Growth Times

A great post today by Suzanne Dingwall Williams of Venture Law Associates LLP in Toronto, regarding the recent considerations by the U.S. to increase the number of H1B visas for skilled foreign workers, apparently thanks to a push by venture capitalists.

The stats she quotes are startling: 

“A recently released study by the NVCA notes that (a) immigrants have started more than 25% of U.S. public companies that were formerly venture backed, and (b) more than 50% of the employment generated by U.S. public venture-backed companies has come from immigrant-founded companies like Intel, eBay, Yahoo!, and Sun.

The New York Times has also taken note, citing Harvard Law professor Vivek Wadhwa’s claim that 52.4% of today’s Silicon Valley startups have at least one foreign founder. US VCs are figuring that, to expand domestic deal flow, they need to expand the immigrant entrepreneur base.”

Having lived in six countries including the U.S., I can tell for a fact that the amount of energy I deployed to learn about and obtain the visas and other administrative passes giving me the right to stay and to work is stupendous. In volume, it easily equals the time required to launch the operations of a start-up. This truly is wasted time. If the U.S. had made it easier for me to stay after my years at Stanford, I’d likely be there. I truly love Canada and Toronto is my favorite city in the world – but on a professional level, for tech entrepreneurs the environment is just not comparable to California. So the main advantage of Canada over the U.S., as Suzie points out, is that it is easier to immigrate as a skilled worker here.

But if that advantage diminishes, what’s left to retain immigrant tech entrepreneurs in Canada?

Better public support for start-ups? More grants? Sure, that’s one thing we have over the U.S. But it’s also a double-edged sword: in the previous years and months, the government and semi-public/nonprofit bodies have rapidly enriched their offering to better support the local tissue of tech entrepreneurs. That part is great. But a problem that’s not often raised -no one wants to publicly irk the hands that feed them, I guess- is the increasing institutionalization of venture commercialization actitivities that came with it: internal competition between agencies and “nonprofits” (whose employees clearly profited from this boom) are now leading some of them to expand into the private sector’s realm, for example by offering free market research and consulting services for start-ups. That move even goes against the public service mandate, as those services are generally only available to handpicked “clients”.

Even though it is motivated by a will to better support start-ups, it troubles me that the government and the bodies it supports increasingly choose to nationalize this activity as opposed to supporting the private providers already present. I didn’t leave the most successful communist country in the world – I’m talking of France – to land back in a growingly soviet-like environment, and have to make a living by begging for public grants! Hubs and catalysts are much needed. But it is to complement and promote, not replace, our private entrepreneurial ecosystem.

Sure, there is a lot of good work done hand-in-hand by private, public and publicly subsidized nonprofit organizations here, but when it comes to actual commercialization projects, it’s been my experience again and again that someone with a guaranteed salary and an institutional job simply doesn’t deliver as much value as a private sector provider whose next job depends on the quality of the one at hand. But unfortunately for us, it’s hard to compete with free. ”Free” also creates the wrong culture up north, with start-ups getting used to focusing on the technology and not investing much in commercialization and marketing, which obviously comes back to bite them. The higher valuation Americans place on commercialization activities, in my opinion, is another characteristic of the U.S. entrepreneurial ecosystem that still makes it more compelling than the Canadian one. With higher quotas for H1B visas, it won’t just attract better entrepreneurs , it will also attract better professionals to support those entrepreneurs.

As for VCs in Canada, there are few left, and so companies here are forced to look south or reduce their fundraising expectations and go after angels (who have done a tremendous job filling the gap left by VCs in early stages, but simply don’t have the same financial firepower). Interestingly, the VCs that are left also tend to only provide small amounts and thus really start looking more like angels with extra overheads. Among the Canadian clients I helped this year, and other start-ups I know here that received term sheets from Canadian VCs, not one accepted them. They went for local angels or U.S. VCs. Canadian VCs are stuck in the middle.

Luckily for Canada, U.S. H1Bs are not as compelling as the permanent residence our country is handing over to skilled workers, since they are tied to employment – it’s E visas and green cards the U.S. should make easier for entrepreneurs to obtain (and perhaps they are working on that too, I haven’t checked). But if the great Canadian advantage in facilitating entry and residence of skilled workers goes away, there will be little left here for immigrant entrepreneurs. A Canadian spouse and public healthcare (also something the U.S. may address) as the main reasons for most of them to stay here doesn’t make for great headlines about the state of our entrepreneurial system.

