play a role in Canada’s ecosystem through ongoing SR&ED accrual debt financing. The SR&ED program, a federal tax incentive program that encourages research and development activities in Canada, has long been the primary source of funding for early stage companies in Canada.
According to Thompson Reuters Canada, between 2000 and 2010, venture capital investment decreased by more than 80 percent from approximately $5.9 billion to $1.1 billion. During the same period, the number of companies receiving venture capital decreased by more than 64 per cent from 1007 to only 357 during that same period.
“We have identified an important gap in the early stage capital markets ecosystem. There needs to be more non-equity (i.e., non-dilutive) funding sources to bridge the funding gap. The SR&ED program in Canada works and provides much needed funding to early stage companies – the only problem I see, is the fact that they have to wait over 12 months to receive their cash”, explained James Ro, Managing Director of North Innovation Fund. “We want to play a role in helping Canadian technology companies reach their next level of growth by financing ongoing SR&ED accruals in advance so that they can use the proceeds to hire more staff, fund working capital needs and execute their growth plan”.
For more information regarding North Innovation Fund and to contact the Fund regarding SR&ED financing or SRED financing opportunities, please visit www.northinnovationfund.com.
