Venture Capital in British Columbia

1. Venture Capital in British Columbia VC 101 – The Basics & Programming How Does British Columbia Measure Up? Access to Capital Strategies for BC R. Todd Tessier Investment Capital Branch June 2006

2. Part I – Venture Capital Basics & Programming

3. The basics … • What is venture capital? Unsecured private financing most often in the form of share capital issued by early stage companies with no tangible assets. What is not venture capital? It is not traditional debt financing nor is it capital raised by a company when it is going public by listing on a stock exchange. What type of securities are issued? Typically preferred or common shares issued to investors that are held for 3 to 7 years before generating a return. What is the typical structure and investment return opportunity? A venture capital investor usually holds less than 20% of a company’s voting shares and earns a capital return through a public offering (IPO) or acquisition/merger transaction.

4. A typical VC investment structure looks like … • Unsecured capital investment, most often in the form of voting equity shares or convertible debt. • Capital that is managed either “professionally” or “privately” with the investment focus on “growing” the business and exiting within 3 to 7 years to coincide with an IPO or buyout. • Investment ranges from $500K to $10M from seed stages until public offering or buyout – total financing may reach up to $50M. • Venture capital investment “stages” are often syndicated with businesses over 3 years receiving capital from up to 5 different VC managers – known as milestone investing. • Venture capital supply is very mobile and supply limited especially in BC.

5. Why is venture capital so prevalent in technology? • Largely because this sector most often works with “human capital” and intangible assets that cannot be secured. • The timeframe for development can be several years from startup to entry into the marketplace with little or no cash flow available to service debt. • Many technology companies require “mentorship” and issuing venture capital to professional or Angel investors provides access to these required skills. • Growth by acquisition or merger is common in this sector and venture capital offers a means by which a company can strategically acquire technology to advance.

6. Who are the “primary” sources of venture capital? • Angel Investors – managing their own money these investors are key to fostering startup companies. • Private Independents – professional funds that are established with investment from institutions or pension funds. • Institutional – most often pension funds or insurance companies seeking venture capital returns to diversify their portfolio. • Retail Funds – professional funds that are established with capital from “individual” investors by offering tax credits. • Corporate/Government – these funds are focused on corporate strategy or diversification needs and usually have only one investor. • Foreign – professional funds or corporate investors pursuing geographic diversification and above market returns. BC encourages the capital supply of retail funds and Angel investment through the issuance of tax credits

7. The Players Corporations Government Crowns Institutional Retail Tax Credit Private Independents Foreign funds Others (Integration) In British Columbia VanCity, HSBC, Canaccord & Newcourt Capital BDC – Vancouver BCIMC, Ontario Teachers, CDP WOF, BCMIF, Discovery Ventures West, Banyan, Yaletown Partners Draper Fisher, OVP, Interwest Microsoft, Kodak, Pfizer Inc. Venture Capital Investors: Who are they?

8. Stages Seed ($0 to $500K) Start-up ($500K to $2M) Early Stage ($2M to $8M) Expansion ($8M to $50M) Mezzanine/Buyout($50M & beyond) Milestones Concept/patent filed, prototype developed Prototype developed to first product completed First product established to early market entry Market acceptance leading to expansion. (IPOs here) Mainstream market and entering new markets Investment Stages: How are they defined?

9. Mezzanine ($50M+) Corporate/Others Early Stage ($2M - $8M) WOF,VW, WOF Lead Seed ($0 - $500K) Angels & Insiders Follow VC Financing “Gap”: A Company Perspective Expansion ($8M - $50M) WOF,VW, HSBC, Institution Round Size Start-up ($500K - $2M) Discovery, BC Advantage Conceptor Patent Prototype FirstProduct EarlyMarket MarketExpansion MainstreamMarket Company Stage

10. Overview of BC Tax Credit Programs “Direct Model” “Indirect or Fund Model“ Individual BC Investors • 2 LSVCC funds • 4 VCC funds • $600M Capital • 30% of BC’s mkt capital 30% tax credit SBVCA 15% tax credit EIA $ Venture Capital Corporation or Labour-Sponsored VCC Shares • Common or Preferred shares • Must not take voting control • Shares held at least 5 years $ Shares $ Shares Eligible Business Corporations SBVCA 95 EBC financings per year Eligible Small Businesses SBVCA – EIA 35 ESB financings per year • Value-added sectors • Employee size limits • Asset limits SBVCA – Small Business Venture Capital Act (1985) - $25M in tax credits raising $84M for annual investment. EIA – Employee Investment Act (1989) - $17M in tax credits per year raising $113M for annual investment.

