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Strategies in global venture capital for the 2002 recovery

Now that the technology hype has died down, the opportunities for the next generation of venture capital fund managers is genuinely exciting. In his annual presentation to Canada's McGill University, Jim de Wilde, previously a professor at the University of Ontario, explores the opportunities available, with a particular emphasis on the Canadian market.

Each year I have a chance to learn from the dialogue with McGill MBAs broadly around the theme of global venture capital trends and strategies.
 
Here are three broad starting-points:

1. Montreal is the bridge between European and North American financial and technology markets and  this is now a key competitive advantage. The European private equities market is well-poised for significant growth, especially if we develop some collaborative business models to syndicate expertise in, e.g Scandinavian wireless technologies and logistics technologies and North American telecommunications players.
2. The borderline between investment banking and venture capital is now being blurred and this is a good thing as it will put a focus on value-added restructuring. In a number of areas (e.g. specialized biotechnology,  pharmacogenomics and bioinfomatics)  the new value to be created is in the financial engineering of new companies that can be created from a number of  firms created in the venture capital boom of the 1997-2000 period. Some are private, some on NASDAQ OTC, some on AIM or the NEUR MARKT, many are on our own CDNX. They were too small as deals for conventional pre-dot.com crash investment banking and now are potentially front-and-centre deals.
3. Venture capital is the creation of value from knowledge and there is much value in science that is away from the limelight. The venture capital community is discovering areas like nanotechnology even with long time frames for development. Other areas of science, some obscure to the capital markets like agricultural chemistry and marine ecology can now receive the attention required to commercialise knowledge-bases that will provide sustained growth over the next decade. I am focusing on alternative energy products and some specialized agricultural products, but in an inventory of knowledge-creators, there are many other niches where significant value can and will be created. They were ignored during the dot com boom.

A. Global trends in investing in technology 

I believe two basic things about the global venture capital arena:

1. It is good news that the gales of creative destruction have blown away in hurricane/typhoon force winds the bad business models that were financed between 1997 and 2000 when there was an oversupply of capital and an undersupply of disciplined long-term management.

2. That global venture capital is the future as we shape a world of value-added company-creating that turns ideas into value. McGill is ideally situated because of its global learning environment and because Montreal instinctively translates Europe to North America and vice versa.

If you look at the recent IPOs on Wall Street as a gauge of investor appetite
you see two encouraging trends: 

(1) the focus on value-added health products;

(2) the focus of productivity-enhancing information technologies (and other technologies). We are not searching for ‘killer aps' in the way we were a few years ago.

What is the market intrigued by right now. The November 1, 2001 Wall Street Journal looked at recent IPO activity. It cited LogicVision www.logicvision.com ( testing-and design for semiconductor manufacturing, ‘a productivity-enhancing innovation' a company incidentally founded by a McGill Professor of Engineering),  www.therasense.com  (glucose testing/simplified medical diagostics) www.givenimaging.com (ingestible image capsules for internal diagnostics) www.odysseyhealthcare.com   (hospice care programmes/medical productivity enhancement again).
 
To deal with global structure-driven trends, let us end this section with the following general observations:

First, productivity-enhancing investments are back in. Technology-push is out and market-pull is back in. We are not talking about defining a new space so much as enhancing the productivity and quality of economic activities. I find this trend enormously positive.
 
Second, the march for global prosperity is creating new demand-structures: cost effective pharmaceuticals,  portable energy,  water purification technologies,  efficient global infrastructure are all areas where international demand will be encouraged creating significant market opportunities.

B. Some new trends in venture portfolio strategies

(1)    We are now much further up the learning curve in what business models work and what business models are purely technology-hype. This venture capital strategies which really are based on the development of a critical mass of scientific expertise and experienced management. Some portfolios are starting to look like corporate kereitsus or the early stages of great companies like 3M and Bausch and Lomb which were consolidation of knowledge and capacity in a specific area. In many venture capital firms,  there is a degree of de facto specialization emerging from their own networks. To pick examples,  regional  funds like Holtron www.holtron.com in Helsinki, or Mosaic Venture Partners (www.mosaicvp.com) in Toronto concentrate local management talent and focus their portfolios on areas of local competitive competence like broadband infrastructure or wireless internet. Alternatively, small companies can grow in a particular space by using public capital markets to acquire companies in a related technology space  (for example, the Canadian story of Enghouse www.enghouse.com in the energy management software space).
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 (2)  Venture capital thinking has become  part of the corporate strategies of companies which operate in a moving technology area. We are building acquisition of new technology strategies into corporate growth models and that applies no only to companies that exist in the technology space but the large corporations who were nervous about venture capital strategies before . Many of the most dynamic venture activities have evolved from corporate venture units   (www.nokiaventurepartners.com , www.mdscapital.com, www.intel.com/capital ). This will strengthen the capacity of the global economy to commercialise technology from new and geographically dispersed sources, accelerating technology-based growth.

