Secure the right funding

February 10, 2021 BDO CANADA

“Funding is like fuel for a car,” suggests Brion Hendry, GTA Tech and Life Sciences Industry Leader at BDO Canada. “If you’ve got too little [capital] you won’t be able to reach your destination. If you’ve got too much, you can get slow and sloppy—you might not be as motivated to make efficient business decisions, for example.”

Saud Juman, founder and former CEO of PolicyMedical, adds: “I think a little bit of fuel helps tremendously. If were to do it again, I’d want to do it faster, at scale and at speed, over, maybe, a five- to seven-year trajectory.”

Raising capital for rapid growth

“Ninety-nine percent of high growth tech companies are not cash-flow positive for some time. Most require funding to support the development of the product and the development of the business—everything from patents to marketing. There’s dilutive and non-dilutive [capital]. Dilutive means we’re giving up equity. Non-dilutive means we aren’t. A blended strategy is definitely the best. If you’re in scale-up mode, you are considering substantial capital. Venture debt and bank loans can be part of that. Government tax credits, like SR&ED, can be part of that,” observes Jamie Barron, a TLS leader who focuses on innovative, high-growth companies. Jamie advises: “But, you have to decide the use of the funds first—what is going to help move the needle on valuation?

Michael Hiley, leader of BDO Canada’s Alberta TLS practice agrees: “In an ideal scenario, you’re looking at a five- to seven-year growth-to-potential-exit lifecycle. The first half is founders defining their products, learning what they need, connecting with the people they need to help them, doing small rounds of financing to stay afloat—and then they either die or they’ll go to revenue. They’ll spend a couple years moving that forward, then exit.”

“If you’re an entrepreneur who starts a manufacturing business, and you grow ten to 15% a year, that’s fantastic. If you start a tech company, and you grow ten to 15% a year, the market is going to tell you that you’re not scaling fast enough. Tech happens at an accelerated pace. If you’ve got a chance to monetize, you take it and run. Then go back and do it again. With the serial tech entrepreneur, the rate of change is so quick that if they see an opportunity, they scale it, they monetize it, and they exit,” says Ryan Farkas, who leads Transaction Advisory Services at BDO Canada.

To scale toward a sale (or, more rarely, an IPO), bigger rounds of funding are needed first.

Mark Skapinker, a venture capitalist with three decades of experience starting, scaling, and selling tech companies says. “We like to get people to think about raising toward a milestone or when they’ve just reached a milestone—X dollars in sales, or X customers, or product maturity, or market share. [...] It is a good basis for being able to raise again—‘Well, I reached this milestone, therefore I’m working on X, Y, Z, and I’m focusing on reaching the next milestone, which will get me to that next valuation.’”

Next, Mark says: “Make sure that there’s a good fit. The investor-founder relationship is important.”

Mark suggests tech entrepreneurs ask themselves a series of questions before approaching an investor: “Does the investor invest in companies like mine? Do they add value? Is the valuation in the range of what they’re looking for? Am I the kind of person they invest in? […] I encourage CEOs to constantly make sure that they’re communicating both with their existing investors and future potential investors. That way everyone knows their story.”

The story is among the intangibles that add value to a company, agrees Daniel Ma, a BDO partner in Financial Advisory Services. “Your tech company is a very unique asset that needs to be priced appropriately. Whether our clients are looking to potentially sell a business, buy a business, or raise additional financing, they need to understand the value of what they’re getting or what they’re giving up. A lot of the valuations that we do in the scale-up space are for the purpose of raising capital. If you’re an entrepreneur, and you own 100% of your business, chances are you’re going to have to give up some of that 100%, so what’s the appropriate value? What exactly are you giving up to raise that capital?”

“When we’re looking at raising capital, there are strategic points at which you have to start thinking about that,” Daniel says. “Generally, value is higher when you’ve achieved certain milestones. A company that has a prototype complete is worth more than a company that doesn’t. A company that has customers or has lined up contracts is worth more than a company that hasn’t. You have to find the right balance between raising capital and meeting milestones. After you meet that next milestone, the company could be worth a lot more and then you can raise capital at a higher valuation.”