11. Small Business Profiles:What do they do? • Data observations: • 54% of the investments were in technology companies – yet a significant portion of capital invested outside Vancouver was placed in traditional sectors. • Information technology, life sciences and manufacturing were the dominant sectors appealing to program investors.

12. Small Business Profiles:Where do they conduct business? • Data observations: • A record 30% of program activity took place outside of the Lower Mainland area – traditionally only 2% of the VC market serves this region. • Out of the 50 program registrations outside of the Lower Mainland, 34 were registered under the direct investment model (68 %) – simplicity works best.

13. 2005 Program Year in Review: Small Business Venture Capital Act – the programs operating under the Act raised $67M for early stage investment (third year running) in 135 companies located throughout BC. This past budget the programs were awarded with another $17M of annual capital capacity. Employee Investment Act – Labour Sponsored registrants such as the Working Opportunity Fund and the BC Medical Innovation Fund only raised $21M of the $105M due to national issues and uncertainty in the marketplace surrounding public policy. National Issues – the province of Ontario announced that it would be phasing out its Labour Sponsored Fund program on a gradual basis and replacing it with programs supporting Angel investment, commercialization and a “Matching Capital Program” that relies on institutions for capital supply.

14. Part II – How Does BC Measure Up?

15. Four key elements in making BC a premiere investment destination: Access to Human Talent Abundant Supply of Capital Premiere Investment Destination Competitive Fiscal Environment Cross border flow of talent & Capital

16. BC - A “small but efficient” marketplace for private capital due to … • An abundance of world-class technology. • Top-of-the-class innovators. • Talented VC managers supported by a tech savvy Angel investor community. • Effective and sound government fiscal policy that contributes to research and the development of innovation. • A proven track record – confirmed by UBC Sauder School of Business. • Ongoing development of intellectual property with market application – now offering tax relief for IP taxable income.

17. World-Class Technology: ICT – Wireless/New MediaBC Technology has reached outer space and at the same time brought the world closer together. Life Sciences and Medical DevicesWith proper fiscal policy, BC excels at developing leading edge technology. It is home to some of the most profitable LS companies in North America. Power and Sustainable TechnologiesA recognized international leader when it comes to developing ‘profitable’ alternate energy sources that will create a better world in the future.

18. Top of their class innovators: What do technology leaders like Nokia, Kodak, McKesson, and Electronic Arts have in common? They all arrived in BC through the acquisition of a world-class company founded on a technology or an innovation developed here. BC’s most famous entrepreneurs include: Dr. Geoffrey Ballard • Voted one of Time Magazine’s “Heroes for the Planet” • Founder of Ballard Power Systems and General Hydrogen Dr. Julia Levy • Founded QLT in 1981 based on her pioneering research in photodynamic therapy • QLT was the nucleus around which BC’s successful biotech cluster grew John Seminerio • Founded OctigaBay which closed US$24M in financing and was later acquired by Cray • Founded Abatis Systems—acquired for US$676M by Redback Networks

19. A “national” snapshot of BC’s access to venture capital: • Highlights: • BC continues to attract at least one-third of its venture capital from foreign investors – but do these companies remain? • The province leads the country in terms of early stage funding for companies and our “Angel Program” is a national leader. • Our domestic capital programs lever an additional $7 of capital per dollar invested. Concerns: • There is a lack of seasoned capital managers in the province – two funds control 68% of the provincial holdings. • According to Thomson Venture Economics, BC placed 20th in terms of capital received. • For perspective … last year Seattle received $750M in capital and San Diego $1.2B.