(3)  Venture capital firms have matured themselves, becoming enormous repositories of information about technology and the new economy. The best firms will adapt and become different kinds of firms, operating with investment banks. Already we are seeing some new financial business models of the type announced by Accel and Kravis Kohlberg and Roberts (KKR) to merge expertise. This is an appropriate reaction to the conditions of the post-new economy  (www.accel-kkr.com) .

(4)    The  Canadian experiment in bringing companies to public markets to raise capital for relatively early-stage development (the CDNX)  creates some unique restrcuturing opportunities. Some Canadian technological successes are well known (e.g. Research in Motion (www.rim.com) and OpenText (www.opentext.com). These have grown up around clusters of engineering excellence like the University of Waterloo in Ontario. Others are concentration of management expertise around specific technology commercialisation activities, most notably Westaim (www.westaim.com).

It is possible that other companies can be created out of a consolidation of companies in the advanced technology space. There are dozens of companies on the CDNX where there is a possibility of restructuring and adding value. For examples of areas of technology outside the limelight which have been commercialised through CDNX IPOs, one can take a look at www.appliedterravision.com  (computerized geological surveying), www.thermalenergy.com  (alternative energy) or www.marbio.com  (marine biology research at the University of British Columbia.
   
C. Strategies for venture capital firms and four potentially ‘hot areas':

Where do we go from here?    

Let us assume that we have cleared away the hype-driven business models of the 1997-2000 period. Let us also assume that we are in an era of experience technology commercialisation management,  strategic corporate venturing and venture capitalists as focused technology-specific operators. First, we keep on doing what we have done well:  finding new technologies that fill market needs. Second, we start to develop global capacities for technology commercialisation and venture capital. Here are three strategies we should be pursuing and four potentially ‘hot' spaces to focus our attention.

1. Create some companies around defineable need (what we always should be doing, ie find new sources of growth) Here are three ideas about companies which need to be created. This is my preferred approach to venture capital strategies, the way I think that great new companies have been ‘invented', commercialised and MBAs recruited to manage.

a. We need on an on-line learning technology company which provides customized curriculum management for educational purposes. Bureaucratic learning models have been rendered obsolete by the explosion of new information sources in old and new media.

b. We need to organise and commercialise areas of agricultural chemistry, biotechnology and entomology to create an environmental insecticide company that can provide safer   pest management. Enhancing agricultural productivity is a key area of growth in the next decade and managing spoilage through insect-damage is a key to a global growth. Somewhere, one of the next Steve Jobs is doing a PhD in entomology.

c. We need to find a way to link privately-generated alternate energy  (Vestas wind turbines in Denmark, batteries and fuel cells applied to power generation in Germany, Canada) to the existing power-grids and then use the internet to price and allocate power distribution and power quality measurement.

There are three businesses of the future driven by market needs. Each commercialises a new area of human knowledge:  educational psychology, entomology, electrochemistry. Each opens up the marketplace to new categories of growth.
  
2. There is the opportunity within a portfolio to use the existing portfolio to restructure within a sector. This is the new venture-capitalist-as-M&A-specialist approach. Restructuring opportunities as a result of the downturn:  The restructuring opportunities which exist in the post-new economy are exciting and have already been the subject of widespread commentary. Quietly for a couple of years, sophisticated venture capitalists have been acting more like investment bankers, trying to create viable companies from the remains of failed IPOs. As the premium is always on management issues,  the challenge is to create from discrete corporate cultures companies which can concentrate management excellence. The Canadian market (the CDNX base) provides a good starting point for this type of strategy.

3. Develop specialized expertise around a technological area to build a specialized investing capacity either via corporate venturing or a specific focused fund strategy. Clearly, I have been advocating a sectoral specialisation, especially with early-stage technology commercialisation. In Canada MDS Capital (www.mdscapital.com)  is the prototype of this model. The concentration of  expertise in energy technologies (www.nthfund.com) or in nanotechnology (www.mmei.com) are relatively small-scale examples of this strategy. It would be a healthy sign if institutional investors sought more activities of this sort to speed up the development of sectors that have not been in the venture capital limelight.

Four hot areas from a Canadian perspective

These are areas which are picked from a vantage point of being a Canadian with access to limited pools of capital but with expertise in global markets, I will focus on four spaces that should create significant growth opportunities.

