Canada’s Entrepreneurial Finance Industry Is Living In A Bubble
Banks spent 2018 fighting to give Canada’s fast-growing tech sector something it hasn’t had much taste for in years: debt.
Canadian scale-ups and venture-capital-firm partners spent much of the past year watching offers for debt financing pile higher than they can ever remember. In interviews with The Globe and Mail, founders, partners, and lenders used phrases like “slugfest” and “arms race” to describe the phenomenon. Both Canadian and American banks are racing to serve young tech companies, by improving loan terms and shoving down rates. This has reshaped how Canadian tech startups secure financing: Debt is so cheap that some small companies that would have never considered it are taking it on as a cushion, giving them extra runway between equity raises without diluting founders’ ownership.
The trend is partly a reflection of Canada’s tech sector’s coming-of-age after its post-financial-crisis doldrums. But it’s also the result of deliberate moves by two major players – one established in debt financing, the other making its return.
California’s Silicon Valley Bank is taking steps to formalize its ability to lend to Canadian clients and hopes to be fully licensed here early next year. Meanwhile, Canadian Imperial Bank of Commerce bought the private specialty-finance firm Wellington Financial in January with ambitions to better serve early- and mid-stage companies with broader banking services. In Wellington, CIBC found a team of experienced tech bankers after Canadian institutions largely shed that expertise in the long tail of the dot-com bust; in CIBC, Wellington found a lower cost of capital thanks to its scale, making debt cheaper to sell for clients.
While both players offer a suite of banking services, it’s been their debt offers that caused jaws to drop in Canada’s tech community in 2018 – and has pushed other lenders, including Royal Bank of Canada and Bank of Montreal, to try harder to entice startups with similar offerings.
While no one interviewed for this story would share numbers on specific rate offers they’d seen – rates vary across lenders as well as by company size, stage and revenue model – they all agreed that the past year saw remarkable drops in cost of capital. Two sources who were not authorized to share confidential rate proposals said that interest rate offers had fallen from 15 to 20 per cent a year ago, but now hover between 10 and 15 per cent, sometimes falling as low as 6 per cent.
“Entrepreneurs 10 years ago wouldn’t have known about venture debt – now they know about it,” says Mark Usher, the veteran technology banker who is managing director and North American market leader for CIBC Innovation Banking – Wellington’s new moniker – and chair of the Canadian Venture Capital & Private Equity Association.
Mr. Usher cautions that founders should be careful and seek the advice of their investors and board when considering debt financing – and warns, too, that the super-competitive Canadian market is not sustainable in the long run. “It will normalize back to historical returns and rates,” he says. “Venture-debt lenders will take losses at some point, then they’ll realize that they weren’t charging enough to make up for the losses, and that’s how it corrects.”
Many in the sector suggest the first sign of the shifting Canadian venture-debt ecosystem happened in March, when Vancouver social-media company Hootsuite Media Inc. signed a $50-million deal with the newly minted CIBC Innovation Banking, having previously largely worked with Silicon Valley Bank. (The American bank says Hootsuite also remains a current client.)
“Even if we never use it, it’s just a nice cushion, and it really doesn’t cost that much to have it,” says Sid Paquette, a managing partner at OMERS Ventures, who oversees the firm’s investment in Hootsuite. “At almost all of my companies … I’m doing a disservice if I don’t encourage them to take on a little bit of debt right now, because it is so cheap.”
Since then, venture-capital partners and tech executives say, the debt rally in Canada has been adopted by firms of all sizes and stages. Janet Bannister, general partner at Real Ventures in Toronto – which focuses on early-stage investments – says that many companies in her portfolio and on her radar are taking on debt financing, largely to accelerate growth without diluting owners’ stakes.
“The banks are increasingly saying, ‘We need to be the banking partners of these young companies, because some of them are going to grow up and be the next Shopify,’” Ms. Bannister says. Still companies need to be prepared for the debt, she says. “If the interest expenses become so onerous that they are impacting growth by forcing the company to curtail spending on things such as development, sales and-or marketing, that can become a problem.”
Bryn Jones, the co-founder of PartnerStack, a Toronto firm that helps software companies grow through partnerships, has spent the last few months evaluating term sheets. “The only banks that really cared before were from the Bay Area,” Mr. Jones says. Now, he continues, “everybody wants to get into it.” The phenomenon has been helpful for companies such as ChatKit, a Toronto e-commerce chat-marketing startup, which did a debt-financing round with CIBC Innovation Banking last July, says founder and chief executive Mazdak Rezvani. “To build a successful Series A round, you need metrics to appeal to an investor. A few extra months of runway really helps.”
Since the debt-rate battle began earlier this year, “all of the banks now have a tech-lending focus and strategy,” says Mr. Usher. His own firm, CIBC Innovation Banking, even hired tech financier Robert Rosen away from American rival Comerica Inc., a long-time leader in offering debt financing for Canadian startups.
Banks’ embrace of tech companies has in some cases turned into a talent war. Devon Dayton, who’d been a part of CIBC’s technology push, left to join the Bank of Montreal in April, just three months after the Wellington deal. He says he’s now charged with “accelerating” BMO’s tech coverage, including both through banking services and providing debt capital to the sector.
Royal Bank of Canada, meanwhile, turned to established Toronto tech lender Espresso Capital in August to partner for venture-debt deals. Espresso has funded more than 230 deals since 2009, the company says, and recently established a new program to lend to software-as-a-service cloud companies up to 24 times their monthly recurring revenue in growth financing, to a maximum of $10-million.
“For the longest time we were the beneficiary of a massively under-served market,” says Alkarim Jivraj, Espresso’s chief executive. Amid what he calls a “slugfest” between banks to offer debt, he says, “we continue to grow, even with the noise around us.”
A rash of Canadian debt-funding options have emerged, in fact, offering loans on such highly specific terms. Toronto’s Fundthrough offers cash advances between clients’ invoices; Clearbanc, co-founded by serial entrepreneur and Dragons’ DenDragon Michele Romanow – and which just raised US$120-million – helps finance young e-commerce businesses by fronting online ad revenue. “How you fund your company probably ends up being the most important decision you make as a founder,” Ms. Romanow says. “With equity, you never get to give it back …. Coming up with as much alternatives around that is really powerful.”
Silicon Valley Bank, which serviced Canadian businesses for about a dozen years but until recently, did so largely from offices in Seattle and Boston, is looking forward to a formal Canadian licence from the Office of the Superintendent of Financial Institutions.
“What the licence will give us in the new year is the opportunity to have feet on the street [and] meet with clients and investors in a more proactive kind of way,” says Barbara Dirks, the bank’s Canadian head. Her colleague Win Bear, who long worked for the lender’s Boston office, says that it’s a historic moment for startup financing – not just in Canada.
“There’s a lot more competition,” Mr. Bear says. “It’s really driven down pricing, much in the same way that increased competition on the growth equity side has increased valuations up to levels that some would argue are unprecedented.”