AN EXPERIENCE IN RAISING VENTURE CAPITAL
When anything works out well there is a tendency to assume that the actions taken were the only correct ones under the circumstances and, further, that those actions had been planned with insight approaching clairvoyance. A more honest approach would be to admit that most decisions will work, a few are so bad that failure is inevitable and some turn out so well that an element of luck is involved.
The SDL story is not one that can readily be repeated because it happened under circumstances that will not likely recur. Therefore, the most useful thing I can pass on from this experience are those repeatable actions that by good luck or good management led to the success of the corporation.
IN THE BEGINNING
If we assume that raising venture capital means obtaining someone else’s money to launch a new venture based on your ideas then some soul searching should be done before you start this process. The rewards can be high but the risks can be high for both you and the investor. Unless you are successful in your first venture you may find that further ventures are difficult to undertake for your risk is your reputation. As this is one of the most precious commodities an individual has, I would not recommend venturing it lightly. Secondly, you will be taking responsibility for other people’s money in amounts that could run into the millions. This is also not a responsibility to be taken lightly. I believe that nothing will scare a venture capitalist more quickly than the feeling that the entrepreneur has his eye solely on the potential gains rather than on the ‘idea.’ The entrepreneur must be prepared to make the transition to becoming the manager of a business and he must communicate this willingness to whoever is going to provide the venture capital.
In one of the best articles I have read on obtaining venture capital (When Venture Capital Dries Up – Mel Mandell, Innovation, March 1971), Mandell refers to those “rare individuals who have that burning ambition to run their own show.” I believe you should make sure that you have the desire to follow through and you should communicate this to the potential investor. I do not mean this to be discouraging but only to suggest that some self analysis in the early stage is necessary.
If you are an idea person but not necessarily the one whose real interest is in running an organization then I would suggest that before looking for venture capital you build around yourself the appropriate talent to carry through. If even this approach does not appeal, you should still not be discouraged for it may be possible for you to sell your idea to someone else for cash or royalties.
SOME GENERALITIES FROM THE SDL APPROACH
SDL was launched at the peak of a bull market and raising $17,500,000 on the basis of an idea would not be easy today and perhaps not even advisable. However, to start at the beginning, the company was founded by three people from IBM and one from outside. Although John Russell, Guy Morton and I had already left IBM to form a small consulting operation, the real entrepreneur in the story was Red Quain an Ottawa lawyer and Chartered Accountant. I emphasize this because Mr. Quain is no longer with SDL although he stayed with us performing a very important function until February of this year. The moral that comes from this has already been stated, i.e., the person with the idea may not necessarily be the person to implement it.
It is also important to note that from its earliest stage, SDL was never a ‘one man wonder.’ There was a balance of technical capability, legal and financial knowledge and some marketing and administrative know-how.
Having decided that the computer services industry was where we should go and having concluded that the market was right for such a venture, we proceeded to develop the plans and carefully document the approach. I might add that this was done while all of us were working full time in our consulting or legal professions. At this point, several important philosophies started to develop. The first was that if we were going to do anything, we would have to do it in the best possible way. Without meaning this to sound like a sales pitch, this became a cornerstone of the SDL approach. It meant that when we wanted to approach a source of underwriting, we should approach one of the largest and most reputable underwriters in the industry. While we could have chosen a number of reputable houses, we felt that Wood Gundy should be our first choice as it was the largest in Canada. It was only later that we would learn just how valuable this approach would prove to be.
Before we approached Wood Gundy, we had drawn together a sizable document outlining the basic approach, market projections, reference documents and a long series of questions and answers that we felt a potential underwriter should ask.
We knew that the underwriter would not likely have much technical expertise and therefore tried to think through each facet of the approach from first principles. It turned out that this had some very beneficial effects on us. This led us to such simple conclusions as acknowledging that if IBM had 75% of the data processing market and the market in Canada is basically a file processing market, then for heaven’s sake, do not try to enter the computer services market with a Wiz Bang 8. The lack of compatibility will only make a tough job that much more difficult. In trying to explain the basic principles to someone else, this almost forced us into common sense approaches and we critiqued our approach ourselves before presenting it to the underwriter.
