$165MM MRI Fund: blessing or curse?
It has only been a few days since the Ontario government announced the first installment of their $165 million Ontario Venture Capital Fund, but the drums are already beating. The concept is pretty clear: Ontario kicks in $90 million, some key institutions add $75 million (RBC-20?, OMERS-20?, Manulife-15? and BDC-20?), a fund of fund manager is hired, and the new manager starts making commitments to various GPs. Soon thereafter, perhaps an additional $100 million can be raised from other institutional investors once everyone gets a chance to see it in action.
There are two schools of thought to this concept:
#1. The Ontario government has turned a group with $1.5 billion of investable capital into one with $165 million. How so, you ask?
A few years ago, RBC Ventures had in excess of $300 million of capital in VC funds and direct investments. People such as John Varghese, Greg Connor, Doug Lucky, Allan Hibben and Wally Hunter managed parts of the portfolio over the decade. RBC Venture Partners sole role now appears to be managing out their old portfolio (overseeing exists of prior investments such as CertaPay and Inea). According to Thomson’s database, the last time the RBC “IT Fund” did a deal was December 2005, the “General Fund” hasn’t done a deal since December 2004, and the “Telecom” Fund’s last round was in May 2006. Only the “Advanced Technology” and “Life Sciences II” Funds have disclosed transactions in 2007. The Advanced Tech fund invested in a San Francisco-based firm called TriCipher; its most recent disclosed investment prior to TirCipher was a follow-on for Agile Systems in May 2005.
OMERS ran a VC fund portfolio with more than $200 million in the market (direct and indirect), under the guidance (at various times) of Lisa Melchior, David Rogers, Scott Hurley and Dominique Hansen. OMERS deftly and directly invested in such tech names as Alterna Technologies, Think Dynamics, Skulogix, Q9, TeraGo, Constellation Software, Xantrex, etc. And backed or led plenty of funds as well. The OMERS tech team was disbanded less than 18 months ago; internally redeployed to the internal merchant banking arm, or otherwise fled to greener pastures.
Then there’s the Ontario government, who was supporting the Ontario venture market via the labour-sponsored fund program until 2005, when it declared a sunset on the provincial government’s component of the tax rebate. At its peak, Ontario’s Labour Sponsored Fund industry (“LSIF”) had about $1 billion of capital to deploy over the horizon of a few key funds.
Between these three vehicles alone, Ontario VC funds and entrepreneurs had more than $1.5 billion to call upon. Now the number is $165 million, even with the addition of Manulife and BDC to the mix.
For Manulife, a new player in venture capital, it may well see the time as being ripe for a new commitment to the asset class given the contraction in the marketplace. And with a market cap of $62 billion, the $15-$20 million they’ve committed to this vehicle won’t move their profit needle either way:
“We are supporting this VC Fund because we think it’s the right initiative at a time when the supply of venture capital in Ontario is less than optimal and investment returns have been rising,” said William Eeuwes, vice-president and head of Manulife’s merchant banking arm.
For the Business Development Bank (BDC), their participation might be characterized as just one more marketing exercise to shield them from ongoing criticism (see posts “The end of cheap debt has arrived“, July 20-07 and “BDC Fact #1“, December 3-07) about their new competitive practices – in violation of their governing Act – within the lending community (from 1999-2001, they did about $33-$35MM, in aggregate, of sub debt deals a year greater than $500k in loan size; from 2001-05 that figure grew to about $61-$66MM a year; in 2006 and 2007, BDC’s sub debt group has averaged $187MM of annual authorizations, according to data collected by Thomson Financial. Six times their figure from earlier this decade. Who could call that “complementary” with the financial services industry? Since 2004, they’ve only syndicated 6 of their 288 sub debt transactions in excess of $500k.)
With this new MRI fund, RBC and OMERS are now reportedly out of the direct tech fund business. As such, a GP might have had the chance to knock on two different doors circa 2004 for a $20MM lead commitment (RBC and OMERS), now they’ll only have one door (MRI Fund). This is not “growing the market”.
As for quantum, even if the MRI Fund grows to $250 million and starts committing capital at a good clip, these funds won’t be deployed over a short timeframe. And nor should they.
As with any fund-of-fund program, the manager will take a three, four or five year view of the marketplace. Divide $165 million by a three year deployment schedule, or $250 million over five years, and not much more than $50 million will be directed towards suitable funds each year.
If the MRI fund of fund manager is thinking about playing a lead role on GPs, that amounts to commitments in the range of $20-$25 million on VC Funds of $100-$200 million in total size (the figures likely being sought by Celtic, Edgestone, VenGrowth, Venture Coaches and VW). As such, this new MRI fund can lead no more than two or three funds a year. And if it tries to lead, there’s nothing left for the rest of the community when they come calling for a “rounder” commitment of $7.5-$10 million.
With Celtic House, Edgestone, VenGrowth, Venture Coaches and Ventures West all in the market today alone, which of these five funds would the new manager (once they’re appointed) pass on? Tough choice.
#2. The other school of thought is that this is a wonderful concept to redirect some of that tax room that was being utilized by the LSIF tax credit.
Or, put another way, since the provincial government did nothing specific for traditional venture capital funds, the new $90 million commitment is better than nothing. Certainly, if you are a GP fundraising right now you’ll be delighted to hear that there is a new door to knock on for a $10 – $25 million commitment to your venture fund.