20. While BC has done an exceptional job at increasing early stage capital … We lack adequate expansion capital to bring innovation fully into the marketplace to retain companies in BC so they may grow to their full economic potential. There are other issues involving the “trends” of the venture capital holdings in the province …

21. An even split still remains between private and government sponsored venture capital holdings – market balance that must be maintained. Approximately 71% of new money raised in BC came from tax credit sponsored funds last year – a noted absence of institutional investment … why? About 65% of the new capital available for investment is held with government sponsored funds – this capital alone will not be enough to retain quality firms in BC and new models must be considered.

22. Other fiscal policy BC employs that accelerates innovation: Accelerators: • Research & Development programming that reduces a company’s ‘burn rate’ on R&D expenditures to as low as 32 cents on the dollar. • The second lowest rate on taxable income in Canada along with a tax rate of 22% on stock options allowing companies to attract and retain key knowledge based workers. • 1,760 graduates in computer science, electrical and computer engineering by 2007. • A new incentive that offers an annual $8 million provincial tax holiday to companies deriving revenues from patented life science IP held in BC. Yet some barriers remain in this area as well: • R&D refundable credits are limited to CCPC companies only. • Intellectual property tax relief is presently limited to Life Sciences. • PNP programs need to be levered to their full potential.

23. In sum BC: • Has proximity to access growing markets, • Has the talent base to innovate opportunities, • Has an adequate supply of early stage capital, and • Is being supported with the right fiscal programming … but What BC lacks is: • Early stage funding that assists with the “commercialization process” of a company before it enters the marketplace, • An adequate supply of “expansion capital” supported by seasoned managers of venture capital – more competition, and • A comprehensive marketing strategy that ensures foreign capital leverage continues to be available for our companies.

24. Part III – Access to capital strategies

25. British Columbia’s Access to Capital Strategy: Last year a strategy was introduced to Finance that focused on: • Expanding the province’s R&D tax credit program to offer refundable BC tax credits to foreign controlled & publicly listed companies. In addition, an incentive was proposed for companies that incur commercialization expenditures so long as the intellectual property and assets remain in BC. • Expanding the tax credits under the Small Business Venture Capital Act to provide innovative companies with access to capital at their earliest stages of development. • The introduction of Matching Capital Program designed to attract capital from institutional investors and increase the number of seasoned venture capital managers to the province, and • A marketing strategy to aggressively promote BC technologies in key markets outside of the province. The following is an update of the status of these particular initiatives

26. #1–Expansion of the R&D Tax Credit program for BC: • Goals • To ensure that innovative companies have access to BC refundable tax credits through all phases of the development regardless of their corporate status, and • To introduce commercialization incentives for companies bringing innovation into the marketplace. • Background • Presently the federal & provincial refundable tax credit is limited to companies that are Canadian Controlled Private Corporations (CCPC). • Both the provinces of Ontario and Quebec recognize the true cost of innovation and offer refundable credits to companies that are either public or foreign controlled. • Federal amendments are proposed to extend the duration of non-refundable tax credits and expand the eligibility thresholds for CCPC applicants. (i.e. income tests) • Consultations • This proposal is overwhelmingly supported by the leading technology associations, the PTC, regional science councils and national agencies such as the Conference Board. • Status • Finance is hesitant to depart from federal rules involving this program – that said there is a commitment to extend the program and a revised submission is planned for this fall. • Estimated cost of this measure is $25M per year of forgone tax revenue.