“I ask clients, ‘When do you want to deal with these issues?’” adds Harry Chana, National Technology and Life Sciences Tax Leader and International Tax Practice Leader. “When do you want to do your next round of financing? When do you think you’ll have other investors involved who will want to do due diligence on your company? When will you potentially want to exit?’ That is when issues get uncovered. The sooner you deal with those issues, the less of a liability it becomes. […] You don’t need to be a $50-million company to have a conversation with, for instance, tax partners. We can do it at any stage of the company. Having those conversations, and, really, being joined at the hip with the client, to say, ‘These are issues you’ll encounter, for instance, if you’re selling to the U.S., or you want to go global.’ We can have really good conversations about the business and around tax issues that follow, in Canada or internationally. Then, the entrepreneur knows the risk, and at what point it is going to impede the business, such that, you know, ‘I don’t get the funding I want because someone doesn’t want to invest in the business knowing that there’s a tax liability.’”

Agile funding tactics

“If you do your homework, you’re more likely to raise money,” Armand Capisciolto, National Accounting Standards partner at BDO, agrees. “Don’t do things on the back of a napkin—be prepared.”

“If you’re looking to raise bank financing to grow your business, for example, the bank is going to ask for projections or for your financials. We can help put those projections together,” Daniel suggests.

“We try to stage it,” Harry adds. “As companies are scaling, we look at a value-chain analysis. ‘You don’t have to conquer everything, but here’s a roadmap based on the business and how you want to grow in the next three or four years. Here’s when you should start taking a look at these issues in a little more depth or take corrective action on it, because if you do a round of fundraising or sell, these issues will come up, and they could pose a significant hindrance to the deal.”

“All of a sudden Google comes knocking, and they want to buy you, and it’s a great amount of money, but you’re not ready for that sale. That means from a tax perspective you’re not structured that efficiently or you’ve got a whole bunch of minority shareholders that you should have taken out years ago, all sorts of different factors that end up costing you money, or potentially derailing a deal,” Michael explains.

“It really starts with understanding the founder or CEO and their business—what are they doing well, and what are they having trouble with,” Harry notes. “When people call me, they don’t want to talk about a tax problem—they want to talk about a business issue. A lot of times, a company is looking for financing. We have a great network of private-equity (PE) firms that we deal with. And we do introductions,” Harry says.

Finding government incentives

Another source of funding that can help a company is non-dilutive, in the form of government grants.

“In Canada, government funding covers five main categories of activity—innovation, people, green technology, expansion, and export,” Craig Mulcahy, the SR&ED and Government Incentives practice leader at BDO Canada explains. “Tech companies most often play in the innovation space. The flagship of that space is the SR&ED program.”

Other innovation programs relevant to scale-ups include Mitacs and the National Research Council Innovation Assistance Program, but there are hundreds of government programs in Canada.

“Typically, at the scale-up stage, you’re starting to get into bigger dollars; there can be unique grants sitting in different spots that tech founders and CEOs aren’t aware of—they’re more specialized than startup grants,” Jamie Barron suggests.

“You need to have a comprehensive strategy, particularly at the scale-up stage. You want a step-raise strategy that positions you for the appropriate valuations along the way. Building a comprehensive financing strategy is my most common piece of advice—what’s your roadmap to fund the expected growth of the business?”

Jamie acknowledges the difficulty of that task: “It’s very time consuming to raise capital. It takes more time than you think. It’s more competitive than you think. It’s very involved. It takes a lot of effort.

However, there’s an abundance of options—whether government programs or other sources of capital—that can provide support in making the effort to scale count.”

Explore other areas important to tech scale-ups:

Let’s see

Contacts

  • Peter Matutat, CPA, CA | Partner, National Technology & Life Sciences Leader
  • Kelly Johnstone, CPA, CA, CPA (Illinois) | Partner
  • Harry Chana, CPA, CA | Partner, International Tax Practice Leader & Transaction Tax Leader
  • Daniel Ma, CPA, CA, CBV | Partner, Financial Advisory Services
  • Deann Young, Senior Manager, Leadership Coaching
  • Armand Capisciolto, FCPA, FCA | National Accounting Standards Partner
  • Marc Fournier, M.Eng, P.Eng, CMC | Partner, Advisory Services
  • Craig Mulcahy, CPA, CGA | Partner, SR&ED and Government Incentives Tax Practice Leader
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