(1) alternate energy, potential power, distributed energy and the creation of energy efficiency through the commercialisation of electrochemistry and electrical engineering; 
(2) distributed knowledge as it can create a new market in scientific publishing and collaborative research;  
(3) digital media and entertainment, a sector where Montreal is developing a competitive advantage through a cluster of advanced technologies and spin-offs from work done at SoftImage;  
the ‘Fincubator' cluster or some areas of wireless technologies in Finland that I have been following,  a country now ranked second in the World Competitiveness Survey for reasons that are obvious to those of us who have been travelling regularly to Finland since 1990.

1. Alternative energy,  distributed power,  energy management systems and the commercialization of new energy production and storage technologies: This is the area on which I have been spending a great deal of time exploring over the last few years. I am particularly looking for business models which link energy generation with internet distribution and costing, that make energy generation a two-way street.. There are a number of exciting potential business models in the above list. In five years the list will also include companies which facilitate portable energy on a commercial scale and companies that have grown around the capacity of small-scale energy producers to supply competitive power back to the grid or specific consumers. If we work from the present to this future vision, then we will produce some significant companies in a number of spaces,  including energy storage technologies,  cogeneration models  (and the pricing technology required to make them work).

2. Open-source and distributed knowledge Like everyone else in venture capital, I have been preoccupied with the issues of valuation of knowledge and new intellectual property that have grown out of the Napster and Linux experiences. There is a business model on the organisation and dissemination of material through web-connected activities. This will transform traditional markets in educational products and create a new business model of scientific publishing and research. The business model may be a variant of a specialized publishing business, or it may be a web VC, where researchers in, say, agricultural chemistry are connected not only with each other but with sources of syndicated venture capital. There are real opportunities for growth in the convergence of scientific publishing, open-source distributed knowledge and web-based syndication of off-the-radar economic activities.
 
3. . Digital media infrastructure for web-cast products. We have seen many avenues of focus:  interactive television,  webcasting,  digital entertainment through gaming,  digital media via webzines, innovative broadband content models (simulcasts etc.) . Some of these are extremely exciting and will undoubtedly be pioneers of some great companies in the year 2011.    

4.  The FINCUBATOR - a wireless internet laboratory Finland 2001. One of the competitive advantages of the Finland experiment is that there is so simply so much innovation taking place. In areas like wireless internet and other applications of wireless technologies, the Finnish model is the laboratory to watch,  now backed by excellent venture capital capabilities. Beyond the excessive hype (paying for parking meters with a mobile phone) and the excessive scepticism (resulting from the overpaying for wireless licenses and WAP generally), there are some interesting business models developing in the incubator that is Finland. Some are appropriately labelled infrastructure investments   and profitability will come (or not) from building global wireless infrastructures. Others are specific wireless-derived innovations that may be profitable on a smaller scale. There are certain spaces which I believe are worth placing markers in especially for telcos looking for the next revenue strategy. They are listed below (not in rank order) as examples of ways wireless technologies might create money-saving or revenue-generating activities. (Note this is in addition to the activities labelled ïnfrastructure which transform non-wireless business models to wireless systems):
 
(a) remote sensing technologies that transforms the business model of the electronic surveillance industry, the patient-monitoring industry, the transportation logistics industry; 

(b) wireless metering technologies that can monitor energy usage and plan energy consumption patterns (the so-called 4 a.m. dishwasher) and create billing models for tracking multiple energy sources in a world of multiple-source energy systems;

(c) wireless broadband and video streaming so that there can be on-site communications     From Polaroid and videoconferencing business models, we know there are limits to these usages.

(d) wireless billing  (on smart roads, at fast-food restaurants) where the revenue streams come from increased activity (at fast-food restaurants) or auction-based activities  (rush-seats at a theatre or any positional good at which auctions are a possible means of determining price)  or simply paying for services which would not otherwise exists . This brings wireless telecom into direct competition with traditional banking and credit card issuers.

(e) entertainment technologies where wireless games and customized  products fill empty  time. This transforms the wireless handheld device into a receiver of customized gaming products.
 
Conclusion

The opportunities for the next generation of private equity / venture capital are genuinely exciting,  more so in a post-hype universe. The next stage of success will be give a competitive advantage to those who are global in their vision:   global sources of knowledge,  globally syndicated capital,  global alliances between best-practices venture capital activities.

Companies cited in this presentation are used as case studies or examples of business models and are not presented as recommendations.

Jim de Wilde is a venture capitalist in Toronto and Montreal. He has taught in a number of Canadian Business Schools and lectured on venture capital in Latin America and Europe. He is currently focusing on alternate energy opportunities. He taught at McGill from 1991-1994 and at the University of Western Ontario School of Business from 1984 to 1990 and lectures on venture capital strategies at the Rotman School of Business at the University of Toronto. He has a PhD from McGill in political science on the political economy of advanced technology industries.