Wood Gundy quite logically advised that we obtain an outside consultant to provide a further critique of our proposed approach. We chose a consultant from the United States, Booz, Allen & Hamilton as we believed that this would lead to a more objective evaluation when the group was far removed from the marketplace. The consultant’s report agreed on all major principles with our approach and this served only to give us a false sense of confidence in our own market projections. We were not, of course, the only company contemplating entering the computer services field. It turned out that everyone else was basing their financing on the same set of projections. For example, if at that time IBM had 80% of the datacentre business, there were likely 10 companies who would be quite content with 5% and somehow this added up to more than 100%.
We also forgot in our marketing projections that we were no longer selling for IBM where at least the reputation of the corporation was not in question. We were, in fact, going to be selling not only a new idea but a new and unknown corporation and we should have been sensible enough to temper our projections for this reason alone.
SDL had been started as a consulting company in March 1968 and the idea to enter the computer services field was first broached in late June of that same year. The development of the ideas and the investigation by the consultant took place over the summer and by mid-September we had a Letter of Intent from the underwriter. We had set ourselves a target of getting into business by July 1 of the following year and had already concluded that our approach should be to buy our own land, design and build our own building and purchase the major revenue producing piece of equipment. The scale of the underwriting had already reached a figure in excess of $15,000,000 and was to culminate in a final underwriting of $17,500,000. Such an underwriting takes time and it therefore became necessary for us to find some bridge financing that would allow us to hire staff, buy the land, retain architects and, in fact, start construction.
On the strength of the Letter of Intent, we started to approach major banking institutions when one of those fortuitous events occurred. An aggressive young banker by the name of Dick Thomson, who is now General Manager of the Toronto-Dominion Bank, heard that we were looking for bridge financing and approached us. After listening to our story, he stated simply that “the T-D would like to be your bankers. What do we have to do to get your business?” I took a deep breath and suggested that he could start by lending us $1,000,000. His reply was “Fine. What else?”
I tell this story as an example of the imagination that can be demonstrated by the Canadian banking field and put this forward as another challenge to those who claim that venture capital is difficult to come by in Canada. Our experience with both Wood Gundy and the Toronto-Dominion Bank would lead me to believe that there is more than enough imagination and backbone in our Canadian financial institutions to back worthwhile ventures. I might add that the Toronto-Dominion Bank ended up lending us $1,250,000 allowing us to start building our building on January 6, to complete it in April in time to accept delivery of an interim rented Model 65 , and build the staff up to 65 in time for our opening on June 29, 1969. One more point is important to note at this time. Much of our effort was directed toward hiring the best people we could find and without doubt the fact that we had a sizable staff even before the final prospectus was completed made a great difference in the success of the underwriting. It is also a tribute to the people themselves when you think that they came with SDL on the basis of nothing more secure than the bank loan that we had obtained from the T-D.
SOME PERSONAL COMMENTS
So far, I have made the story sound somewhat mechanical, i.e., the story may sound as though there is little more to obtaining an underwriting than coming up with a good idea, planning and researching your work carefully and then approaching your chosen source of venture capital. I believe that all of this is necessary but if this was all that was required, financing new ideas would be a relatively easy process.
I believe it would be more useful to go behind the scenes to try to determine not only why the underwriting was successful but why SDL as a company has continued to enjoy some measure of success. To do this I will have to become somewhat more personal but I believe the points are fundamental.
To continue the story past the underwriting and we should remember that a business must survive many years after the raising of the venture capital, I should point out that SDL could have foundered in early 1970. I mentioned that our market projections were overly optimistic. Despite the size of the underwriting, we had underestimated the amount of working capital that would give a sufficient margin of error should these projections prove to be overly optimistic. By early 1970, the stock market was at the lowest it had been for many years. Fortunately, our underwriter had counselled us to obtain a strong and hard working outside Board. We had also assumed a policy of being very open with the investors who had put up the original capital. These factors now came into play and when we concluded we needed another $1,500,000 we were able to raise this even in the depressed market.
