MaRS Library High-tech startups and the venture capital (VC) investment model
Investments in high-tech startups make up most of the venture capital (VC) investing in North America. Canada’s Venture Capital& Private Equity Association (CVCA) publishes online the annual investment statistics collected by Thomson Reuters on behalf of the industry. The CVCA also lists their current investment classifications (similar to those used in U.S. publications) and the breakdown by sector of venture capital investment. In general, they cite four main sectors:
- Information technology (IT)
- Life sciences
- Energy and environmental technologies (clean tech)
- Traditional—including consumer and business services, onsumer products, and manufacturing
In the US and the UK, a number of venture capital firms focus on investing in socially-responsible start-ups, and this type of investment firm is starting to emerge in Ontario.
Trends in venture capital investing
As in other areas of the investment industry, venture investing trends emerge. It is important for startups to understand the trends that may affect an investor’s decision to consider their plan.
In Canada, the relatively new area of clean tech maintained a consistent level of venture capital investment from 2007 to 2008, while investment in all other sectors declined significantly. This reflects a social trend of environmental focus as well as anticipated increases in spending by governments and other enterprises on this kind of technology.
Software firms received proportionately more funding in the U.S. and Canada in 2008. This trend likely stems from a reaction to challenging economic times when investors prefer businesses that require lower levels of total capital (this is a key characteristic of the software industry compared to others in the IT sector).
Startups should not focus too much attention on the latest fad in investing or try to force their idea to fit a current trend. Venture capital investors are most interested in a business that offers them an opportunity for a significant return and they will see past opportunities that smack of the “flavour of the month” or attempts to “green-wash” a business (that is, the practice of trying to quantify and emphasize a plan’s minor environmental angle).
Case study: Why do high-tech startups fit the venture capital (VC) model?
Home to a large number of VCs, Silicon Valley got its name from the semiconductor industry that was born there, flourished, and continues to attract a significant amount of capital.
What is it about the semiconductor industry that appealed to VCs?
- A disruptive invention (something that is ten times faster, better, smaller or cheaper) will encourage a fresh round of growth opportunity. For example, a high-tech startup that delivers a chipset with the highest quality of video output for a mobile device and which takes up a small footprint and is priced well for the value it delivers will have a large market opportunity to be designed into millions of mobile devices.
- The industry uses a production model where third party-fabrication plants (“Fab”) are common. This enables start-ups to access the same production capability as a mature player in the industry. High-tech start-ups require capital only for the design and testing of the new chipset, as well as the marketing, sales and distribution.
- Chips are often designed for a single specific purpose, making the value proposition easy to explain.
- Large-scale electronics providers (customers) are relatively easy to identify, and their planning cycles provide an opportunity for a product to be included in the design before the product is commercially available.
- While the chip industry is attractive, it also carries a reasonably high level of risk; this includes risks associated with concentration of customers, competition, and the possible failure to create a disruptive technology that can be produced in scale.
- Venture capital investors have demonstrated that they will engage a higher degree of risk if the potential for a significant return exists from a large market opportunity and if they have a high degree of confidence in the management team to execute their business plan.
To find out if your industry is attractive to potential investors, review investor websites to determine their current areas of focus and their investment criteria.
Some VC firms have mandates that prevent them from investing outside of their target industry, so don’t take it personally if they decided not to meet you or finance your business. Move on and spend time with investors who are interested and will invest in your field.
If you cannot find a local investor, look to the U.S. or elsewhere on the international stage for VC firms who may have interest. Keep in mind that some of those firms may only consider early-stage investments in local companies, so you may need to relocate some or all of your business to the investor’s location as a condition of their investment.
Thinking of raising money? We’ve created a free online course to help you get investment-ready. Check out Introduction to Investment Readiness and learn useful tips, tactics and strategies to prepare for your seed fundraising round.
Canada’s Venture Capital& Private Equity Association. Retrieved April 19, 2009, from http://www.cvca.ca.
National Venture Capital Association. Retrieved April 19, 2009, from http://www.nvca.org/def.html.
- Common share investments and early-round equity financing.
- Taking your Series A pitch on the road: Are you ready for prime time?.
- Concept stage of company development: Funding, investors, risks and expectations.
- Medical devices and disruptive technology: Boston Scientific.
- Research and development (R&D) funding programs.