Venture Capital

Explaining the ‘lack of’ Venture Capital in Toronto

I figured it would be appropriate to write about the lack of a growing and robust venture capital community in Toronto since it cropped up in three places over the last 2 days  – once with several folks at Startup Drinks last night, today over coffee with Jeremy Laurin of OCE’s Investment Accelerator Fund and on Quora (the new social network launched by the ex-CTO of Facebook). On a side note, Quora is actually pretty snazzy with super-high-quality people.

Back to the main point of this thread — I’ve been talking about this situation for roughly 3.5 years now — first in the biotech/life science VC community in Toronto and now with the ICT community. I believe there is one problem at the root of both sectors — we need a kick-start in Canada.

What does that mean, a kick-start? Well, most people believe that there is a fundamental funding gap in Toronto’s venture community between pioneering research (in universities, by startups, etc…) and venture capital finance-able deals. That may be the case, but that is a different argument for a different day. I believe there is a more substantial funding gap that exists once a ’successful Canadian company’ reaches the point of raising a round of capital greater than $15 million. The existing VCs in the community (generally) just can’t get those kinds of deals done. It’s not in our Canadian cards (given the average fund size, risk thresholds, etc…). Canadians need later-stage financing options (or Government money) to back those deals and to create a better later-stage ecosystem.

So, what happens instead? Great Canadian companies knock on the doors of VCs South of the border who are flushed with cash and willing to invest larger amounts in later rounds. For the record, I love US VCs. However, for the purpose of this discussion, or monologue rather, they have tended to bring companies close to home to minimize their geographical risk with the investment. Now, as companies continue to grow and are eventually sold, the successful founders and key employees of those companies often (not always) stay South of the border to further progress their careers — joining US companies, or launching other companies in those locales. Worse for Canada, those successful folks often reinvest in US VC funds or Angel invest in other local US companies rather than Canadian startups.

Envision that cycle reoccurring over and over for the last 30 years. The trend becomes large enough that a substantial amount of capital, and human capital for that matter, gets lost from the Canadian startup ecosystem.

Some say that there is a lack of venture capital in Toronto because there just aren’t great deals. I disagree. I think that there is a lot of talent in Toronto and in the surrounding areas, like Waterloo for example.

Now, the scenario I’ve described may not be the only reason for the lack of capital in Toronto (or Canada), but I feel that it is a significant part of the problem. What are your thoughts?

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The Importance of Customer Acquisition Costs for Startups

I recently came across the blog of David Skok of Matrix Partners and was inspired to write this post by an article on customer acquisition costs. If you have not yet read through his blog’s vast resources for entrepreneurs, I suggest you do so – particularly if you plan to pitch your startup to VCs anytime soon.

After being pitched countless times by startups, as a VC I’d like to identify a common misconception that web-based startups often have about their own growth potential and the costs associated with their plans. Management of web services companies, SaaS companies and mobile (web-based) applications commonly believe that because they are situated online, customers will come across their service, submit a purchase order (or subscribe) and notify friends or other companies to use the service as well. Although this may happen from time to time, it is very rare for any company to experience sustained viral growth.

Many companies don’t understand the difference between viral marketing and viral growth. Viral marketing is essentially “word of mouth” or “person-to-person distribution” and is the latest buzzword. Viral growth implies a K-factor greater than 1 (i.e. for each new person who tries a product/service, they will each invite more than 1 registered user of the product on average). Since true viral growth is so hard to achieve in practice, many companies miscalculate the actual costs it will incur to acquire customers. As David points out in his article, the majority of startup pitches lack detail/emphasis on how much it will cost to acquire customers. I second this statement entirely.

Business Model Viability
For a business to be profitable on each new customer, startups must balance two variables: (1) Cost to Acquire Customers (CAC); and (2) Lifetime Value of a Customer (LTV).

CAC can be calculated by taking the business’s entire cost of sales and marketing over a given period (including salaries and other employee expenses) and divide it by the number of customers that the business acquired in that period.

LTV can be calculated by looking at the Average Revenue Per User/Customer (ARPU) over the lifetime of a business’s relationship with a customer.

As Steve Blank mentioned in his recent post, an early indication that a business has found the right business model is when the cost of acquiring customers becomes less than the revenues generated from the customer. “For web startups, this is when the cost of customer acquisition is less than the lifetime value of that customer. For biotech startups, it’s when the cost of the R&D required to find and clinically test a drug is less than the market demand for that drug.”


Credit: David Skok.

Zynga is a great example of a company that has managed to decipher the business model of online social gaming. After thousands of A/B tests and experiments, Zynga finally found a business model where CAC was less than LTV. Once they cracked the nut, the company spent so much on customer acquisition that it was rumored that they accounted for upwards of 30% of Facebook’s revenue in 2009 though its aggressive social ad buying strategies. Similar business models and opportunities exist in virtual worlds, massively multiplayer online games (MMOGs) and many other online businesses. Many social games, such as those created by Zynga, leverage virtual currency, micro-transactions, emotional response mechanisms and social influence to promote the sale of decorative and functional virtual goods.

Before investing in a web-centric startup, good VCs will look deep into a company’s business model and know to look for CAC and LTV metrics. In fact, Trident Capital recently held a meeting with their online advertising and ecommerce companies to help exchange best practices for customer acquisition and improving LTV. My advice to startups: prove out your business model and you will have a much better shot at raising VC dollars. Skok suggests that two key equations be followed by web startups:

  • CAC < LTV (3x appears to be a rough minimum for SaaS businesses)
  • CAC should be recovered in < 12 months (for subscription businesses)

Startups, if you’ve already figured out your business model and how to make CAC < LTV, stay very quiet and add as much fuel to the fire as you can afford. Your competitors will likely try to hone-in on your tactics and fight back for their share of the market.


