Venture capital firms are vital for the growth of early-stage businesses in Canada. However, they are not a good fit for all entrepreneurs, and other options should be considered before taking an investment from a VC.Nathan Denette/The Canadian Press
Daryl Ching is the founder and owner of Vistance Capital Advisory, which provides accounting, capital raising and financial management services to small- and medium-sized companies.
For a startup, an institutional market of investors exists for companies that are looking to hit home runs seeking explosive revenue growth and quick exits. However, the trade-off is often loss of control over the business. The collapse of Vancouver’s Bench Accounting at the end of last year is a cautionary tale about the consequences of taking large equity investments from institutional investors, whose goals are misaligned with the founder’s vision.
Canada is a great environment for tech startups or other highly scalable industries. There are also plenty of inducements, such as the Scientific Research and Experimental Development tax-incentive program that subsidizes innovation to push development in technology. If you are looking to start a business with a hockey stick revenue graph, and look to exit in three to five years, you are well aligned with most early-stage investors.
The primary variable for valuation in early-stage businesses is annual growth in revenue, an indicator of future market dominance and profit. Whether the businesses were actually turning a profit was a secondary concern. During COVID-19, there was a shift in focus back to profit, but the pendulum has certainly swung back the other way to focus on revenue. This incentivizes small businesses to generate sales at all costs, even if it means incurring substantial losses. As a result, the environment fosters CEOs that are more focused on business development and pay little attention to operating costs.
While this certainly increases the chance of a high-growth success story, it also increases the chance of business failure, and we know more businesses fail than succeed. Founders that do not meet aggressive business targets or do not agree with the board’s direction find themselves replaced by a new CEO. Businesses that fail to raise their next tranche of financing go bankrupt because they have been crippled by excessive cash burn from their losses.
Bench Accounting had raised more than US$100-million from investors including Shopify Inc. Following the firm’s implosion, Ian Crosby, the founder of Bench Accounting, posted a statement indicating that he was terminated by the board of directors in November, 2021, because board members were looking to “take the company in a new direction” that Mr. Crosby felt “was a very bad idea.” He goes on to say that he “wanted to continue with what was working” and what his partners “signed on to distribute.” We will never know if Mr. Crosby’s vision was the right one, but we do know that the new direction led to catastrophic business failure a month ago, leaving more than 11,000 small businesses in the lurch, scrambling to find new accounting services at year end.
There are a couple lessons that can be learned from Mr. Crosby’s story. While it is easy to get seduced by a large capital investment, entrepreneurs should think long and hard about giving up control of their business, and this may mean taking less capital for a slower growth strategy. Entrepreneurs should also only take capital from investors that are aligned with their vision and long-term goals. On any capital raise, due diligence should be a two-way street. Business owners should take the time to investigate potential key stakeholders and speak to other businesses that have received capital from those investors to gauge their experience.
Venture capital firms are vital for the growth of early-stage businesses in Canada. However, they are not a good fit for all entrepreneurs, and other options should be considered before taking an investment from a VC. For business owners who wish to maintain control of their business or wish to pursue a more organic long-term growth strategy, they may want to consider taking a smaller equity investment, debt financing, investments from friends and family or personally invest in the business.