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Varun Mathur, the Techvibes Community Manager, who I just learnt is based in Toronto (I look forward to meeting you, Varun), made an excellent point yesterday in his Techvibes post on What Separates 37signals And Twitter ? 

For all the talk about “getting to revenue” as fast as possible, VCs are still valuing companies based on hype and unproven potential for exponential revenues. You can build valuations based on traffic, but if you can’t attach a realistic average $ amount to a visitor, and if you are going to hemorrhage your traffic as soon as you offer ads, then your valuation is built on shaky grounds – which in finance means you should likely be extremely conservative or discount it.

I don’t say there is never a case for giving high valuation to companies that have great brand awareness and usage even if they haven’t made a buck yet, but my thesis is that the risk of this revenue never materializing should lead to discounting valuations more heavily than they currently are. VCs should put their valuation through a simple risk-based, probabilistic tree analysis, contemplating the likelihood of 3 basic scenarios:

1. will never get to revenue and can’t sell or IPO company
2. can never get to revenue but can get company acquired
3. can get to revenue (and then look at the different types of revenue to differentiate linear from exponential in particular)

The problem, which ultimately has to do with the probability and payoff you attribute to each scenario, is especially with number 2. Even in this market, founders and VCs can rely on overpriced acquisitions to unload a company to an unsuspecting acquirer (hello eBay).  And so, with the right connections, the probability of scenario 2 is still implicitly weighted higher than it should likely be in VC valuation models.

My theory is that the Silicon Valley is an echo chamber for tech venture hype (just like Wall Street for blue chips), and a lot of founders and investors are masters at amplifying and riding this wave – rather than focusing on actually creating a revenue engine. In other words, ladies and gentlemen, yes, there are a lot of respectable-looking scammers in that business, and very successful ones too.  VCs won’t tell you this but lots of them love embracing irrational exuberance, because bubbles is how they get rich quick. 

Right now the real-time web is where this exuberance can be found. To Varun’s point questioning whether 37signals didn’t get Twitter-type valuation because of its Chicago location, I would add that perhaps the main reason why a valley-based Twitter will get a higher valuation than a Chicago-based or Canada-based twitter is that irrational exuberance dies off quickly when you have to take a 5h flight to close an acquisition -  reality-distortion fields don’t work well that far from the epicenter of the tech mecca. Locations that can turn perception into reality have a clear edge in businesses that rely on hypothesis for their valuation. So, yes, if 37signals want to reach astronomical values, it would do well to move to Mountain View or Palo Alto, drop any source of revenue, and change its name to reduce the likelihood their past revenue figures will constrain their future valuation.

However, that’s not all. In all fairness, one must point out that the potential for exponential revenues by 37signals as a platform developer targeting, well, application developers, is lower than a Twitter that can be used by potentially anyone. There is a lesson here for business models. Based on whether you target revenue or fundraising, your runway and product mix looks very different. In the first case (seeking revenues), you often need to diversify across a small range of products to test and create multiple sources of revenues – alpha, beta and subsequent market iterations are less dangerous because they don’t impact your long-term success as badly as a highly hyped flop from a VC-funded venture. You can fix things, there is less pressure to grow to $100M in 5 years, and quite often the decision to give you money is distributed across many potential users as opposed to concentrated on just a few VCs (who know and speak to each other).

In the second case (seeking capital), you often have only one chance to build buzz, and if it fails to support your story, it’s unlikely you’ll raise a round, and it’s likely you’ll die of capital thirst. So you want to bet the farm on one-single make-or-break application. It’s a different discipline. But still, the problem remains in the fundraising model, that it doesn’t encourage you to build your product with a revenue model in mind, until often too late in the game.

All in all, that’s a real problem for venture consultants like me as we generally encourage start-ups to get to revenue asap, and then a Twitter investment by VCs reactivates pipe dreams that all you need to do is a cool app and you’ll be a millionaire. If you are after VC money, it’s better not to make revenues if those are going to disprove the revenue potential of your model… Maybe that’s why new VCs need to emerge that don’t take a “winners take all” approach to investment, and instead focus on growing real revenues across their portfolio. Mmm, sounds like a hybrid of VC and management consultant… Did I just evolve my model? Thanks Varun!

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• Why Facebook’s IPO could be disappointingly weak (dailyfinance.com)
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• Facebook Now Has Over 300 Million Users (mashable.com)
• The Twitter investment and the decline of venture capital (cdixon.org)
• Intuit Buys Mint.com for $170 million (businesspundit.com)

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