Venture Capital Dos and Don’ts

There is much to like about the recently announced Atlantic Canada Regional Venture Fund.

It has been established with about $50 million of funding, mostly from provincial governments plus the Business Development Bank of Canada. The mandate is to invest in “early-stage, innovation-based Atlantic Canadian” companies with a special focus on information and communications technology, clean technology, and oceans technology.

The two independent investment managers have each invested $500,000 of their own money. The measure of success is investment return and that is the basis on which they will make their choices.

There is an advisory committee of the other investors, but it is primarily for operational oversight. They are not involved in investment decisions except those few that exceed the normal size limits.

In other words, the management will be like a privately run fund and just about immune to political interference. This should result in a tight focus on firms that have a real chance of succeeding, and a hard-nosed response to those that stumble.

This creates the real possibility of attracting additional capital from purely private firms. Those investors will shy away when governments with other agendas are involved in making choices.

It should be recognized that $50 million spread over four provinces will not go very far. Nova Scotia might expect to see three or four investments over the next five years. If the model seems to be working, subsequent funds with the same or different managers could be established.

At present, there are three other ways that Nova Scotian taxpayer money is directly invested in the economy, with progressively greater degrees of government involvement.

Innovacorp “targets early-stage knowledge-based companies in Nova Scotia.” The average recent investment has been $500,000. Those above $250,000 are approved by a board that includes two Deputy Ministers. The Minister of Economic Development is always quoted in the press release, but apparently is not personally involved in the choices. Investments are chosen based on prospects for a good rate of return. Partners are usually other arms of government.

Nova Scotia Business Inc. “invests in companies seeking growth capital, and looks for venture capital investors as partners in Nova Scotia’s knowledge-based economy.”

Investments are made in promising firms that will provide a “significant economic benefit.” This is a somewhat wooly mixture of possible investment return and potential for jobs. Investments so far amount to $55 million in 15 companies. Private sector partners are rare.

NSBI has a strong private sector board and investment committee to review proposals but all choices have to be approved by the Minister for up to $3 million, and by the full cabinet above that. These approval processes add time but no value to the decision making process.

Finally, some proposals, including those that don’t meet even NSBI’s soft criteria, are dealt with directly by the Department of Economic Development and Tourism. The Nova Scotia Jobs Fund “pursues investment opportunities for assisting communities in transition, supporting industry sectors, offering regional support, assisting small businesses programs, and investing in infrastructure and large industrial ventures.”

Its predecessor, the Industrial Expansion Fund, was scathingly reviewed by the Auditor General in May, 2011. To quote, “Confidential Cabinet review and approval is the only significant control or oversight of this program. Similarly, following approval of assistance, IEF has inadequate processes, controls or documentation supporting ongoing management of loans.”

Government claims to now benefit from the advice of the Jobs Fund Board, but they have no decision-making power. The criteria are even more vague than those used at NSBI. Decisions made this way result in losses for taxpayers and embarrassment for the government — Scanwood, Bowater, and DSM Trenton being just a few of the examples.

This government is by no means unique, but it has managed to be even worse than its recent predecessors. Odd things happen behind Cabinet doors when the voice of economic realism is absent.

Hopefully the new Venture Fund is an indication that government has learned some humility.

This is not to argue that the Venture Fund should be the only fund or that every government investment vehicle should be structured in exactly the same way.

But it is imperative that any investment decision be made only if chosen and recommended by knowledgeable people working with clear and sensible criteria. The government has shown that it knows the way. The question is whether that way will be followed.

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