Moreover, assuming the manager picks well, the Province can expect to earn a good return relative to its funding cost (Provincial Savings Bonds or the institutional debt market). Good returns will only encourage an increase to the $90 million over time.
Unfortunately, assuming it takes merely three years to get the MRI fund deployed (and it can’t start making commitments until Q1 2008 at least), these new limited partners won’t know how things are going for four or five years after that, given the normal cycle of venture capital investing and harvesting. It isn’t as though the entire fund will be put into the hands of GPs over a month or two in 2008. Which takes us to 2015 or 2016 before the LPs will have a sense if they should increase, or even roll, their commitments.
Nevertheless, there are certainly folks in the venture community who are anxious to have the chance to access a portion of this capital:
“Canada’s Venture Capital and Private Equity Association (CVCA) is pleased to see the Government of Ontario’s plan for stimulating the province’s venture capital sector,” said CVCA Executive Director Richard Rémillard. “We have always believed that it is vital that we build a strong venture capital market in Ontario if we want to build world-class, high-growth companies here, and it is very encouraging to see that the Government of Ontario recognizes this reality. We have supported this program since it was first announced in the March 2006 Budget and we look forward to seeing the capital deployed into Ontario’s venture capital market very soon.”
Then there’s the issue of who is going to manage the MRI Fund on behalf of these limited partners; who will have the pleasure of choosing amoung the worthy GPs? Ontario Finance Minister Dwight Duncan said again last week at a TFSA meeting that “he wouldn’t be deciding which venture capital firms” tapped the $165 million.
Rumours are that a fund manager is currently being short-listed. Candidates for the role are the usual fund-of-fund manager suspects: CSFB, Kensington Capital Partners, Oak Hill, Paul Capital, TD Private Equity Partners, etc. Pretty much similar to the list of players that bid for the CPPIB’s Venture Capital Fund-of-Fund mandate when Edgestone’s then-role was put out to tender in 2005. The name Rho is also out there as a candidate to manage the fund, but as a player in the domestic VC market, the conflict concerns will be insurmountable.
The choices are pretty clear. Is the Ontario government going to hire a firm with an office in California (Oak Hill) or New York (Paul Capital) to choose which VCs are the best to grow the Ontario economy? What a sad statement that would be regarding the very industry they’re trying to foster.
Oak Hill is already busy with their PSP mandate, and Paul is very active outside of Canada on behalf of CPPIB (see prior post “CPPIB U.S. general partner Q2 2007 performance numbers“, November 17-07)
Then there’s TD’s Private Equity Investors group, which currently manages the CPPIB $150 million fund-of-fund commitment that Canada’s VC community can access (CPPIB has made it clear that they will no longer invest directly in Canadian VC funds, only through TD’s fund-of-fund vehicle). In terms of pitching for this mandate, it is an obvious conflict for TD and they are probably not even under consideration. After all, does the Ontario Government benefit by going to all of this trouble to create a new funding vehicle, only to find themselves supporting whatever Canadian VC funds the CPPIB is playing in?
For TD, the internal challenges seem insurmountable. Let’s say ABC’s VC team pitches them today. Which pot of money would TD commit? CPPIBs? The MRI Funds? Worse, if TD passed on another fund a few months ago, would they look at the same team again for the MRI mandate? How would they explain to CPPIB that we “didn’t think ABC Venture Fund was right for you, but it seemed right for the MRI group.” It isn’t a question of ethics, its just one of practicality.
And what if that fund didn’t perform well? Would MRI’s leadership wonder if they got stuffed with a poorly performing GP (there are less than 40 venture funds with true critical mass to choose from, after all), but TD protected their larger business relationship with CPPIB (TD managers several funds for CPPIB, not just venture) by passing as far as the CPPIB’s vehicle was concerned?
None of these are conversations folks want to have. Which likely puts TD out of the running.
Which leaves Kensington as the obvious qualified choice among the fund-of-fund candidates being bandied about in the industry.
As for me, I don’t believe the MRI Fund is the solution. Perhaps it is a useful step along the road for the Provincial Government. A piece of the puzzle. But it will not arrest the crisis that some of us believe is going on right now in the Ontario venture capital industry (see prior post “Ontario politicians asked to address deteriorating VC climate“, October 1-07).
Turning $1.5 billion of venture capital into $165 million was a mistake, but it can be fixed. The multi-year downward trend in Ontario’s VC stats are stark. But that milk is spilt.
Hopefully, the refreshed government at Queen’s Park will use their new mandate to engage with the venture capital industry and help solve the challenges that are borne out in the stats. Having had the pleasure of meeting Ministers Dwight Duncan and Sandra Pupatello last Thursday, I was impressed with the high level of their personal engagement. Minister Duncan took a morning before the throne speech to meet with representatives from a variety of industries, and any time a cabinet minister squeezes a meeting into a day that didn’t lend itself to ad hoc meetings you know he’s reaching out.
As for Minister Pupatello, I’ve met many a politician in my years and she’s as interested and proactive as they come. There was an energy swirling around her team that spoke volumes about their hopes to accomplish some things in 2008 and beyond.
The MRI Fund is not the silver bullet, but the good news is that key provincial Ministers and their public servants seem open to the concept that this is just the first step of many required.