The money was raised by selling additional shares to about a dozen Canadian institutions. This was literally a door-to-door sale by Wood Gundy and the corporate management. Wood Gundy trusted us to meet our revised projections and the founders of the company, in turn, showed their trust by giving up a small portion of their original equity as a bonus to those who would buy shares in the corporation in this type of market. That sense of trust paid off for everyone concerned. The stock rebounded in a way that has now tripled the price paid at that time. The company went on to meet its projections and the underwriter had demonstrated to the financial market that it was prepared to support any underwriting it recommended,
I cannot over-emphasize the extreme importance of a trusting and open relationship with your underwriter. If you have chosen wisely, this trust will pay off many times over. Remember, you are not underwriting once but rather you are establishing a long-term relationship with the financial community.
As a company we have gone out of our way to maintain this relationship with both suppliers and customers. I can remember an instance which was not untypical where our builder who had done an outstanding job for us approached us for an advanced progress payment. Knowing that this was what he was about to request and knowing that the request could be somewhat embarrassing, I started the meeting by presenting him with a cheque for $200,000 which was approximately the amount my sources had advised me he was looking for. The meeting turned from one of embarrassment into one of complete mutual trust and the builder went on to complete the building on a schedule that is almost unheard of in the Canadian construction trade.
I would also suggest that striving for a perfect deal is the best way to wind up with no deal at all. The rewards from a successful venture can be substantial and the risk of losing the opportunity of obtaining a mutually satisfactory deal by striving to get the last nickel at every turn will likely end up with the deal falling through or if it does go through with sufficient bad feeling generated that an on-going good relationship with the financial community is very difficult to maintain.
At the risk of over-emphasizing a point made earlier, do not forget while you are selling your idea, the market potential, the return on investment and all the other factors that you must also sell yourselves. I remember at one point asking our potential underwriters how they could really evaluate a complex technical proposal such as ours even with the aid of outside consultants. Without hesitation, the underwriter replied “we are not underwriting the concept, we are underwriting the people.” I remember thinking about this for a moment and then commenting that he was probably right because the best insurance the underwriter had was to be dealing with a group of people who would be simply too ashamed to fail. The investor must be sold on people plus plans.
SOME CONCLUDING THOUGHTS
SDL had to choose the path of a public underwriting because of the size of the investment required. I should point out that this is by no means the only approach to raising venture capital. In fact, an early public underwriting of a relatively small venture may be unwise.
For example, I have already said that no entrepreneur should start a project if he does not believe that he has an on-going operation. This means that the entrepreneur must be very aware of what will happen the publicly offered stock price after the underwriting. It is no reflection on the underwriter to note that if the size of the issue is very small, there may not be sufficient stock trading to enable the underwriter to make a good after-market and if the underwriter cannot make some money by continuing to trade and create a market in the stock the underwriter may lose interest and the stock may become unrealistically priced. I would suggest therefore that public underwritings should be used only when necessary. Public companies incur many costs that smaller private companies do not.
It is also more difficult to take a company public that has no earnings record. Therefore, I would suggest that you consider all other sources of venture capital before deciding on the public underwriting. It should be borne in mind that many large corporations will now provide seed money to new ventures to encourage entrepreneurs within their corporations to stay somewhat in the corporate sphere while getting what every entrepreneur wants which is ‘a piece of the action.’ Other sources of venture capital are corporations specializing in this field. I would also, of course, suggest that bank financing is often overlooked by those who have a preconceived notion that Canadian banks are so conservative they invest only in Canada Savings Bonds.
Finally, let me assure you that there is nothing more stimulating or more exciting than undertaking to do your own thing with your own idea. You have to be constantly aware of opportunities. The ideas and opportunities may not all be yours but when you see the right one, act aggressively. Like a football player, you may spend a lot of time blocking in the backfield and will get very few chances to carry the ball. But when you see a hole in the line and someone gives you the ball, run like hell!