Credit: Steve Blank.

Leverage Startup Metrics
Startups are different from larger companies and therefore need different metrics than larger companies. Metrics will give startups a lens into how well the search for the business model is going and help to identify when to scale the company. Besides CAC and LTV, some essential metrics that startups should be familiar with include Viral Coefficient (K-factor)  and Customer Lifecycle. Dave McClure from Founders Fund recently updated his Startup Metrics for Pirates presentation for web sales pipelines. Take a look!

Questions to my Readers
Please consider the following questions and share your perspectives with my other readers and the tech community at large.

  1. What metrics do you consider the most valuable?
  2. Do you use any tools to help measure specific metrics for your business?
  3. What mistakes have you made (and corrected) that can help others succeed?
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Larry Cheng Updates Global VC Blog List

Larry Cheng updated his Global VC Blog list today (originally posted in May 2009 as top-100 in Google Reader subscriptions) and has re-ranked the global top VC blogs by average monthly unique visitors on compete.com for Q4 2009 (oct+nov+dec)/3.

As per the latest global VC blog listing, Fred Wilson from Union Square Ventures (Blog: A VC) took the top spot, shifting Guy Kawasaki from Garage Technology Ventures (Blog: How To Change The World) into second place.

Here’s the top 1012 for Q4 2009:

  1. Fred Wilson, Union Square Ventures, A VC (100,279)
  2. Guy Kawasaki, Garage Technology Ventures, How To Change The World (82,838)
  3. Paul Graham, YCombinator, Essays (71,924)
  4. Brad Feld, Foundry Group, Feld Thoughts (45,633)
  5. Mark Suster, GRP Partners, Both Sides of the Table (39,389)
  6. Bill Gurley, Benchmark Capital, Above The Crowd (23,084)
  7. Dave McClure, Founders Fund, Master of 500 Hats (21,462)
  8. Josh Kopelman, First Round Capital, Redeye VC (12,972)
  9. Bijan Sabet, Spark Capital, Bijan Sabet (12,451)
  10. Jeremy Liew, Lightspeed Ventures Partners, LSVP (12,097)
  11. Mark Peter Davis, DFJ Gotham Ventures, Venture Made Transparent (12,010)
  12. Larry Cheng, Volition Capital, Thinking About Thinking (11,851)

I kept 12 for obvious reasons. Check out the full list.

Larry, thanks for keeping tabs on all these metrics — it’s a great service to everyone looking to find knowledge in the VC and startup domains. The only problem with this methodology is that compete.com tracks only US traffic, while the blog listing is global in scope. Perhaps your next update in April 2010 can use Alexa rankings or some other novel solution.

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What Tina Seelig Wished She Knew When She Was 20

Over the last week, I had the opportunity to start and finish Tina Seelig’s new book “What I Wish I Knew When I Was 20“. The book delivers a series of stories — among other things — each seemingly designed to teach a lesson or prove a point; a number of stories discuss very innovative and creative solutions people undertook to solve real-world problems and to create value. Together, these pearls of wisdom can inspire the uninspired, and give a gentle nudge to those needing a push to get going.

In her book, Tina discusses the Stanford Technology Ventures Program (“STVP“), and how it looks to create “T-shaped people” — described as having a depth of knowledge in at least one discipline and a breadth of knowledge in innovation and entrepreneurship. I think this is a fantastic approach, and that this recipe is the right combination to create truly successful entrepreneurs. It would be nice to see some Canadian schools taking that approach. She also discusses her class-turned-global innovation assignments, that have become the Global Innovation Tournament — I’m hoping to participate in a judging capacity for the Toronto contingent this year — but of course, I’d rather be in the competition itself. Maybe I’ll get a chance if I make it into the Stanford GSB next year!?

Later on in the book, Tina begins discussing risk profiles of entrepreneurs (I can relate closely with this), and I found it quite interesting to read that apparently most entrepreneurs don’t see themselves as big risk takers. Only after some reflection did I understand what she meant. To paraphrase her text, “After analyzing the landscape, building a great team, and putting together a detailed plan, [entrepreneurs] feel as though they have squeezed as much risk out of the venture as they can. In fact, they spend most of their efforts working to reduce the risks for their business.”

Wearing my VC hat, this actually makes a lot of sense. We, as VCs, constantly look at how well entrepreneurs de-risk their ventures and we calculate our willingness to invest by how well an entrepreneur has evaluated their market opportunity, filled their management team and advisory board(s) with competent and complimentary folks, and developed their technology to a stage where it can be demonstrable. Essentially, the reward that entrepreneurs can receive for successfully de-risking their venture is generally referred to as a better valuation from VCs, and consequently, higher equity ownerships for the entrepreneur(s) at the table.

I recommend this book to CEOs and decision makers that need to reignite their creativity as well as to students aspiring to do great things, but who are waiting for permission to do so from some authority figure. In this book, the author acts as an agent of empowerment to allow the reader the feeling that they should embrace their skills and capabilities, and act on their desires to create products, services and organizations that can change the world.

What have you envisioned that could change the world? I dare you to chase that opportunity.

Have you recently dropped everything to take on a new challenge? Share your story below! Was it worth it?

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