27. #2–Expanding Tax Credits under the SBVCA by $10M • Goals • To ensure that innovative companies have access to capital at the earliest stage of innovation, and • To attract companies and talent to BC that are seeking start up capital - Urigen. • Background • The changes to the SBVCA brought in 2003 have been successful and BC now leads the country in terms of seed capital availability for technology companies. • For the past 3 years the programs operating under the SBVCA have sold out, but the Labour Sponsored Funds operating under the Employee Investment Act (EIA) have not faired as well – last year only $21M of the $80M available was raised. • Supply of tax credit sponsored capital does not appear to be a problem – efficiency is the issue. Legislative amendments are being proposed to consolidate the Acts. • Consultations • Expansion to the SBVCA is broadly endorsed by the BCTIA, regional science councils, the PTC and of course the venture capital community that rely on tax credits. • Status • Finance provided an increase of $5M to the SBVCA in the last budget. They have also called for the evaluation of alternative capital models and a review of the EIA.

28. #3–Introducing a Matching Capital Program for BC • Goals • To ensure that promising companies in BC have access to expansion financing so the province can retain long term economic benefits, and • Increase the presence of seasoned capital managers in BC while maintaining a balance between tax credit sponsored and institutional backed capital supply. • Background • To ensure BC has a marketplace for capital that is sustainable in the long term it must foster supply from institutional sources of capital. • The province of Ontario announced in its past budget that it would introduce a capital model that relies on institutional investment ($90M) – to coincide with the announcement of phasing out the Labour Sponsored Fund tax credit programs over a 5 year period. • BC had a similar model in place in 1995 that was a success. The province lags in terms of expansion capital and this “pre IPO” gap cannot be met with tax credits alone. • Consultations • Endorsed by the PTC & BCTIA with consultations now complete involving VC managers and institutional investors. • Status • A complete evaluation of the program has just been completed by PWC and a revised submission is planned for the fall.

29. Overview of BC Matching Capital Program • Every $1 of BC capital is match with $3 to $4 from institutional investors – up to $500M invested • Investors earn capital in priority over BC government • An amount equal to BC’s contributed capital is invested in the province • Province contributes $80M to $100M over 3 years • Earns capital back over7 to 10 years Matching Capital Fund $100 M $ $ $ $ IT Software LP $100 M Capital Tech Energy LP $100 M Capital IT Wireless LP $100 M Capital Life Sciences LP $200 M Capital Portfolio Companies – 30 to 40 business investments over 5 yrs

30. #4–Marketing our technology opportunities in global markets • Goals • To ensure that innovative companies from BC continue to access at least one-third of their venture capital financing from prime U.S. and Asian markets, and • To attract critical talent to the province – research & entrepreneurial – who are neededto supporting the ongoing growth of our knowledge based industries. • Background • The Ministry is in the process of developing Sector Asset Maps that will assist our “In Market Representatives” and technology associations in attracting capital and talent. • With LEBC now being transitioned back into the Ministry, technology associations will be working to develop trade missions comprised of top researchers, CEOs and venture capital managers to forge research collaborations and financing syndication. • A new section of the Investment Capital Branch will continue to work on addressing taxation impediments to the cross-border flow of capital and assess new capital models. • Progress to Date • A combination of branch capital investment and 8 missions to Europe and the US have been completed resulting in significant capital leverage – next slide. • Status • Sector asset maps will be completed by this fall to time with placements of Ministry IMRs.

31. Program Capital Leverage 2005/2006 - $M

32. In sum this strategy strives to: • Maximize the growth of our world class industry clusters by developing marketing collateral and policy that promotes foreign direct investment in British Columbia • Ensure that our province has an optimal supply of foreign private capitalto support the growth of our innovative early stage companies throughBritish Columbia, and • British Columbia can attract seasoned entrepreneurs, capital managers and skilled researchers to the province to support the needs of our knowledge based and value added sectors of our economy. • Linkages to the Ministry and the Five “Great Goals”: • British Columbia is recognized as a preferred place to invest, do businessand as a key gateway to the Pacific Coast, • To make British Columbia the best educated, most literate jurisdiction onthe continent, and • To create more jobs per capita than anywhere else in Canada.

33. Thank you for your time and consideration Contact: R. Todd Tessier, Director International Capital Markets Section Investment Capital Branch Ministry of Economic Development Phone: (250) 952-0612 Mobile: (250) 217-2471 Email: todd.tessier@gov.bc.ca